4 The public finances
Summary
4.01 This Chapter sets out projections for the public finances up to 2001-02 after allowing for the measures in the Budget and the new assessment of economic prospects. It also includes an analysis of changes from the 1995 Budget projections. Historical series and further detail on the forecast for 1996-97 and 1997-98 are presented in Annex A. Annex B provides a guide to the different accounting conventions used in the presentation of public finances in this Chapter and elsewhere.
4.02 The projections show a steady fiscal tightening over the next five years, mainly as a result of slow growth in public spending. The PSBR is projected to fall steadily from 3 1/2 per cent of GDP in 1996-97 to be close to balance in 1999-2000, and in surplus thereafter.
The budget deficit
4.03 The projected path for the PSBR is summarised in Table 4.1.
Table 4.1 Public sector borrowing requirement(1)
| | Outturn | Forecast | Projection(2) |
| | 1995-96 | 1996-97 | 1997-98 | 1998-99 | 1999-00 | 2000-01 | 2001-02 |
| £ billion |
| General government expenditure | 303.0 | 308.5 | 319.0 | 327 | 336 | 345 | 353 |
| General government receipts | 269.2 | 280.9 | 299.4 | 315 | 333 | 352 | 370 |
| General government borrowing requirement | 33.8 | 27.7 | 19.6 | 12 | 4 | -7 | -18 |
| PCMOB(3) | -2.2 | -1.3 | -0.4 | 0 | 0 | 0 | 0 |
| PSBR | 31.7 | 26.4 | 19.2 | 12 | 3 | -8 | -18 |
| Per cent of money GDP |
| General government expenditure | 42 3/4 | 41 1/4 | 40 1/2 | 39 1/2 | 39 | 38 1/4 | 37 1/2 |
| General government receipts | 38 | 37 3/4 | 38 | 38 | 38 1/2 | 39 | 39 1/4 |
| General government borrowing requirement | 4 3/4 | 3 3/4 | 2 1/2 | 1 1/2 | 1/2 | - 3/4 | -2 |
| PCMOB(3) | - 1/4 | - 1/4 | 0 | 0 | 0 | 0 | 0 |
| PSBR | 4 1/2 | 3 1/2 | 2 1/2 | 1 1/2 | 1/2 | - 3/4 | -2 |
| Money GDP - £ billion | 708.5 | 745.7 | 786.9 | 826 | 864 | 903 | 943 |
(1) In this and other tables, constituent items may not sum to totals because of rounding.
(2) Projections are rounded to the nearest £1 billion from 1998-99 onwards.
(3) Public corporations' market and overseas borrowing.
The PSBR in the short term
4.04 The outturn for the PSBR in 1995-96 was £31 1/2 billion, 4 1/2 per cent of GDP. The latest forecast for the PSBR in 1996-97 is £26 1/2 billion, 3 1/2 per cent of GDP. This represents a fall of £19 billion from the cyclical peak three years earlier.
4.05 Taking into account the tax changes announced in the Budget and the new public expenditure plans, the PSBR in 1997-98 is forecast to fall to £19billion, 2 1/2 per cent of GDP. The fall in the PSBR as a per cent of GDP between 1995-96 and 1997-98 is almost entirely due to low growth in public spending.
Medium-term PSBR projections
4.06 The projections of the public finances in the medium term are based on the assumptions on the economy set out in Table 3.11 in Chapter 3. The PSBR is projected to fall steadily, from borrowing of 3 1/2 per cent of GDP in 1996-97 to be close to balance - borrowing of under 1/2 per cent of GDP - in 1999-2000, with debt repayments in the following two years. The main influence behind the falling PSBR is the slow growth in public spending implied by the new spending plans. Of a total reduction in the PSBR of over 5 per cent of GDP in the five years up to 2001-02, around three-quarters is attributable to the projected fall in spending relative to GDP. Growth in receipts over the medium term is a little faster than that of GDP, which is the normal expectation given growth close to trend and unchanged tax policies (defined as including the existing commitments to real increases in road fuel and tobacco duties).
Other measures of the fiscal stance
4.07 Table 4.2 gives an alternative presentation of the fiscal projections on a national accounts basis (see Annex B). The table sets out projections of the current balance of the public sector and of the public sector's financial deficit and shows how they relate to the PSBR. The table also shows the financial deficit for general government.
4.08 The balance on the public sector's current account is forecast to move from a deficit of £21 billion in 1996-97 to a surplus of £4 billion in 1999-2000. Net capital spending - the public sector's deficit on capital account - is forecast at £8 1/2 billion in 1996-97, and at lower levels in future years. This reflects the increased use of private finance for what would have been up until recently publicly financed capital spending. (Capital spending under the private finance initiative does not score as public sector capital spending.) The public sector financial deficit (PSFD) is forecast at £29 1/2 billion in 1996-97, and projected to decline steadily thereafter, coming close to balance in 1999-2000, and going into surplus thereafter.
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Table 4.2 The public sector's finances
| | £ billion |
| | Outturn | Forecast | Projection(4) |
| | 1995-96 | 1996-97 | 1997-98 | 1998-99 | 1999-00 | 2000-01 | 2001-02 |
| Receipts(1) | 271.9 | 286.2 | 304.0 | 320 | 338 | 357 | 376 |
| Current expenditure(1), (2) | 296.4 | 307.1 | 317.7 | 325 | 334 | 342 | 350 |
| Current balance(1) | -24.5 | -20.9 | -13.8 | -6 | 4 | 15 | 26 |
| Net capital spending(1), (3), (5) | 10.3 | 8.6 | 6.7 | 6 | 6 | 6 | 6 |
| Financial deficit(1) | 34.8 | 29.4 | 20.5 | 12 | 2 | -9 | -21 |
| Privatisation proceeds and other financial transactions | 3.1 | 3.0 | 1.3 | -0 | -1 | -2 | -3 |
| PSBR | 31.7 | 26.4 | 19.2 | 12 | 3 | -8 | -18 |
| General government financial deficit(6) - £ billion | 35.8 | 30.4 | 20.3 | 12 | 2 | -9 | -21 |
| - per cent of GDP(6) | 5 | 4 | 2 1/2 | 1 1/2 | 1/4 | -1 | -2 1/4 |
(1) Figures on a national accounts basis. See Annex B.
(2) Includes depreciation of fixed capital.
(3) Net of depreciation and less capital transfer receipts.
(4) Rounded to the nearest £1 billion.
(5) Does not include capital expenditure under the Private Finance Initiative, which is expected to amount to £10.4 billion over three years to 1999-00. See Table 5.5.
(6) Definition as for Maastricht criterion. GDP is on an ESA basis.
4.09 For 1996-97, the PSFD is forecast to be higher than the PSBR by £3 billion. This has been the pattern for a number of years, and largely reflects privatisation proceeds (£4 1/2 billion in 1996-97). The other financial transactions which account for the gap between the PSBR and the PSFD - the main ones are net lending to the private sector and accruals adjustments on receipts and spending to put them onto a cash basis - increase the PSBR relative to the PSFD in 1996-97, and are expected to continue to do so. With privatisation proceeds expected to be at much lower levels in future years than in the recent past, the PSBR is higher than the PSFD in the medium term projections.
4.10 The general government financial deficit (GGFD) is the measure used in the Maastricht criteria which will be used to help determine eligibility for participation in the start of the single currency in 1999. The GGFD is forecast at £30 1/2 billion, 4 per cent of GDP, for 1996-97, falling to 2 1/2 per cent of GDP in 1997-98, below the 3 per cent reference value, enabling the United Kingdom to meet the 1997 deficit criterion for qualification for participation in the single currency. (The UK already meets the criterion on government debt.) The GGFD is projected to be in approximate balance by 1999-2000 and in surplus thereafter.
4.11 The difference between the GGFD and the PSFD is the public corporations' financial deficit. Public corporations have been in surplus in recent years but following recent privatisations the sector is expected to be in approximate balance from 1997-98 onwards.
Public sector debt
4.12 Table 4.3 sets out projections for the stock of net public sector debt and gross general government debt. (Definitions are set out in Annex B.) Public sector debt stood at £323 billion - 44 1/2 per cent of GDP - at end-March 1996. The latest forecasts for the PSBR imply a further increase in the debt/GDP ratio in the short term, to a peak of 46 per cent of GDP at end-March 1998. Thereafter the ratio is projected to fall, as the PSBR is brought down to balance and then goes into surplus.
Table 4.3 Public sector debt(1)
| | Outturn | Forecast | Projection |
| | 1995-96 | 1996-97 | 1997-98 | 1998-99 | 1999-00 | 2000-01 | 2001-02 |
| Net public sector debt | |
| £ billion(2) | 323 | 350 | 371 | 384 | 388 | 382 | 364 |
| per cent of GDP(3) | 44 1/2 | 45 1/2 | 46 | 45 1/2 | 44 | 41 1/2 | 37 1/2 |
| Gross general government debt | |
| £ billion(2) | 379 | 411 | 433 | 448 | 454 | 450 | 433 |
| per cent of GDP(4) | 53 3/4 | 55 1/4 | 55 1/4 | 54 1/2 | 52 3/4 | 50 | 46 1/4 |
(1) At end-March.
(2) Rounded to the nearest £1 billion.
(3) GDP centred on end-March.
(4) Ratio as defined as for Maastricht criterion. GDP is on an ESA basis, year ending in March.
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4.13 Gross general government debt is the measure of debt used in the Maastricht criteria. The ratio of debt to GDP on this measure and calculated as for the Maastricht criterion stood at 53 3/4 per cent of GDP at end-March 1996, and is forecast to rise to a peak of 55 1/4 per cent of GDP at end-March 1997, before first stabilising and then declining. The forecast peak is comfortably below the Maastricht criterion of 60 per cent.
General government receipts
4.14 Table 4.4 shows the outturn for 1995-96 and forecasts and projections from 1996-97 up to 2001-02 for general government receipts and its principal components. Table 4.5 shows the same information for receipts as a percent of GDP. A more detailed breakdown for 1995-96 outturns and for the forecasts for 1996-97 and 1997-98 is shown in Table 4A.1.
Table 4.4 General government receipts
| | £ billion |
| | Outturn | Forecast | Projection(3) |
| | 1995-96 | 1996-97 | 1997-98 | 1998-99 | 1999-00 | 2000-01 | 2001-02 |
| Income tax | 68.0 | 68.1 | 71.8 | 76 | 81 | 87 | 93 |
| Corporation tax | 23.6 | 26.1 | 27.2 | 29 | 33 | 36 | 38 |
| Value added tax | 43.1 | 47.5 | 50.7 | 54 | 56 | 59 | 61 |
| Excise duties(1) | 28.4 | 31.0 | 34.1 | 37 | 40 | 43 | 46 |
| Other taxes and royalties(2) | 44.2 | 46.2 | 49.3 | 51 | 53 | 56 | 58 |
| Social security contributions | 44.5 | 46.7 | 49.1 | 52 | 54 | 56 | 59 |
| Other receipts | 17.4 | 15.3 | 17.2 | 16 | 16 | 16 | 16 |
| General government receipts | 269.2 | 280.9 | 299.4 | 315 | 333 | 352 | 370 |
(1) Fuel, alcohol and tobacco duties.
(2) Includes council tax as well as other central government taxes.
(3) Rounded to the nearest £1 billion.
Receipts in 1996-97
4.15 General government receipts are now expected to rise by a bit under 4 1/2 per cent in 1996-97. This is slightly lower than the forecast increase in money GDP, and the ratio of receipts to GDP is expected to fall marginally. This fall reflects a reduction in other (non-tax) receipts, a category which includes certain accruals and accounting adjustments. (The main factor behind the low level in 1996-97 is the accruals adjustment on index-linked gilts, reflecting a large redemption in September.) Taxes as a percent of GDP in 1996-97 are more or less unchanged from 1995-96.
4.16 This nevertheless represents faster growth in receipts relative to GDP than projected in the Budget a year ago, when the receipts to GDP ratio was forecast to fall by a half percentage point and the tax to GDP ratio by a quarter point. A contributory factor is higher forecast growth in corporation tax receipts - a rise of 11 per cent as compared with 8per cent in the last Budget - reflecting a large increase in advance corporation tax (ACT) as a result of rapid growth in dividends and other distributions on which ACT is charged. Growth in VAT receipts is also higher than forecast in the last Budget (although the level of receipts is lower). But the rise in income tax is smaller.
Shortfall in VAT receipts
The outturns for VAT receipts have been consistently below the forecasts published in the FSBR since 1989-90. Recent work by HM Treasury and Customs and Excise analyses how the problem has arisen and suggests what may lie behind it.
The VAT forecasts are derived from forecasts of the underlying tax base, the largest component of which is consumer spending. Errors in the forecasts of consumer spending, however, play little part in explaining the shortfall; it appears rather that there has been a shift in the relationship between VAT receipts and consumer spending.
The chart below shows that, although the ratio of VAT receipts to consumer spending has been rising since the early 1980s, the underlying ratio - after adjusting for increases in the VAT rate and other changes in coverage - peaked in the late 1980s and has been falling since then. Up to two years ago, VAT forecasts had assumed that this was cyclical and would reverse as the recovery progressed, but this has not happened. Had the underlying ratio remained constant at its level at the end of the 1980s, VAT receipts in 1995-96 would have been £6 billion higher.
CHART HERE
No single explanation of this has emerged, but a number of significant contributory factors can be identified:
- better tax planning and increasing tax avoidance by companies;
- greater than expected revenue losses from a range of tax regime changes (such as increases in the VAT registration threshold);
- losses resulting from successful legal challenges to Customs and Excise's interpretation of the law;
- and, until recently, worsening tax compliance by traders.
Other factors which may also have contributed on a smaller scale include the introduction of the National Lottery and growth in the shadow economy.
VAT receipts have picked up this year, and it looks likely that 1996-97 will see the first rise in the VAT/consumer spending ratio since the late 1980s, but to a level only slightly higher than two years earlier. Adjusted for the Budget tax measures and extra tax from the "spend to save" package, the forecasts imply a broadly flat ratio of VAT to consumer spending over the next few years. This is similar to the experience of the second half of the 1980s, the last time when consumer spending was growing at the relatively high real rates now forecast.
Receipts in 1997-98
4.17 General government receipts are forecast to rise by 6 1/2 per cent in
1997-98, which is a bit higher than the forecast rise in money GDP. The net impact of the Budget measures on receipts in 1997-98 is only marginal - a net reduction of £ 1/4 billion (-£ 3/4 billion from the Budget tax changes, +£ 1/2 billion from the "spend-to-save" package).
Receipts in the medium term
4.18 Over the medium term, general government receipts are projected to rise somewhat faster than money GDP. The net impact of the Budget measures is to raise receipts in the medium term. The Budget tax measures have a net yield of £ 3/4 billion by 1999-2000, and the "spend-to-save" package is expected to bring in an extra £2 1/4 billion a year by then. This reinforces the underlying trend of receipts growing slightly faster than GDP. As usual, the medium-term receipts projections have been made on the conventional assumption of no further changes in tax rates and an indexed tax system (except for the commitment to real increases for tobacco and road fuel duties).
Table 4.5 General government receipts as a percent of GDP
| | Outturn | Forecast | Projection |
| 1995-96 | 1996-97 | 1997-98 | 1998-99 | 1999-00 | 2000-01 | 2001-02 |
| Income tax(2) | 9.6 | 9.1 | 9.1 | 9.2 | 9.4 | 9.6 | 9.8 |
| Corporation tax(2) | 3.3 | 3.5 | 3.5 | 3.6 | 3.8 | 3.9 | 4.0 |
| Value added tax(2) | 6.1 | 6.4 | 6.4 | 6.5 | 6.5 | 6.5 | 6.5 |
| Excise duties(1) (2) | 4.0 | 4.2 | 4.3 | 4.5 | 4.6 | 4.7 | 4.9 |
| Other taxes and royalties(1) (2) | 6.2 | 6.2 | 6.3 | 6.2 | 6.1 | 6.2 | 6.2 |
| Social security contributions(2) | 6.3 | 6.3 | 6.2 | 6.2 | 6.3 | 6.3 | 6.3 |
| Other receipts(3) | 2.5 | 2.0 | 2.2 | 2.0 | 1.8 | 1.8 | 1.7 |
| GGR | 38.0 | 37.7 | 38.0 | 38.1 | 38.5 | 39.0 | 39.3 |
| Total taxes and social security contributions(4) | 35.7 | 35.8 | 36.2 | 36.5 | 37.0 | 37.5 | 37.9 |
(1) For definitions see footnotes to Table 4.4.
(2) Cash receipts.
(3) Includes accruals adjustments.
(4) Measured on a national accounts (accruals) basis.
Taxes as a share of GDP
4.19 Tax and social security contribution revenues (on a national accounts basis - the "tax burden") are now forecast at 35 3/4 per cent of GDP in 1996-97, which is a similar level to 1995-96. A rise in the tax/GDP ratio is forecast for 1997-98. Income tax is expected to fall as a percent of GDP in 1996--97, reflecting both last year's Budget and the rising cost of tax relief on profit-related pay. However, this is offset by increases (as a percent of GDP) in receipts of VAT, corporation tax and excise duties. For 1997-98, income tax receipts are flat as a percent of GDP, with the Budget measures offsetting real fiscal drag. But there are increases in receipts of certain other taxes, some of which reflect the Budget measures. Over the medium term, the tax/GDP ratio is projected to continue rising. The usual contributions from income tax (real fiscal drag) and excise duties (the policy of real increases for tobacco and road fuel duties) are re-inforced by the net impact of the Budget measures, especially from the "spend-to-save" package.
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General government expenditure
4.20 The Government's objective for public spending is to reduce it as a share of GDP over time, and in particular to reduce it to below 40 per cent. On present plans, this objective will be achieved in 1997-98. The objective is expressed in terms of GGE(X), an aggregate which excludes - from total general government expenditure - privatisation proceeds and spending financed out of National Lottery proceeds, and which also nets off interest and dividend receipts from gross payments.
4.21 Table 4.6 shows the 1995-96 outturn and forecasts and projections for 1996-97 up to 2001-02 for general government expenditure (GGE) and its main components. The projections up to 1999-2000 are consistent with the new public spending plans. Figures for later years assume that Control Total spending will grow by 3/4 per cent a year in real terms.
Table 4.6 General government expenditure
| | £ billion |
| | Outturn | Forecast | Projection(1) |
| | 1995-96 | 1996-97 | 1997-98 | 1998-99 | 1999-00 | 2000-01 | 2001-02 |
| Control Total | 255.2 | 260.6 | 266.5 | 274 | 281 | 289 | 297 |
| Cyclical social security(2) | 14.5 | 14.3 | 14.1 | 14 | 15 | 15 | 16 |
| Central government debt interest | 20.0 | 22.2 | 24.8 | 24 | 24 | 24 | 23 |
| Accounting adjustments | 10.1 | 10.3 | 9.2 | 10 | 11 | 11 | 11 |
| GGE(X)(3) | 299.7 | 307.4 | 314.7 | 322 | 331 | 339 | 347 |
| Privatisation proceeds | -2.4 | -4.5 | -2.0 | -1 1/2 | -1 | -1 | -1 |
| Other adjustments | 5.8 | 5.6 | 6.3 | 7 | 7 | 7 | 7 |
| GGE | 303.0 | 308.5 | 319.0 | 327 | 336 | 345 | 353 |
| GGE(X)(3)/GDP ratio - per cent | 42 1/4 | 41 1/4 | 40 | 39 | 38 1/4 | 37 1/2 | 36 3/4 |
| Real Growth - per cent: Control Total | 1/2 | - 1/4 | 1/4 | 3/4 | 1/2 | 3/4 | 3/4 |
| GGE(X)(3) | 1 1/2 | 0 | 1/4 | 1/2 | 1/2 | 1/2 | 1/4 |
(1) Rounded to the nearest £1 billion, except for privatisation proceeds which are rounded to nearest £ 1/2 billion.
(2) For unemployed assumptions underlying projections, see economic assumptions for public expenditure, paragraph 5A.5.
(3) Excluding privatisation proceeds and lottery financed spending and net of interest and dividend receipts.
Expenditure in 1996-97
4.22 GGE(X) in 1996-97 is forecast to rise by 2 1/2 per cent, which is rather lower than the expected growth in money GDP. Control Total spending is forecast at £260.6 billion, which represents an overspend of £0.5 billion on the plans in last year's Budget. The overspend mainly reflects unanticipated spending on measures to combat BSE, which is expected to reach £1 1/2 billion in 1996-97. The forecast for Control Total spending represents a fall of 1/4 per cent in real terms on 1995-96.
Expenditure over the medium term
4.23 The new public spending plans provide for Control Total spending to rise at an average of 2 1/2 per cent a year in cash terms over the next three years. Measured in real terms, the level of spending projected for 1999-2000 is only 1 1/2 per cent higher than in 1996-97. The projected real terms increase in GGE(X) is marginally smaller, a total of 1 1/4 per cent over three years.
4.24 Outside the Control Total, cyclical social security is projected to fall in real terms reflecting the assumption of falling unemployment - from an average of just under 2 million (Great Britain) for 1996-97 to 1.6million by 1999-2000. The projections also take account of Budget policy changes, which are expected to reduce spending by nearly £1 billion (6 per cent) by 1999-2000. Debt interest payments (net of receipts) are projected to continue rising in 1997-98, but thereafter to flatten off and start to decline as the level of new borrowing is reduced.
Expenditure as a share of GDP
4.25 The ratio of GGE(X) to GDP is expected to fall by one percentage point in 1996-97 to 41 1/4 per cent, a reduction of 2 1/4 percentage points from the cyclical peak in 1992-93. The public expenditure plans imply a sharp fall in this ratio over the next three years, with GGE(X) as a per cent of GDP just below the 40per cent target in 1997-98 and coming significantly below it in 1998-99. With tight control of spending assumed to be maintained through the medium term, and with debt interest expenditure benefitting from the projected reduction in borrowing, the downward trend in the GGE(X)/GDP ratio is projected to continue.
CHART HERE
[Prepared November 1996]