EY ITEM Club Budget Preview 2014
With just over three months having passed since the Office for Budget Responsibility (OBR) published its last forecast, the economic and fiscal outlook has not changed significantly.
However, the Chancellor is likely to be able to celebrate a modest upgrade to the short-term forecast for economic growth, as well as small downgrades to the projections for government borrowing. Our forecasts, based upon unchanged policy, point to the Government achieving a modest surplus of £5bn on the underlying PSNB measure in 2018-19, around £3bn higher than the OBR’s December forecast.
The implications for policy are dependent on the Chancellor’s ambitions. If he wants the OBR to continue to project a budget surplus by the end of the forecast horizon, then he has very little room for manoeuvre – any giveaways will have to be small scale or largely offset by savings elsewhere, a less than ideal situation given the proximity of the election. However, the additional year of spending restraint introduced in the Autumn Statement means that the current plans should see borrowing almost £32bn (1.6% of GDP) lower than it would need to be to comply with the fiscal mandate, assuming no major changes to the output gap forecasts. Such a large and favourable gap between what needs to be done to comply with the fiscal rules and what the Chancellor plans to do will no doubt lead to calls to use some of that buffer to loosen the pressure of austerity in areas which could win votes in May 2015.
Though the Government’s over-arching fiscal plan has been in place since its first Budget in June 2010, the Chancellor has been unable to resist using subsequent Budgets and Autumn Statements to tinker with the fiscal framework. And with an election looming on the horizon, we can safely predict that Budget 2014 will also see a large number of individual policy measures. Having made good progress in reforming the corporate tax system, we would hope that changes in this area are kept to a minimum. But there is a good chance of seeing him implement policy changes in three other key areas:
The EY ITEM Club Budget Preview
The EY ITEM Club Budget Preview×
- Addressing the so-called “cost of living crisis”: though on some measures wages are increasing once more in real terms, and by mid-year are likely to be doing so on all measures, real wages are still more than 7½% lower than they were in 2007 so the Chancellor is likely to want to be seen to be doing something to address the so-called “cost of living crisis”. Raising the income tax personal allowance has been a favoured option thus far, but it is now at such a high level that further rises are costly and do not benefit the lowest paid who have already been taken out of the income tax system. The Chancellor is unlikely to be able to resist an increase which is a little higher than inflation and may find it politically desirable to allow those who pay the 40% income tax rate to benefit as well. However, the lower paid would gain more from an increase in the National Insurance primary threshold which has moved from being in line with the income tax personal allowance seven years ago to being almost £1,700 lower in 2013-14.
- Using fiscal policy to help rebalance the economy: the Chancellor has promised measures to promote a rebalancing of the economy. In practice there is very little that he can do in terms of promoting UK exports, so any measures are likely to be focused on supporting investment. These could include an extension of the higher limit for the Annual Investment Allowance, which is due to drop back from £250,000 to £25,000 at the end of 2014. Alternatively more generous capital allowances could be linked to policies around Enterprise Zones, in order to support regional growth. One industry where the introduction of capital allowances would be particular welcome is energy – there is a very real risk that the UK could be sleepwalking into an energy capacity crisis and while a more certain and consistent policy environment would help, there is also a case for offering financial incentives to encourage energy companies to invest in projects which increase the UK’s future power generation capacity.
- Further measures related to the housing market: thus far the Chancellor’s interventions in the housing market have been well judged, helping to set in train a recovery in housing demand which, in turn, has encouraged house builders to ramp up their building plans. Now is the time to build on this progress, particularly in terms of ensuring that the recovery in house building continues to gain momentum. The Government should be doing more to resolve rigidities in the planning system and by more rapidly selling off its brownfield land to developers. A bolder solution would be for the Government to use its own low borrowing costs to fund a programme of house building; this would be a more direct solution to the supply shortages, although such a move looks to be a long shot. The Chancellor could also use fiscal policy to try and cool the prime Central London investment market, by implementing a more aggressive capital gains tax regime on non-residents or raising the rate of stamp duty payable on high value properties. More wide-ranging reform of the stamp duty system would be desirable, particularly to remove the ‘cliff edges’ at the various thresholds which cause significant distortions to the market around these price levels, though this does not appear to be on the Chancellor’s radar at present.