B  The Public Finances

B2  For 1998-99 as a whole, it is estimated that there will be a net repayment of £1 billion. This estimate is still uncertain; the levels of both spending and receipts towards the end of the financial year are always hard to predict. A provisional estimate of the outturn will be published by the Office for National Statistics on 20 April 1999.

B3  It is estimated that the current budget will be in surplus by £4 billion (½ per cent of GDP) in 1998-99. The first estimate of the outturn will be published by the Office for National Statistics on 27 May 1999. This year's surplus compares with a deficit of £22½ billion (3 per cent of GDP) in 1996-97. An estimated ¾ per cent of this 3½ per cent of GDP improvement is accounted for by above-trend economic growth. About ¾ per cent is accounted for by tax measures in the 1997 and 1998 Budgets. The remainder mainly reflects comparatively slow growth of public spending, as the Government has kept within the plans it inherited for the first two years.

B4  Table B3 compares these latest estimates for 1998-99 with the forecasts that were made in the 1998 Budget and the 1998 PBR. Comparisons with the 1998 Budget forecasts are complicated by the introduction of the new European System of National Accounts (ESA95) in September 1998. To facilitate comparison, the 1998 Budget forecasts are adjusted for classification changes, so as to put them on the same basis as the estimated outturns.

B5  On constant definitions, the improvement in the public finances has been greater than expected at the time of the last Budget. The estimated current budget surplus of £4 billion in 1998-99 compares with a forecast of balance in the last Budget. Receipts, especially from income tax and social security contributions, have been higher than expected, while expenditure, especially on social security, has been lower. Forecast surpluses have been revised downwards slightly since the PBR. This mainly reflects lower receipts than expected from corporation tax. The estimated net debt repayment of £1 billion compares with a forecast of net borrowing of £5 billion in the last Budget.

B6  The debt burden has fallen more quickly than expected in last year's Budget. From a peak of 44.7 per cent of GDP in mid-1997, the net debt ratio fell below 40 per cent at end-January 1999. Borrowing is usually high in the last two months of the financial year, and the ratio may be a little above 40 per cent at end-March.

B9  Ten of the eleven key assumptions and conventions audited by the National Audit Office (NAO) and used for last year's Budget projections (see page 109 of the March 1998 FSBR and the NAO report Audit of Assumptions for the Budget, 19 March 1998, HC 616) are unchanged. In accordance with these assumptions and conventions, oil prices are assumed flat at $11 a barrel (in real terms), equity prices are projected to grow from current levels in line with money GDP, and interest rates are projected in line with market expectations.

B10  A new, more cautious, planning assumption is used for projecting expenditure on social security. Previously, the projections were based on the assumption that claimant unemployment would remain constant. This assumption is a long-standing convention that was endorsed by the National Audit Office (NAO) before the 1997 Budget and has been retained in subsequent forecasts. While simple and transparent, such an assumption does not provide a consistently cautious basis for projecting social security expenditure at every point in the cycle.

B15  From 2001-02 onwards, with the economy growing at or slightly above trend, the projected current budget surpluses gradually build up. Current expenditure rises in line with GDP, while receipts rise slightly faster because of real fiscal drag (the tendency under a progressive income tax system for receipts to grow faster than incomes as incomes grow), the impact of past Budget measures and real increases in excise duties. Over the economic cycle (1997-98 to 2002-03), the surpluses average ½ per cent of GDP; so that the golden rule is met with a margin to spare - Table B7.

B16  Net borrowing is expected to become positive again next year, partly reflecting the reduction in the current budget surplus and partly an increase in public investment. Although net investment is projected to more than double as a share of GDP between 1998-99 and 2001-02, net borrowing remains low as a percentage of GDP.

B17  Table B6 also shows the definition of the budget deficit - general government net borrowing on an ESA79 basis - used in the Excessive Deficits Procedure of the Maastricht Treaty. The reference level of 3 per cent of GDP is achieved very comfortably. There was a surplus on the Maastricht measure of 0.6 per cent of GDP in 1998. A small deficit of 0.3 per cent of GDP is forecast for 1999.

PUBLIC SECTOR DEBT

B18  Table B8 sets out projections for two measures of debt. Public sector net debt (used to judge the sustainable investment rule) is approximately the stock counterpart of public sector borrowing, while general government gross debt is the Maastricht measure. Both measures rose sharply over the first half of the 1990s as a result of the high levels of government borrowing and slow growth in money GDP, but peaked as a percentage of GDP in 1997. Public sector net debt is projected to fall from under 41 per cent of GDP at the end of the current financial year to under 35 per cent in five years time. General government gross debt was 51 per cent of GDP at end-1998 - comfortably below the Maastricht criterion of 60 per cent - and is projected to fall to 42 per cent of GDP.

RECEIPTS

B19  In total, the Budget measures have little effect on taxes on an accruals basis in 1999-2000 and 2000-01, and reduce tax accruals by £2½ billion in 2001-02. The reduction in 2001-02 mainly reflects the lower rates of income tax.

B20  Table B9 gives projections of receipts, as a percentage of GDP, over the medium term. A more detailed breakdown, in £ billion, for 1998-99 and 1999-2000 is given in table B10. Excluding the windfall tax, total receipts are estimated to rise by 6 per cent in 1998-99, which is rather faster than forecast money GDP growth of 4½ per cent. This relatively strong growth of receipts mostly reflects the effects of past Budget measures, together with the normal tendency for the receipts-to-GDP ratio to rise when GDP is growing. The growth of receipts is forecast to slow to 4 per cent next year. The slowdown in the economy (with money GDP growing by 3¾ per cent) is expected to affect corporation tax receipts in particular, following several years of rapid growth. The 1998 Budget measures, which included the introduction of quarterly tax instalments for large companies, will bring forward the response of corporation tax to the slowdown in the economy. The ratio of corporation tax to GDP increased from 2·3 per cent in 1993-94 to 3·7 per cent in 1997-98. It is forecast to fall back to 3.4 per cent over the next two years, and then to remain at about 3·5 per cent thereafter.

B21  The growth of receipts picks up from 2000-01 as the economy demonstrates stronger growth. Excluding Budget measures, the underlying receipts-to-GDP ratio rises by about 0·1 per cent a year on average over the next five years, largely reflecting the effects of real fiscal drag on income tax receipts and the fuel and tobacco escalators.

Income tax receipts

B23  Higher receipts from self assessment and PAYE have boosted current year income tax receipts, which have been revised up by £½ billion since the PBR. The introduction of self assessment contributed to the rapid growth of income tax receipts last year. Self assessment receipts have risen a little further in 1998-99, suggesting that self assessment has led to a permanent step increase in the tax base. The lower forecast of income tax payments for 1999-2000 mostly reflects the introduction of the 10p lower rate of income tax.

Corporation tax

B24  Following weaker than expected receipts of advance corporation tax (ACT) and mainstream payments, corporation tax in 1998-99 is likely to fall short of the PBR forecast by about £1½ billion. This partly reflects lower dividends for some companies and higher than expected set off of previous ACT payments. With the abolition of ACT in April 1999, the impact on forecasts is relatively small.

VAT receipts

B25  VAT receipts have been slightly weaker than expected since the PBR, and the estimate for the current year has been revised down by £0·9 billion. The latest figures suggest a slight fall in the ratio of VAT receipts to consumer spending in 1998-99, following a slight increase in 1997-98. The projections continue to assume a modest downward trend in the VAT ratio - an assumption audited by the NAO. Compared with a flat VAT ratio, this cautious assumption reduces receipts by over £1 billion by 2003-04.

Excise duties

B26  Excise duties are expected to fall short of the PBR estimate by about £0.4 billion this year and £2·4 billion in 1999-2000.

B27  Bringing forward the tobacco duty escalator from December to March increases tax accruals. Tax accruals measure receipts at the time the product is finally sold, and this is the basis on which total current receipts are shown in Tables B9 and B10. The timing of cash receipts is also likely to change, which affects the cash figures for excise duties shown in the two tables. With the December escalator, a high proportion of the year's tobacco duty was collected in December as manufacturers anticipated the annual tax increases by accelerating clearances. In the absence of such forestalling, there is likely to be a temporary dip in cash receipts in 1999-2000. An offsetting accruals adjustment is included in the 'accounting adjustments'.

B28  The forecast of receipts from tobacco duty also takes account of new evidence, available since the PBR, that cigarette smuggling and the loss of revenue associated with it, has been growing rapidly. It is very hard to predict the extent of the future loss of receipts from smuggling. The Government is taking measures to tackle the problem - see Chapter 1.

B29  Forecast receipts from excise duties are also lower by about £ ½ billion a year because of the switch to consumption of cleaner fuels associated with the rapidly growing availability of ultra low sulphur diesel and, from the end of this year, the ban on leaded petrol.

Social security contributions

B30  Social security (national insurance) contributions have grown strongly since the PBR and the estimate for receipts in the current year has been revised up slightly. Nonetheless, the forecast for 1999-2000 has been revised down by £1·3 billion since the PBR. This partly reflects upward revisions to the costings of the 1998 Budget reforms.

Other taxes and receipts

B31  Overall, the yield from other taxes and receipts since the PBR has been much as expected. The forecast for 1999-2000 has been revised up significantly however. This reflects in part higher forecasts of capital taxes and stamp duty following a recovery in equity prices since November, together with upward revisions to business rates.

Total taxes

B32  Chart B2 shows the tax/GDP ratio, measured as total taxes and social security contributions, net of tax credits, as a percentage of GDP (see the conventions section at the end of this Annex). It is forecast to fall by a ½ percentage point next year. Apart from the windfall tax, which increased the tax ratio in 1998-99, this fall largely reflects the effects of the economic slowdown, especially on corporation tax receipts. Thereafter, the tax ratio is projected to rise (on average) by a little over 0.1 percentage points a year, mainly reflecting real fiscal drag.

PROSPECTS

B34  Table B13 shows the projections for public expenditure for the three years, 1999-2000 to 2001-02, covered by the Comprehensive Spending Review (CSR). These projections cover the whole public sector, using the aggregate Total Managed Expenditure (TME). TME is split into Departmental Expenditure Limits (DEL), for which three-year plans are set, and Annually Managed Expenditure (AME).

B35  Excluding classifications changes, DEL is unchanged from the CSR apart from bringing forward £¼ billion of expenditure under the Capital Modernisation Fund from 2001-02 to 1999-2000. However the components of AME have been reviewed. Since the PBR there has been a downward revision to next year's forecast of social security benefit expenditure. This is in spite of the change in the unemployment assumption, and reflects consistently lower outturns over the past two years which have changed the view of future trends. Debt interest is lower, reflecting both lower interest rates and RPI inflation. The AME margin has been set at its CSR level. The overall effect is to reduce AME by £4·7 billion, £4·2 billion and £5·4 billion in 1999-00, 2000-01 and 2001-02 respectively. This decrease feeds directly through into lower TME.

B36  Current expenditure for 1999-2000 to 2001-02 is now lower than in the CSR (after adjusting for classification changes), because of the forecast reductions made to AME. The average real growth rate over the CSR period is 2¼ per cent, as set by the CSR in July 1998. As shown in the CSR, the ratio of net investment to GDP doubles between 1998-99 and 2001-02. (The levels of net investment are lower than shown in the CSR, but this mainly reflects ESA95 classification changes, which have substantially increased the estimated level of depreciation.)

B37  Chart B3 shows the ratio of TME to GDP. The ratio rises very slightly over the next three years, reflecting the higher levels of public investment.

B38  The CSR plans extend only to 2001-02. The spending totals for the last two years of the projection period are illustrative. They assume that real current expenditure continues to grow by 2¼ per cent a year and net investment continues to rise as a share of GDP (from 1 per cent in 2001-02 to 1½ per cent in 2003-04).

FORECAST ERRORS AND RISKS

B42  The fiscal balances are the difference between two large aggregates of spending and receipts, and forecasts of them are inevitably subject to wide margins of error. Over the past five years, the average absolute error (i.e. the average error irrespective of whether the errors have been positive or negative) for one-year ahead forecasts of net borrowing has been over 1 per cent of GDP, or plus or minus £8½ billion at today's prices. The error tends to grow as the forecast horizon lengthens (see table B13 on page 122 of the PBR). Much of this error arises from errors in the forecasts of GDP.

B43  Short-term forecasts of the public finances are critically dependent on the path of the economy, as most tax revenues and some public expenditure (especially social security) vary automatically with the economic cycle. If GDP growth were 1 per cent higher or lower than assumed over the coming year, net borrowing might be lower or higher by 0.4 per cent of GDP in the first year (equivalent to about £3½ billion) and lower or higher by a further 0.3 per cent of GDP (£2½ billion) in the second year.

B44  Such errors in short-term growth forecasts may have only a temporary effect on the public finances. For a given path of trend output, higher or lower growth in the short term will be followed by lower or higher growth later on, and the public finances may be little affected on average over the cycle. However, errors in estimating the cyclical position of the economy in relation to its trend - the output gap - will have a permanent effect on prospects.

B45  It is for this reason that Chapter 2 of the EFSR illustrates the effect of uncertainty over the cyclical position of the economy by showing a cautious case in which the output gap is 1 per cent higher than the central view. On this assumption, the Government would still remain on track to meet the golden rule.

CAPITAL SPENDING AND PRIVATE FINANCE INITIATIVE

Capital spending

B46  On national accounts definitions, public sector capital expenditure has been falling in recent years. However, these definitions exclude capital spending by the private sector under the Private Finance Initiative (PFI), which also benefits public services and is discussed in the next section.

Private Finance Initiative

B47  Under the Private Finance Initiative (PFI) the public sector purchases services from a private sector partner. In addition to requiring capital investment to be undertaken by the private sector, its ability to be innovative and manage risks appropriately allocated to it can result in a specified level of service at a price that represents value for money.

B48  The PFI has now become an established method of delivering many public services which require significant investment in capital assets. Projects with a combined capital value of around £4 billion have been signed since the General Election in such diverse areas as schools, colleges, hospitals, local authorities, defence, IT and property management. Approval of a PFI scheme depends on a thorough assessment of the lifetime costs of both providing and maintaining the underlying asset and the running costs of delivering the required service. The PFI provides considerable investment opportunities for the private sector, while, in return, the contractual relationship with the public sector ensures the ongoing delivery of cost effective and quality services.

B49  The Government is committed to developing PFI and other partnership arrangements with the private sector to enhance further the delivery of public services and ensure the delivery of a higher sustainable level of public sector investment. The Government wants to exploit all commercial potential and spare capacity in public sector assets through a sensible balance of risk and reward. A review of the progress made in the delivery of PFI and other Public Private Partnerships was announced in November 1998. Its purpose is to assist the Government to maintain the momentum for improvement in PFI and to extend this to other Public Private Partnerships, such as the Wider Markets Initiative which was launched in July 1998.

B50  Table B16 shows a breakdown by Department of the estimated public sector investment resulting from both signed contracts and those expected to be signed over the next three years. From 1999-000 to 2001-02, some £11 billion of new investment is expected as a result of PFI. Under PFI, the public sector contracts for services not assets, and capital investment is only one of the activities undertaken by the private sector in order to supply these services. The figures in Table B16 therefore do not reflect the total value of the contracts.

B51  Table B17 shows a forecast of the estimated payments by the public sector flowing from new private investment over the next twenty five years. Actual expenditure will depend on the details of the payment mechanism for each contract.

Asset sales

B52  Table B18 shows estimated receipts from asset and loan sales for 1998-99, and projections to 2001-02. Planned sales of fixed assets by central government are set out in their Departmental Investment Strategies, and total £1 billion per year over the next three years.

B53  The figures for sales of financial assets include proceeds from the sale of British Energy debt and from the Public Private Partnerships for Belfast port, National Air Traffic Services and the Defence Evaluation and Research Agency.

DEPARTMENTAL PROGRAMMES

B54  Table B19 analyses the Control Total by department, showing changes from previous plans as published in the March 1998 Financial Statement and Budget Report. It also shows total changes from plans inherited from the previous Government, published in the March 1997 Public Expenditure Statistical Analyses. Central government support for local authorities and the financing requirements of nationalised industries have been attributed to the appropriate departments; departmental groupings are defined at the end of the annex.

B55  In the July 1997 Budget the Government announced that it would work within the previous Government's plans for the first two years of the Parliament. Taking 1997-98 and 1998-99 together, it is estimated that spending will undershoot these plans by £2 billion.

B56  The main differences from the March 1997 plans are as follows:

• The extra resources for the NHS and schools announced since the General Election are reflected in the lines for local government and the territorial departments as well as those for Education and Health.
• The increases in the Education and Employment line also reflect a re-profiling of the sale of student loans and take up of end-year flexibility.
• A substantial underspend is expected on social security expenditure, which largely reflects lower than expected claimants.
• The increase in 1998-99 for net payments to European Community Institutions is largely due to a change introduced in 1998 to the financing practice for the EC Budget. Adjustments to be made in respect of the UK's gross contributions to the 1998 EC Budget, which under earlier practice would have been made in 1999, were drawn forward into 1998.

Public borrowing by Sector

B57  The monthly outturns for central government borrowing are measured from the cash flows into and out of central government's funds and accounts, after consolidation. Table B21 sets out the 1997-98 outturn and 1998-99 and 1999-2000 forecasts for central government borrowing in terms of this cash flow presentation, which is used in the ONS monthly press release

B58  In 1998-99 estimates for both net borrowing and the own account net cash requirement are substantially lower than the forecasts in the last Budget. The cash forecast is almost £7 billion lower, partly because of lower cash outlays (down £5½ billion) and partly higher cash receipts (up £1½ billion). The reduction in net borrowing is slightly smaller than that to the cash requirement because of changes to the financial transactions - particularly a reduction in accounts receivable, reflecting lower accruals of tax relative to cash for tobacco duty and business rates.

B59  For 1999-2000, the forecast for net borrowing is £6 billion higher than in the current year; but with changes to the financial transactions, own account net cash requirement is £9 billion higher. Net lending includes a larger sale of student loans in 1999-2000 than 1998-99. The adjustment for interest on gilts is down because lower inflation in 1999-2000 reduces the uplift on index-linked gilts. Higher accruals of tax relative to cash are forecast in 1999-2000, particularly for tobacco duty and business rates.

B60  Table B22 updates the financing arithmetic for 1998-99 to allow for the latest central government net cash requirement forecast, and sets out the financing arithmetic for
1999-2000.

B61  The gilts issuance programme for 1998-99 was revised in November 1998, following the November PBR. However at that stage, gilt sales in 1998-99 had already reached £6·5 billion, against a revised gilts financing requirement in the PBR of £6·4 billion. The Government announced that, although there would be no further issuance of conventional gilts in 1998-99, the remaining index-linked auctions would take place as planned. If this resulted in excess gilt sales, such sales were necessary in order to meet the commitment to a minimum issuance of £2·5 billion (cash) of index-linked gilts in 1998-99 (and in future years) in support of the move to index-linked auctions. The latest view of the financing arithmetic in Table B22 shows forecast excess gilt sales of £2·3 billion in 1998-99. These excess sales will be unwound in 1999-2000 by a residual adjustment which reduces the initial requirement for gilt sales in that year.

B62  The requirement for gilt sales in 1999-2000 is further reduced by the increase in the level of the stock of Treasury bills and other short-term debt which will be required if, as planned, the Debt Management Office (DMO) take over responsibility for cash management in that year. However this is more than offset by the additional requirement in 1999-2000 to finance investment in the foreign currency reserves which has previously been financed by issuance of Euro Treasury bills. The main details of the debt management plans for 1999-2000 are contained in the remits to the UK Debt Management Office and National Savings announced on 9 March. Full details, including the remits, will be published in the 1999-2000 Debt Management Report.