4 The public finances

4.01 This chapter sets out projections for the public finances up to 1999-2000 after allowing for the measures in the Budget and the new assessment of economic prospects. It also includes an analysis of changes from the November 1993 Budget projections. Historical series and further detail on the forecasts for 1994-95 and 1995-96 are presented in Annex A. Annex B provides a guide to the different accounting conventions used in presentation of the public finances in this chapter and elsewhere.

4.02 The main projections suggest that the public sector borrowing requirement (PSBR) is likely to return more quickly to balance than envisaged a year ago, with the public sector current account in surplus by 1997-98. Before then, the deficit will have fallen below the reference level of 3 per cent for the European Union's excessive deficits procedure.

The budget deficit

4.03 The projected path for the PSBR is summarised in Table 4.1.

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The PSBR in the short term

4.04 The outturn for the PSBR in 1993-94 was £45.4 billion, 7 per cent of GDP. This was a cyclical peak in borrowing, which is now running at a significantly lower level. The latest forecast for the PSBR in 1994-95 is £34 1/2 billion, 5 per cent of GDP.

4.05 Taking into account the tax changes announced in the Budget and the new public expenditure plans, the PSBR in 1995-96 is forecast to fall to £21 1/2 billion, 3 per cent of GDP. This means that the PSBR will have more than halved in two years.

4.06 Receipts in 1995-96 are forecast to rise substantially faster than money GDP, reflecting the phased tax increases announced in the two 1993 Budgets and a cyclical recovery in corporation tax receipts. Public expenditure is projected to grow more slowly than GDP despite rising debt interest payments.

Medium-term PSBR projections

4.07 The projections of the public finances in the medium term are based on the assumptions for the economy set out in Annex A to Chapter 3. As the economic recovery continues and the measures in the 1993 and 1994 Budgets come through, the PSBR falls further, with a small debt repayment projected by 1998-99. Receipts rise slightly faster than GDP, and public expenditure is projected to fall as a percent of GDP in line with the new spending plans.

Other measures of the fiscal stance

4.08 Table 4.2, which is the cash counterpart of Table 1.1, sets out projections of the current deficit of the public sector and the financial deficit for both general government and the public sector as a whole, and shows howthey relate to the PSBR. The deficit on the public sector's current account is forecast to fall steadily from £28 billion in 1994-95, and give way to a surplus from 1997-98 onwards.

4.09 Net capital spending - the public sector's balance on capital account - is forecast at £12 1/2 billion in 1994-95, when it is boosted by temporarily high local authorities' spending. Slightly lower net spending is projected for future years. The public sector financial deficit (PSFD) is projected to fall steadily from £40 1/2 billion in 1994-95, with a surplus achieved by the end of the decade. The gap between the PSFD and the PSBR falls from around £6 billion in 1994-95 as privatisation proceeds decline.

4.10 The general government financial deficit (GGFD) - the measure used to monitor budget deficits under the European Union excessive deficits procedure - is forecast at £42 billion for 1994-95, 6 1/4 per cent of GDP. It is forecast to fall to 2 1/4 per cent of GDP in 1996-97, below the 3 per cent reference level for deficits used in the excessive deficits procedure. The GGFD is slightly higher than the PSFD up to 1997-98 because public corporations are forecast to be in small financial surplus.

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Public sector debt

4.11 Table 4.3 sets out projections for the stock of net public sector debt and gross general government debt. (Definitions are s et out in Annex B.) Net public sector debt at end-March 1994 stood at £252 billion, 38 1/4 per cent of GDP. The latest forecasts for the PSBR imply a further increase in the ratio, which reaches a peak of 42 3/4 per cent of GDP at end-March 1996. Thereafter the ratio is projected to fall steadily as the PSBR is brought down further.

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4.12 Gross general government debt, the measure used for the European Union's excessive deficits procedure, stood at 47 per cent of GDP at end-March 1994. It is projected to peak at 49 1/4 per cent of GDP at end-March 1996, comfortably below the reference level of 60 per cent, and to fall back thereafter.

General government receipts

4.13 Table 4.4 shows the outturns for 1993-94, short-term forecasts for 1994-95 and 1995-96 and medium-term projections up to 1999-2000 for general government receipts and its principal components. Table 4A.1 gives a more detailed breakdown for the 1993-94 outturns and for the short-term forecasts.

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Receipts in 1994-95

4.14 General government receipts are now expected to rise by 9 1/2 per cent in 1994-95, well above the forecast increase in money GDP. This will be the first time for five years that receipts have risen faster than GDP. Much of the rise reflects the effects of tax increases announced in the two 1993 Budgets. But corporation tax receipts are also forecast to rise sharply - by around 35 per cent - because of the cyclical recovery in profits last year.

Receipts in 1995-96 and beyond

4.15 General government receipts are forecast to rise by 10 1/2 per cent in 1995-96, again much faster than money GDP as the cyclical recovery continues. The further changes in income tax reliefs and VAT announced in the two 1993 Budgets, and due to take effect in April 1995, will raise taxes by a further £2 3/4 billion in 1995-96 and another £ 3/4 billion in 1996-97. The tax changes announced in this Budget do not chang e the projections significantly. Leaving aside the temporary reduction in business rates from the new transitional relief scheme they reduce taxes by around £ 1/2 billion a year.

4.16 After 1996-97, when the tax increases have worked fully through, receipts are projected to increase at an average 5 1/2 per cent per annum, marginally higher than money GDP reflecting the over-indexation of tobacco and road fuel duties and real fiscal drag.

Taxes as a share of GDP

4.17 Tax and social security revenues fell quite markedly as a share of GDP during the recession to reach a trough of 33 3/4 per cent in 1993-94, the lowest level for 20 years. But following the tax increases announced in the two 1993 Budgets, and with a strong cyclical recovery now under way, the tax/GDP ratio is expected to rise sharply in 1994 - 95 to 35 1/4 per cent, 1 1/2 percentage points up on the previous year.

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4.18 The same factors contribute to a further sharp rise in the tax/GDP ratio forecast for 1995-96, which will bring the ratio back close to the level at the beginning of the recession. Thereafter, on the conventional assumption of no changes in tax rates and an indexed tax system (except where a policy of real rises in rates has been announced), the ratio is projected to continue rising, but at a much slower rate.

General government expenditure

4.19 The Government's objective for public spending is to reduce general government expenditure (GGE) excluding privatisation p roceeds as a share of GDP over time. This aggregate includes spending within the Control Total, cyclical social security expenditure, debt interest payments and various accounting adjustments needed for consistency with the national accounts. The new plans show real GGE growth over the next three years averaging between 1/2 and 3/4 per cent per annum, well below the projected growth rate of the economy.

4.20 Table 4.5 shows the 1993-94 outturn, forecasts for 1994-95 and projections up to 1999-2000 for GGE and its main components. The projections up to 1997-98 are consistent with the new public spending plans. Figures for the later years assume that Control Total spending will grow by 1 per cent a year in real terms.

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Expenditure in 1994-95

4.21 GGE excluding privatisation proceeds in 1994-95 is now forecast to rise by 4 1/4 per cent, a bit below the expected growth in money GDP. Control Total spending is forecast at £249 1/2 billion, £1 1/4 billion lower than the plans in last year's Budget. This still represents a real terms increase of 1 1/4 per cent on 1993-94 spending.

Expenditure over the medium term

4.22 The new public spending plans provide for Control Total spending to rise at under 3 per cent a year in cash terms over the next three years. This represents an average of only 1/4 per cent a year growth in real terms. The projected increase in GGE is a little higher - an average of 3 1/4 per cent per annum in cash, or between 1/2 and 3/4 per cent in real terms.

4.23 Outside the Control Total, cyclical social security is broadly flat in cash terms, as Budget measures offset the underlying upward trend. However accounting adjustments are projected to rise, reflecting among other things the spending of National Lottery proceeds. Debt interest payments are also rising, as a consequence of the recent high borrowing requirements. Central government debt interest is forecast to increase by over one-third in the three years from 1993-94 to 1996-97; thereafter it is projected to flatten out as borrowing is reduced.

Expenditure as a share of GDP

4.24 The ratio of GGE (excluding privatisation proceeds) to GDP, which increased sharply during the recession, stood at 44 1/4 per cent in 1993-94, marginally below its peak in the previous year. The ratio is expected to fall by around 3/4 percentage point in 1994-95, and the new public expenditure plans imply a further fall of around 2 1/2 percentage points over the next three years. The medium-term projections show this fall continuing, with the GGE/GDP ratio in 1999-2000 down to 39 1/4 per cent, a similar level to 1988-89.

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Changes since the last Budget

4.25 Table 4.6 summarises changes in the PSBR projections since the last Budget. More detail for 1994-95 and 1995-96 is given in Annex A.

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PSBR in 1993-94 and 1994-95

4.26 The outturn for the PSBR in 1993-94 was £3.7 billion lower than the forecast made in the last Budget, adjusted for subsequent classification changes. The forecast for 1994-95 has been reduced by £3 billion. In both cases this is due primarily to lower cash spending.

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The projections

4.27 The PSBR projections are lower than those in the last Budget. Spending is lower throughout in cash terms reflecting the new plans in the Budget. In the short run, apart from the impact of the Budget measures, receipts are little changed because the impact of lower prices is offset by higher activity. But in the medium term receipts are lower. The Budget measures contribute relatively little to these lower medium-term receipts, as Table 4.7 shows. General government receipts are little different as a percent of GDP from the projections in the last Budget.

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4.28 Most of the reduction in general government expenditure is accounted for by the reductions in Control Total spending announced in the Budget. But there are also significant reductions in cyclical social security, both because prices and unemployment are lower than envisaged a year ago and because of the measures in the Budget. The projection of debt interest is little changed from a year ago; the impact of higher long-term interest rates is offset by the effect of a lower borrowing profile.

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4.29 The level of prices (as measured by the GDP deflator) now forecast for 1995-96 is 2 1/2 per cent lower than assu med in last year's Budget projections, and this reduction is projected to persist in the medium term. The cash reductions announced in the Budget bring Control Total spending in real terms below the levels in last year's Budget plans, as Table 4.8 illustrates. On top of this, the cash reductions in cyclical social security represent a significant real terms reduction in spending. As a result, the GGE/GDP ratio is lower throughout than in last year's Budget projections.

Funding policy

4.30 Funding policy will continue on the basis set out in the 1994-95 MTFS and the gilts remit published on 17 March 1994 and updated in the Summer Economic Forecast. Table 4.9 updates the funding arithmetic to allow for the new PSBR forecast, the latest information on gilts sales, National Savings and other changes. It is expected that £10.5 billion of gilt sales will be required in the months November 1994 to March 1995 to achieve full funding.

4.31 New remits for gilts and National Savings will be published just b efore the start of the financial year 1995-96. The remits will explain funding policy in more detail and how it will be implemented.

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Margins of error and alternative projections

Average errors
4.32 The PSBR forecasts are subject to a wide margin of error. Over the past ten years the average absolute error on forecasts of the current year made in the autumn (November Budget forecast for last year, Autumn Statement forecasts for previous years) has averaged 3/4 per cent of GDP, equivalent to plus or minus £4 1/2 billion in today's terms. The average absolute error in projections for the year ahead, adjusted for subsequent Budget measures, is 1 1/2 per cent of GDP, or plus or minus £10 1/2 billion in today's terms.

Alternative projections

4.33 There are inevitably uncertainties about the path of the economy and these can be a source of error in the medium-term projections for the public finances. Cyclical variations in output automatically produce variations in tax revenues and, to a lesser extent, in government expenditure. Given a higher degree of spare capacity, growth could be stronger for a period without generating inflationary pressures. On the other hand some indicators suggest rather little spare capacity, in which case sustainable medium-term growth might be weaker. The growth rates in Table 4.10 differ from the main projection by 1/2 per cent in either direction from 1995-96.

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4.34 Table 4.11 shows the path of the PSBR on unchanged policies in these alternative projections. Public expenditure within the Control Total is assumed to be unchanged, but cyclical social security and debt interest payments are allowed to vary. Tax rates, allowances and thresholds are assumed to be at the same levels as in the main projection, with revenues allowed to vary automatically with the output path.

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4.35 The stronger growth projection moves the public sector into significant surplus by the end of the decade on present plans. Even in the slower growth projection, public expenditure restraint is sufficient to keep the PSBR on a downward trend. 

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Reviewed 1 October 1996