HM TREASU RY BUDGET 2013 HC 1033 March 2013 BUDGET 2013 Return to an order of the House of Commons dated 20 March 2013 Copy of the Budget Report - March 2013 as laid before the House of Commons by the Chancellor of the Exchequer when opening the Budget. Greg Clark Her Majesty's Treasury 20 March 2013 Ordered by the House of Commons to be printed 20 March 2013 HC 1033 LONDON: The Stationery Office ?45.00 (C) Crown copyright 2013 You may re-use this information (not including logos) free of charge in any format or medium, under the terms of the Open Government Licence. To view this licence, visit http://www.nationalarchives.gov.uk/doc/open-government-licence/ or write to the Information Policy Team, The National Archives, Kew, London TW9 4DU, or email: psi@nationalarchives.gsi.gov.uk. Any queries regarding this publication should be sent to us at: public.enquiries@hm-treasury.gov.uk. This publication is also available on http://www.official-documents.gov.uk/ ISBN: 9780102982275 PU1457 Printed in the UK by The Stationery Office Limited on behalf of the Controller of Her Majesty's Stationery Office ID 2547399 03/13 Printed on paper containing 75% recycled fibre content minimum The Budget Report is presented pursuant to section 2 of the Budget Responsibility and National Audit Act 2011 and in accordance with the Charter for Budget Responsibility. The Budget Report, combined with the Office for Budget Responsibility's Economic and fiscal outlook, constitutes the Government's assessment under section 5 of the European Communities (Amendment) Act 1993 that will form the basis of the Government's submissions to the European Commission under 121 TFEU (ex Articles 99/103 TEU) and Article 126 TFEU (ex Article 104/104c TEU) after the assessment is approved by Parliament. Contents Page Executive Summary 1 Budget Report Chapter 1 Budget Report 9 The economy and public finances Growth Fairness 9 33 51 Chapter 2 Budget policy decisions 63 Annex A Financing 95 Office for Budget Responsibility: Budget forecast Annex B Office for Budget Responsibility's Economic and fiscal outlook: selected tables 99 List of abbreviations 107 List of tables 110 List of charts 111 Budget 2013 Executive Summary The Government's objective is to equip the UK to succeed in the global race, build a stronger economy and a fairer society and to support aspiration. This Budget will help those who aspire to work hard and get on, care for their families, buy a home, start or grow a business and save for retirement. The UK economy is recovering from the biggest financial crisis in generations, one of the deepest recessions of any major economy and a decade of growth built on unsustainable levels of debt. The Government's plan for the economy, first set out in June Budget 2010, is based on: o fiscal responsibility to deal with our debts with a credible deficit reduction plan; o monetary activism to support demand and keep interest rates low; and o supply-side reform to help businesses create jobs and deliver lasting prosperity. Where resources allow, the Government is committed to keeping costs down for families to help with the cost of living. This Budget builds on the progress that has been made in challenging circumstances, with further action on each element of the Government's plan: o the deficit as a share of GDP is forecast to fall by a third over the three years from 2009-10 and interest rates are near record lows. Budget 2013 announces further detail on the Government's deficit reduction plans, new steps to ensure active monetary policy continues to play a full role in supporting the economy with an updated remit for the Monetary Policy Committee (MPC), and further measures to ease the longterm pressure on the public finances; o employment is at record levels, exceeding the pre-crisis peak, and the UK is now eighth in the World Economic Forum Global Competitiveness Report. Budget 2013 sets out further reforms to help businesses create jobs, help people buy their own home and give Britain the lowest corporation tax rate in the G20; and o the Government's reforms to the personal tax system will have lifted 2.4 million low income workers out of tax altogether by April 2013. Budget 2013 announces further actions to ease the cost of living, help people plan for retirement and deliver on the Government's ambition to make the first ?10,000 of income free from income tax. This Budget sets out these and other reforms under the themes of: the economy and public finances, growth and fairness. The economy and public finances Three key factors, first set out in the Office for Budget Responsibility's (OBR) November 2011 Economic and fiscal outlook, have resulted in a more subdued and uneven recovery than expected: Budget 2013 1 o evidence has accumulated that suggests the impact of the financial crisis on GDP and underlying productivity has been greater than expected; o the euro area sovereign debt crisis and global uncertainty have damaged confidence and reduced external demand; and o commodity price driven inflation since 2011 has reduced real incomes and raised business costs. As a result of the ongoing effect of these factors, the OBR's forecast revises down growth in 2013 and 2014. However, the forecast for UK employment from 2013 has been revised up. Economic forecast GDP growth in 2012 was slightly stronger than expected at Autumn Statement 2012. However, reflecting the lower than expected momentum in the final quarter of 2012 and smaller contributions to growth from net trade and consumption, the OBR has revised its forecast for GDP growth in 2013 from 1.2 per cent to 0.6 per cent and from 2.0 per cent to 1.8 per cent for 2014. The OBR's forecast for GDP growth from 2015 onwards is unchanged from its forecast at Autumn Statement 2012. The OBR expects employment to rise in every year of the forecast period reaching 30.5 million by 2017. Total market sector employment is expected to rise by around 2.6 million between the start of 2011 and the start of 2018. The OBR has revised down its unemployment forecast by 0.3 percentage points to 7.9 per cent in 2013 and by 0.2 percentage points in 2017 to 6.9 per cent. The OBR has revised its inflation forecast up slightly. The OBR attributes this to higher oil prices and higher import prices but expects it to return to target by early 2016. Fiscal forecast Public sector net borrowing is forecast to fall by a third over the three years from 2009-10, from its post-war peak of 11.2 per cent of GDP, to 7.4 per cent of GDP in 2012-13.1 It is then forecast to continue to fall to 5.0 per cent of GDP in 2015-16 and 2.2 per cent of GDP in 2017-18. Public sector net debt as a share of GDP is forecast to peak at 85.6 per cent of GDP in 2016-17, before falling to 84.8 per cent of GDP in 2017-18. The Government's response Monetary policy has a critical role to play in supporting the economy as the Government delivers on its commitment to necessary fiscal consolidation. To ensure that it can continue to play that role fully, the Government has reviewed the monetary policy framework in international and historical context and the Review of the monetary policy framework is published alongside this Budget. As a result, the Government has: retained a flexible inflation targeting framework and reaffirmed the 2 per cent inflation target, which applies at all times; updated the remit to clarify the tradeoffs that are involved in setting monetary policy to meet a forward-looking inflation target; and has requested that the MPC provides in its August 2013 Inflation Report an assessment of the merits of using intermediate thresholds in the operation and communication of monetary policy. This excludes the effect on public sector net investment in 2012-13 of transferring assets from the Royal Mail Pension Plan to the public sector. 1 2 Budget 2013 Public spending control is central to the Government's commitment to reduce the deficit. Departments have consistently underspent against plans, by an average of ?4.0 billion over the last three years. Faster progress in delivering savings, combined with improvements to spending control, mean that departmental underspends in 2012-13 are higher than usual at ?11.5 billion. Building on this lower level of spending, Budget 2013 announces a reduction in resource Departmental Expenditure Limits (DEL) by ?1.1 billion in 2013-14 and ?1.2 billion in 2014-15. In the short term, these funds will be used to help support housing. The schools and health budgets remain unchanged. In addition this Budget: o fixes the envelope for Total Managed Expenditure (TME) for 2015-16. Individual departmental budgets will be published in a Spending Round on 26 June 2013. Health, schools and Official Development Assistance will be protected; o announces that public sector pay awards in 2015-16 will be limited to an average of up to 1 per cent; o confirms the path of future fiscal consolidation, expressed as an assumption that TME in 2016-17 and 2017-18 will continue to fall at the same rate as over the Spending Review 2010 period; and o announces that the Government will strengthen the public spending framework by introducing a firm limit on a significant proportion of Annually Managed Expenditure (AME), including areas of welfare expenditure. This will be designed in a way that allows the automatic stabilisers to operate to support the economy. Including all measures set out in this Budget, the OBR's March 2013 Economic and fiscal outlook concludes that the Government remains on course to meet the fiscal mandate a year early. The OBR has forecast that public sector net debt as a percentage of GDP will be falling in 2017-18, two years later than set out in the supplementary debt target. The Government's judgement is that significant changes to the path of consolidation in the short term would constrain the automatic stabilisers, limiting their ability to support the economy. Budget 2013 is therefore fiscally neutral and reinforces the Government's commitment to deficit reduction. The first section of Chapter 1 sets out the Government's economic and fiscal plans in more detail. Growth The Government is delivering an ambitious programme of supply-side reform to equip the UK to succeed in the global race and to support aspiration. Budget 2013 sets out further action the Government will take to help UK businesses create jobs and to help people buy their own home. The Government will: o make the UK tax system the most competitive in the G20 by reducing the main rate of corporation tax by an additional 1 percentage point in April 2015, so it reaches 20 per cent, the joint lowest level in the G20; o from April 2014, give businesses and charities an entitlement to a ?2,000 Employment Allowance per year towards their employer National Insurance contributions (NICs) bill. This will particularly help small businesses who want to hire their first employee or expand their workforce; Budget 2013 3 o increase capital spending plans by ?3 billion a year from 2015-16, to lock in recent increases in capital spending over the Spending Review 2010 period, funded through reductions in current spending. As a result, public investment as a share of GDP will be higher on average over this Parliament and the next Parliament collectively than it was under the previous government. The Government will also set out long-term plans to 2020-21 for the most economically valuable areas of capital expenditure in the 2015-16 Spending Round; o provide ?1.6 billion of funding to support strategies in 11 key sectors as part of its industrial strategy. From this fund the Government, in partnership with industry, will create an Aerospace Technology Institute, which will provide a total of ?2.1 billion of research and development support over seven years, with the Government and industry contributing equal shares; o take forward Lord Heseltine's recommendation on the creation of a Single Local Growth Fund, devolved to the local level through new Local Growth Deals. The Fund will be operational by April 2015; and o introduce a package of support for the UK shale gas industry including introducing a new shale gas field allowance and extending the ring fence expenditure supplement from six to ten years for shale gas projects, to promote investment in the industry at an early stage of its development. This Budget also announces major reforms, including over ?5.4 billion of financial support, to tackle long-term problems in the housing market and to support those who want to get on or move up the housing ladder. The Government will: o introduce a major new housing scheme, Help to Buy, with two key elements. First, from April 2013, the Government will extend First Buy to all those who aspire to own a new build home. The Government will provide an equity loan worth up to 20 per cent of the value of a new build home, repayable once the home is sold, and significantly widen the eligibility criteria to ensure as many people as possible are able to benefit, including increasing the maximum home value to ?600,000 and removing the income cap constraint. Second, the Government will create a mortgage guarantee for lenders who offer mortgages to people with a deposit of between 5 per cent and 20 per cent on homes with a value of up to ?600,000. This will increase the availability of mortgages on new or existing properties for those with small deposits; o give more social tenants the opportunity of home ownership by reducing the qualifying period for Right to Buy from five years to three years and raising the maximum discount cash cap in London to ?100,000; and o invest in new affordable homes by doubling the existing affordable homes guarantee programme, providing up to an additional ?225 million to support a further 15,000 affordable homes in England by 2015. The second section of Chapter 1 sets out further detail on these and other announcements. Fairness The Government's economic and fiscal strategy is underpinned by its commitment to fairness and its desire to support those who want to work hard and get on. Budget 2013 announces policies to make the tax and welfare system fairer, to support aspiration and to keep costs down for households and businesses. 4 Budget 2013 The Government will: o meet its commitment to make the first ?10,000 of income free from income tax a year ahead of schedule: the personal allowance will be increased by ?560 to ?10,000 in 2014-15. By April 2014, 2.7 million low income individuals under 65 will have been lifted out of income tax altogether and from April 2014 the typical basic rate taxpayer will pay ?705 less income tax a year in cash terms as a result of this Government's actions; o cancel the fuel duty increase that was planned for 1 September 2013 to support households and businesses. This will mean that fuel duty will have been frozen for nearly three and a half years, the longest duty freeze for over 20 years. From April 2013, pump prices will be 13 pence per litre lower than under the previous government's plans; o introduce a new Tax-Free Childcare Scheme. The Government will support working families with 20 per cent of their childcare costs up to ?1,200 per child per year. This new system will be phased in from autumn 2015, over time replacing the existing system of Employer Supported Childcare (ESC). At the point the new offer is introduced, existing members of ESC can choose to remain in that scheme. In addition, the Government will increase childcare support within Universal Credit, to improve work incentives and ensure that it is worthwhile to work up to full-time hours for low and middle income parents; o introduce the single-tier State Pension in 2016-17 to provide clarity and confidence to those saving for their retirement. This will end contracting out of the State Second Pension, so that everyone will pay the same rate of NICs and build up access to the same single-tier State Pension; o implement the ?72,000 cap on reasonable social care costs, drawing on the Dilnot Commission's recommendations, and extend the means test to give more people access to financial support for their residential care costs from April 2016. This will provide peace of mind to those who want to plan for their old age and leave savings to their children; and o reduce general beer duty by 2 per cent from 25 March 2013, worth 1 penny on a pint of beer, cancel the escalator for beer duty next year and instead increase it by inflation thereafter, to support community pubs. In addition, this Budget announces a significant crackdown on tax avoidance and evasion, which in total raises over ?4.6 billion in new revenue over the next five years. As part of this, the Isle of Man, Guernsey and Jersey have agreed to enter tax information exchange agreements with the UK that will significantly increase the amount of information automatically exchanged on potentially taxable income, in order to identify and tackle evasion. In addition, the Government will remove the presumption of selfemployment for limited liability partnership (LLP) partners, to tackle the disguising of employment relationships through LLPs and counter the artificial allocation of profits to partners (in both LLPs and other partnerships) to achieve a tax advantage. The third section of Chapter 1 sets out further information on these and other announcements. Further information on the estimated distributional impact of this Budget is available in Impact on households: distributional analysis to accompany Budget 2013.2 Chapter 2 provides more information on the fiscal impact of this Budget and sets out all new Budget announcements in full. Annex A presents financing information. Annex B presents selected tables from the OBR's March 2013 Economic and fiscal outlook. 2 Available on the HM Treasury website at www.hm-treasury.gov.uk. Budget 2013 5 Budget decisions and government spending and revenue A summary of Budget policy decisions is set out in the table below. Table 1: Summary of Budget policy decisions1 2013-14 2014-15 ? million 2015-16 2016-17 2017-18 Total tax policy decisions -290 -2,705 -2,850 +1,740 +1,305 Total tax policy decisions excluding impact on government departments -290 -2,705 -2,850 -1,585 -1,980 +1,605 +1,315 +1,055 -1,650 0 -2,850 0 +1,740 0 +1,305 Total spending policy decisions TOTAL POLICY DECISIONS 1 Costings reflect the OBR's latest economic and fiscal determinants. Chart 1 presents public spending by main function. TME in 2013-14 is expected to be around ?720 billion. TME is divided into DEL and AME. Chart 1: Government spending 2013-14 Other - ?53 billion Debt interest - ?51 billion Public order and safety - ?31 billion Social protection - ?220 billion Housing and enviroment - ?23 billion Defence - ?40 billion Education - ?97 billion Transport - ?21 billion Personal social services - ?31 billion Industry, agriculture and employment - ?16 billion Health - ?137 billion Source: Office for Budget Responsibility, 2013-14 estimates. Allocations to functions are based on HM Treasury analyses. Chart 2 shows the different sources of government revenue. Public sector current receipts are expected to be around ?612 billion in 2013-14. Chart 2: Government receipts 2013-14 Other - ?107 billion Income Tax - ?155 billion Council tax - ?27 billion Business rates - ?27 billion VAT - ?103 billion Corporation tax - ?39 billion National Insurance contributions - ?107 billion Excise duties - ?47 billion Source: Office for Budget Responsibility, 2013-14 estimates. Other receipts include capital taxes, stamp duties, vehicle excise duties and some other tax and non-tax receipts - for example, interest and dividends. Figures may not sum due to rounding. 6 Budget 2013 Budget Report 1 Budget Report The economy and public finances 1.1 The UK economy is recovering from the most damaging financial crisis in generations after a decade of growth built on unsustainable levels of debt. The Government inherited the largest deficit since the Second World War and the UK experienced one of the deepest recessions of any major economy. Across the world, recovery over the past four years has been slower than forecast and the euro area is now in recession. 1.2 The Government's economic strategy set out in the June Budget 2010 is designed to protect the economy through the recent period of global uncertainty and provide the foundations for recovery. This strategy is restoring the public finances to a sustainable path and the deficit has been reduced by a third over the three years from 2009-10. The UK is seen as a relative safe haven, with low market interest rates helping to keep interest payments lower for families, businesses and the taxpayer. This strategy has helped the Government to equip the UK to compete in the global race to build a stronger economy and a fairer society. The UK has the fourth lowest corporation tax rate in the G20 and will reduce the rate by an additional 1 percentage point in April 2015 to 20 per cent, the joint lowest in the G20; it has risen to eighth in the 2012 World Economic Forum Global Competitiveness Report; and the 2012 KPMG Annual Survey of Tax Competitiveness looked at six key competitor economies and found that out of these the UK was the most commonly cited as being in the top three.1 The UK economy since 2010 1.3 Three key factors, first set out in the Office for Budget Responsibility's (OBR) November 2011 Economic and fiscal outlook, have resulted in a more subdued and uneven recovery than expected and continued to weigh on the UK economy through 2012: o evidence has accumulated that suggests the impact of the financial crisis on GDP and underlying productivity has been greater than expected; o the euro area sovereign debt crisis and global uncertainty have damaged confidence and reduced external demand; and o commodity price driven inflation since 2011 has reduced real incomes and raised business costs. 1.4 Economic recovery continues to be more uneven than originally expected. While UK GDP grew by 0.3 per cent in the year to the fourth quarter of 2012, slightly higher than forecast at Autumn Statement 2012, it was choppy through the year and fell 0.3 per cent in the fourth quarter.2 Nominal GDP growth in the year to the fourth quarter of 2012 was only 1.3 per cent. Recovery has also been uneven in other countries. Euro area GDP fell by 0.9 per cent in the year to the fourth quarter of 2012, falling by 0.6 per cent in the fourth quarter alone. GDP growth for the US and Japan was also weak in the fourth quarter.3 The OBR's Budget 2013 forecast revises down UK GDP growth slightly in 2013 and 2014, reflecting this reduced momentum The Global Competitiveness Report 2012-13, World Economic Forum, 2012. KPMG Annual Survey of Tax Competitiveness, KPMG, February 2013. 2 All UK economy data from the Office for National Statistics (ONS) unless otherwise stated. 3 Main Economic Indicators, Organisation for Economic Co-operation and Development (OECD). 1 Budget 2013 9 in the UK and globally, and smaller contributions to growth from net trade and consumption. By the end of the forecast horizon, the level of GDP is 0.6 per cent below the level forecast at Autumn Statement 2012. The OBR assumes around two thirds of the reduction in real GDP growth to be cyclical rather than structural. 1.5 The UK economy's performance through 2012 included relative strength in domestic demand but relative weakness in external sources of growth. Compared with the OBR forecast in the November 2011 Economic and fiscal outlook, GDP growth in the year to the fourth quarter of 2012 under-performed by 0.8 percentage points. The contribution of domestic demand out-performed that forecast by 1.2 percentage points and net trade under-performed by 1.7 percentage points, as shown in Chart 1.1. Indeed, given the relative strength of domestic demand, GDP could have grown by 2.1 per cent in the year to the fourth quarter had exports grown by the 5.7 per cent forecast in November 2011, and adjusting for the likely import content of those additional exports. Over that period, goods export volumes to the European Union (EU) fell by 2.5 per cent, while goods export volumes outside the EU grew by 1.2 per cent. Chart 1.1: Outturn compared with the OBR's November 2011 forecast1 2.0 Percentage point contributions to GDP growth in the four quarters to 2012Q4 1.5 1.0 0.5 0.0 -0.5 -1.0 GDP growth (per cent) Domestic demand OBR's November 2011 forecast Net trade 2012Q4 outturn The difference between the sum of the components and the total is accounted for by differences in the statistical discrepancy in the forecast and the latest estimate of GDP. Source: Office for Budget Responsibility and Office for National Statistics. 1 1.6 UK inflation has fallen by almost half from its peak of 5.2 per cent in September 2011 to 2.8 per cent in February 2013. Pressure from commodity price rises in 2011 has eased, though commodity prices remain high. 1.7 The OBR's October 2012 Forecast evaluation report showed that the shortfall in growth compared with its June Budget 2010 forecast could largely be explained by private consumption, investment and net trade, in roughly equal measure, reflecting shocks from commodity prices, financial conditions and confidence. The Forecast evaluation report noted that nominal consumer spending had been broadly in line with forecast, with unexpected inflation explaining the weakness of real private consumption relative to forecast. Table 1.1 shows a broadly similar breakdown across the private sector by the third quarter of 2012 using the same approach with the latest data. The direct contribution of government consumption and investment subtracted less from GDP growth than forecast at the June Budget 2010, largely due to lower than expected inflation in the government sector with nominal spending lower than forecast but real spending higher than forecast with higher public sector productivity. 10 Budget 2013 1.8 Fiscal multipliers estimate the impact of different elements of tax and spending consolidation on GDP. The OBR's October 2012 Forecast evaluation report did not see evidence to suggest that multipliers were significantly different than estimated in the June Budget 2010 forecast. The OBR has not altered the estimated fiscal multipliers being used in its latest forecast. Table 1.1: Contributions to real GDP growth from 2010Q1 to 2012Q3 Percentage points Private consumption Private investment Total government Net trade Stocks GDP 2.3 0.6 2.9 0.7 -1.6 -0.5 2.1 0.6 0.8 0.9 6.5 2.3 -1.7 -2.2 1.1 -1.5 0.1 -4.2 June 2010 forecast Latest data Difference1 1 Difference in unrounded numbers, rounded to one decimal place. Source: Office for Budget Responsibility and HM Treasury. 1.9 The UK labour market has continued to perform more strongly than forecast despite the headwinds to GDP growth, with a net increase of over one million jobs in the private sector since the first quarter of 2010.4 Comparing the fourth quarter of 2012 to a year earlier, employment rose by 584,000, the fastest growth since 1989, with participation in the labour market rising by 428,000 and unemployment falling by 156,000. At the end of 2012, employment levels were the highest recorded and above the pre-crisis peak. Unemployment in the three months to December 2012 stood at 7.8 per cent in the UK, lower than in the euro area and lower than that following previous UK recessions. Employment performance in the UK compares favourably with post-war experience, as shown in Chart 1.2, and internationally, as discussed later in this chapter. The OBR expects employment to continue to rise over the forecast period. Chart 1.2: Employment levels through recessions and recoveries 103 Employment, level indexed to 100 at pre-recession GDP peak 102 101 100 99 98 97 96 95 94 93 92 91 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 Quarters after peak in GDP 1973Q2-1978Q1 1979Q2-1984Q1 1990Q2-1995Q1 2008Q1-2012Q4 Source: Office for National Statistics and HM Treasury. Labour Market Statistics, ONS, January 2013. These figures exclude the impact of the reclassification from June 2012 of 196,000 employees in some educational bodies from the public to the private sector. 4 Budget 2013 11 1.10 The persistent effects of the financial crisis continue to weigh on the UK recovery. The Bank of England's November 2012 Inflation Report and the OBR's December 2012 Economic and fiscal outlook set out the channels along which productivity might have been held back due to these persistent effects.5 For example: the higher cost and availability of credit; the pace at which credit is reallocated to more efficient uses; and a lower risk appetite among lenders. UK imbalances and relative economic performance 1.11 It has been estimated that by 2008, as the crisis hit, the UK private sector had become the most indebted in the world.6 Deleveraging has since weighed on UK growth. Some progress has been made, with private sector debt falling by over 40 percentage points of GDP since its peak in the first quarter of 2010, as Chart 1.3 shows. Chart 1.3: Private sector debt in the UK 500 Per cent of GDP Gross interest-bearing liabilities 450 400 350 300 250 200 150 100 50 0 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 Non-financial corporations 2010 2012 Households Financial corporations 2008 Total private sector debt Source:Office for National Statistics. 1.12 Autumn Statement 2012 illustrated the impact of the financial crisis and post-crisis deleveraging on the financial sector, which has contracted 13 per cent in real terms since the economy's pre-crisis peak. Output of the North Sea oil and gas sector, which has continued a long-term decline related to maturing fields, has fallen 47 per cent since the economy's pre-crisis peak. The rest of the economy, accounting for nearly 90 per cent of Gross Value Added (GVA), has performed more strongly. 1.13 Outside the energy and financial sectors, the UK economy has performed better than the euro area and similarly to France, as Chart 1.4 shows.7 1.14 Chart 1.5 shows employment in the UK has performed relatively strongly in international context. By comparison with the first quarter of 2008, UK employment is higher than all major advanced economies except Germany. UK employment growth was stronger than all G7 economies except the US between the third quarter of 2012 and a year earlier. Inflation Report, Bank of England, November 2012. Economic and fiscal outlook, OBR, December 2012. Debt and deleveraging: The global credit bubble and its economic consequences, McKinsey Global Institute, January 2010. 7 Chart 1.4 uses OECD data and energy sector refers to the energy extraction and usage category. This is comprised of 'mining and quarrying (including oil and gas extraction)', 'electricity, gas, stream and air' and 'water supply and sewerage'. 5 6 12 Budget 2013 Chart 1.4: GVA excluding energy and financial services in the largest EU economies 102 GVA, volumes indexed to 100 at 2008Q1 100 98 96 94 92 90 2008 2009 2010 2011 2012 Euro area Germany France Netherlands Spain Italy UK Source: OECD and HM Treasury. Chart 1.5: International comparison of employment since the crisis 106 Employment, level indexed to 100 at 2008Q1 104 102 100 98 96 94 92 90 88 86 84 82 2009 2008 2010 2011 2012 Germany France Netherlands Euro area Italy US Japan Spain UK Source: OECD and HM Treasury. Budget 2013 13 Euro area crisis and global developments 1.15 Autumn Statement 2012 highlighted three key global risks to the UK economy: the euro area sovereign debt crisis, the US 'fiscal cliff' and slowing growth in emerging economies. These risks have started to ease in recent months and there are signs of confidence returning to financial markets, but this is yet to feed through to the performance of the wider economy. 1.16 The euro area is the key market for UK exporters, accounting for 42 per cent of UK exports in 2011. As a consequence, the euro area sovereign debt crisis and subsequent recession have weighed heavily on the UK recovery. Action by European policy makers in 2012 helped ease the crisis and there are signs of investor confidence improving, but as the situation in Cyprus demonstrates the challenges facing the euro area are not fully resolved. Output has been weaker than anticipated, and the OBR has revised down its forecast for 2013 GDP growth in the euro area to -0.5 per cent and does not expect it to start recovering until the second half of 2013. 1.17 The US was the destination for around 16 per cent of UK exports in 2011. The American Taxpayer Relief Act enacted on 2 January 2013 averted over half of the sharp fiscal tightening that was possible for 2013, the 'fiscal cliff'.8 The US Congressional Budget Office expects the US fiscal consolidation to reduce US GDP growth by around 1 1/2 percentage points in 2013, leaving growth for the year at around 1 1/2 per cent.9 However, with further US fiscal negotiations outstanding, there may be further changes to the US fiscal outlook in coming months. 1.18 Brazil, Russia, India and China taken together were the destination for 6.5 per cent of UK exports in 2011. Growth has stabilised in China and the International Monetary Fund (IMF) has forecast China's GDP will grow by 8.2 per cent in 2013 compared with 7.8 per cent in 2012. The IMF forecast for 2013 GDP growth in emerging economies as a whole is 5.5 per cent. Emerging markets and developing economies remain an important driver of global growth. In 2011 they accounted for 36 per cent of world GDP, up from 28 per cent in 2007 before the global crisis hit.10 From a low base, UK exporters continue to take advantage of this trend through trade with emerging economies. Between 2009 and 2012 UK goods exports to Brazil increased by 49 per cent, to Russia by 133 per cent, to India by 59 per cent and to China by 96 per cent.11 1.19 The easing of risks has been reflected in global stock markets. Between Autumn Statement 2012 and Budget 2013 the UK's FTSE 100 index has risen 10 per cent, the US's S&P 500 index 11 per cent and the euro area's Euro Stoxx 50 index 5 per cent. Over the same period global stock market values have risen by more than $3 trillion.12 The US 2013 financial year runs from October 2012 to September 2013. The Budget and Economic Outlook: Fiscal Years 2013 to 2023, US Congressional Budget Office, February 2013. 10 World Economic Outlook, IMF, October 2012. 11 UK Trade - January 2013, ONS, March 2013. 12 Bloomberg. Closing price 5 December 2012 and 15 March 2013. 8 9 14 Budget 2013 Economic forecast Table 1.2: Summary of the OBR's central economic forecast1 Percentage change on a year earlier, unless otherwise stated Forecast 2011 GDP growth Main components of GDP Household consumption2 General government consumption Fixed investment Business General government Private dwellings Change in inventories3 Net trade3 CPI inflation Employment (millions) 1 2012 2013 2014 2015 2016 2017 0.9 0.2 0.6 1.8 2.3 2.7 2.8 -1.0 1.0 0.5 1.2 1.7 2.4 2.8 -0.1 2.6 0.4 -0.7 -0.4 -1.0 -1.8 -2.9 3.1 -26.2 2.3 0.3 1.2 4.5 29.2 1.4 4.9 2.7 -5.4 -0.2 -0.8 2.8 29.5 2.2 1.9 2.6 2.0 -0.2 0.1 2.8 29.8 6.7 6.1 5.0 8.9 0.0 0.1 2.4 29.9 8.1 8.6 1.8 10.0 0.0 0.1 2.1 30.1 7.7 8.6 -1.5 10.0 0.0 0.1 2.0 30.3 7.8 8.6 -1.2 9.7 0.0 0.1 2.0 30.5 All figures in this table are rounded to the nearest decimal place. This is not intended to convey a degree of unwarranted accuracy. Components may not sum to total due to rounding, omission of transfer costs of land and existing buildings, and the statistical discrepancy. 2 Includes households and non-profit institutions serving households. 3 Contribution to GDP growth, percentage points. Source: Office for Budget Responsibility. 1.20 GDP growth in 2012 was slightly stronger than expected at Autumn Statement 2012. However, reflecting the lower-than-expected momentum in the final quarter of 2012, the OBR has revised its forecast for GDP growth in 2013 from 1.2 per cent to 0.6 per cent. The OBR has revised its forecast for GDP growth in 2014 from 2.0 per cent to 1.8 per cent. These revisions reflect smaller contributions to growth from net trade and consumption. The OBR forecast for GDP growth from 2015 onwards is unchanged from its forecast at Autumn Statement 2012. By the end of the forecast horizon, the level of GDP is 0.6 per cent below the level forecast at Autumn Statement 2012. The OBR assumes around two thirds of the reduction in real GDP growth to be cyclical rather than structural. 1.21 Risks to UK growth have become more balanced. Global risks have started to ease. As the Funding for Lending Scheme (FLS) begins to gain traction, UK credit conditions have improved. Interest rates have fallen, in particular mortgage rates, and credit availability for businesses has increased. House prices increased by 2.2 per cent in the year to January 2013 and property transactions have risen.13 As credit conditions continue to ease, the property market is expected to pick up and growth in transactions to continue. While growth remains subdued, the Governor of the Bank of England has said "there are good reasons to suppose that a gentle recovery is underway".14 The IMF forecasts UK GDP per person to grow faster than the rest of the G7 between 2012 and 2017, with the exception of the US.15 1.22 The OBR has revised up its forecast for UK employment from 2013. It has revised down its unemployment forecast by 0.3 percentage points to 7.9 per cent in 2013 and by 0.2 percentage points in 2017 to 6.9 per cent. It expects employment to rise in every year of the forecast period, reaching 30.5 million by 2017. The OBR expects total market sector employment to rise by around 2.6 million between the start of 2011 and the start of 2018, more than offsetting the total reduction in general government employment of around 1.2 million. House Price Index, January 2013, ONS, March 2013. Monthly Property Transactions, January 2013, HM Revenue and Customs, February 2013. 14 Mervyn King, speech, the Confederation of British Industry (CBI), Northern Ireland Mid-Winter Dinner, Belfast, 22 January 2013. 15 World Economic Outlook, IMF, October 2012. 13 Budget 2013 15 1.23 The OBR has revised its inflation forecast up, broadly in line with the Bank of England's February 2013 Inflation Report forecast. The OBR attributes this to higher oil prices and higher import prices as a result of recent exchange rate movements. This upward pressure is partially offset in 2013 and 2014 by cancellation of the fuel duty rise that was planned for 1 September 2013. The OBR forecasts inflation to return to target by early 2016 and remain close to target thereafter. The OBR's forecast for the GDP deflator, a broader measure of inflation in the economy, has been revised down. This, combined with the revisions to real GDP, leaves the level of nominal GDP 2.5 per cent lower in 2017 than was forecast at Autumn Statement 2012. Real GDP accounts for around 0.6 percentage points of this revision, with the remainder reflecting a lower GDP deflator. 1.24 The OBR forecast shows the UK economy rebalancing over the forecast period. Having grown by almost 5 per cent in 2012, business investment is forecast to pick up again in 2014 and make an increasing contribution to GDP growth thereafter, rising to nearly 1 percentage point by 2017. After falling in 2012, UK exports are also expected to pick up and net trade is forecast to make a small positive contribution to growth from 2013. Household consumption is forecast to grow more slowly than GDP on average, with the saving ratio declining but remaining at 5 per cent or above throughout. The Government's strategy 1.25 The Government's strategy is designed to protect the economy through this period of global uncertainty, to maintain market confidence in the UK and to lay the foundations for a stronger, more balanced economy in the future. The Government is taking decisive action through: o monetary activism and credit easing, stimulating demand, maintaining price stability and supporting the flow of credit in the economy; o deficit reduction, returning the public finances to a sustainable position and ensuring that fiscal credibility underpins low long-term interest rates; o reform of the financial system, improving the regulatory framework to reduce risks to the taxpayer and build the resilience of the system; and o a comprehensive package of structural reforms, rebalancing and strengthening the economy for the future, including an ambitious housing package and programme of infrastructure investment. Monetary activism Monetary policy 1.26 Monetary policy has a critical role to play in supporting the economy as the Government delivers on its commitment to necessary fiscal consolidation. To ensure that it can continue to play that role fully, the Government has reviewed the monetary policy framework in international and historical context. This Review of the monetary policy framework is published alongside this Budget.16 As a result, the Government has: o retained a flexible inflation targeting framework and reaffirmed the 2 per cent inflation target, which applies at all times; o updated the remit to clarify the trade-offs that are involved in setting monetary policy to meet a forward-looking inflation target; and o requested that the Monetary Policy Committee (MPC) provides in its August 2013 Inflation Report an assessment of the merits of using intermediate thresholds in the operation and communication of monetary policy. 16 16 Available on the HM Treasury website at www.hm-treasury.gov.uk. Budget 2013 1.27 The Government has concluded that a flexible inflation targeting framework has served, and will continue to serve, the UK well, and that the credible commitment to medium-term price stability provided by the 2 per cent inflation target must remain at the core of the framework. Price stability is an essential pre-requisite for economic prosperity. In this Budget, the Government reaffirms the operational target for the MPC remains an inflation rate of 2 per cent, measured by the 12-month increase in the Consumer Prices Index (CPI). The target applies at all times. 1.28 The remit continues to recognise that the actual inflation rate may depart from its target as a result of shocks and disturbances, and that the MPC may therefore wish to allow inflation to deviate from the target temporarily in order not to cause undesirable volatility in output. It clarifies the consideration that, in some circumstances, may be given to financial imbalances and requires that the MPC should have regard to the policy actions of the Financial Policy Committee (FPC). The remit goes further by clarifying that in exceptional circumstances, where shocks are particularly large and with persistent effects, the MPC is likely to be faced with more significant trade-offs between the speed with which it aims to bring inflation back to target and the consideration that should be placed on the variability of output. The remit requires that in forming and communicating its judgements the MPC should promote understanding of the trade-offs inherent in setting monetary policy to meet a forward-looking inflation target while giving due consideration to output volatility. 1.29 The remit also continues to require an exchange of open letters between the Governor of the Bank of England and the Chancellor of the Exchequer if inflation moves away from the target by more than 1 percentage point in either direction. The Government believes the open letter system, required in the remits for the MPC since 1997, provides a formal mechanism of transparency and accountability. The remit now requires that the open letter from the Governor should be sent alongside the minutes of the MPC meeting that followed the publication of the CPI data, referring as necessary to the Bank's latest Inflation Report and forecasts and covering the MPC's judgements on the trade-offs inherent in setting monetary policy. The reason for publishing this letter alongside the minutes is to allow the MPC time to form and communicate its strategy towards returning inflation to the target after consideration of the trade-offs. The Government believes that any future open letters will therefore result in a more meaningful exchange about the MPC's strategy than has been possible before now. 1.30 As with many central banks in advanced economies since the global financial crisis hit, the Bank of England has deployed a range of unconventional instruments in order to deliver the support it judged necessary. Alongside holding Bank Rate at a record low, the Bank of England, with the Treasury, has launched the FLS, discussed below, and the MPC's programme of asset purchases financed by the issuance of central bank reserves reached a stock of ?375 billion in November 2012. The Government confirms in Budget 2013 that the Asset Purchase Facility will remain in place for the financial year 2013-14. 1.31 With the UK continuing to face exceptional economic challenges, the remit recognises that the MPC may judge it necessary to use other unconventional instruments in order to support the economy in the context of price stability. Where those instruments have implications for credit risk or credit allocation, the remit ensures that appropriate governance arrangements are in place to ensure accountability. The MPC may also judge it to be appropriate to deploy explicit forward guidance including intermediate thresholds - policy commitments conditional on future economic developments - in order to influence expectations and thereby meet its objectives more effectively. The remit requests that the MPC provides in its August 2013 Inflation Report an assessment of the merits of using intermediate thresholds. Budget 2013 17 Credit easing 1.32 The FLS complements the Bank of England's asset purchase programme by delivering support to the economy through the banking system. The FLS reduces bank funding costs and provides strong incentives for banks to increase their lending to households and non-financial businesses in the UK. There are currently 39 banks and building societies participating in the Scheme, who make up over 80 per cent of the stock of loans. Chart 1.6: Average quoted interest rates on mortgages 7 Percentage points 6 5 4 3 2 1 0 2-year fixed-rate 90 per cent loan-to-value ratio 2-year fixed-rate 75 per cent loan-to-value ratio July 2012 February 2013 Source: Bank of England. Chart 1.7: Indicative senior unsecured bond spreads1 FLS announcement 400 Basis points 350 300 250 200 150 100 50 0 Jul-2011 Sep-2011 Nov-2011 Jan-2012 Mar-2012 May-2012 Jul-2012 UK Sep-2012 Nov-2012 Jan-2013 Mar-2013 Europe The data show an unweighted average of the spread between euro-denominated senior unsecured bonds and equivalent-maturity swap rates for a selected bond issued by each of a selection of large banks in the region. The selected bonds have residual maturities of up to six years. Source: Bank of England. 1 18 Budget 2013 1.33 The FLS is improving credit conditions in the UK. Wholesale bank funding costs have declined significantly as a result of the FLS and wider international developments and are now at very low levels. This is feeding through to the wider economy. The number of high loanto-value mortgage products available in the market has increased by about 30 per cent and mortgage approvals are increasing. Between July 2012 and January 2013, the average quoted rate for 2-year fixed-rate mortgages with 90 per cent loan-to-value ratio fell by more than one percentage point, as shown in Chart 1.6. Chart 1.7 shows that, together with a general improvement in financial markets, the FLS has led to reductions in bank funding costs. 1.34 Credit availability for businesses has also improved and is expected to improve further in the coming months. Several banks participating in the FLS have introduced discounted loans for small and medium-sized enterprises. 1.35 The FLS has been a clear success, with strong signs that lower bank funding costs are now being reflected in lower lending rates and increased credit availability. Banks expect to expand their lending to the real economy and their use of the Scheme throughout the year. HM Treasury and the Bank of England are now actively considering whether there are potential extensions to the scheme that will boost lending further. 1.36 Building on the FLS, the Government wants to go further in order to deliver on its commitment to make the aspiration of home ownership a reality for as many households as possible. Budget 2013 therefore announces Help to Buy, a package of measures that will increase the supply of low-deposit mortgages for credit-worthy households, increase the supply of new housing and contribute to economic growth. Details of the Help to Buy package are set out in the next section. Deficit reduction Fiscal strategy 1.37 The Government inherited the largest deficit in post-war history due to the financial crisis of 2008 and 2009 and unsustainable pre-crisis increases in public spending. The historically high level of borrowing risked undermining fairness, growth and economic stability in the UK. In 2010 the Government set out clear, credible and specific medium-term fiscal consolidation plans to return the public finances to a sustainable path. 1.38 The Government's fiscal strategy has been effective in providing protection against a challenging backdrop of global uncertainty and fiscal vulnerabilities. This has restored fiscal credibility, allowing activist monetary policy and the automatic stabilisers to support the economy, and is consistent with the approach recommended by international organisations. As stated by the Organisation for Economic Co-operation and Development (OECD), "monetary policy and the operation of the automatic stabilisers should support the economy in the short term".17 Uncertainty in the global outlook further reinforces the case for stability in the Government's consolidation plans. 1.39 In line with the Government's fiscal strategy, Budget 2013 sets out: o a fiscally neutral Budget that reinforces the Government's commitment to deficit reduction, primarily through spending consolidation; o a reduction in Resource Departmental Expenditure Limits (RDEL) of ?1.1 billion in 2013-14 and ?1.2 billion in 2014-15, helping to support the housing package in the short term and contributing to the overall savings required from current spending in 2015-16; 17 OECD Economic Survey: United Kingdom 2013, OECD, February 2013. Budget 2013 19 o an envelope for current spending in 2015-16 of ?694.2 billion, enabling the Government to increase capital spending plans by ?3 billion a year and ensuring consolidation is underpinned by clear, credible and specific medium-term plans for delivery; and o a sustained decline in the structural deficit as headwinds to growth ease, with cyclically-adjusted net borrowing falling by an annual average of around 1 per cent of GDP over the forecast period. Implementing fiscal consolidation 1.40 The Government remains committed to reducing the deficit and addressing the permanent structural deterioration in the public finances caused by the lasting impact of the financial crisis. Implementation of the fiscal consolidation plans is well underway: o by the end of 2012-13, around 70 per cent of the annual fiscal consolidation planned for the Spending Review 2010 period will have been achieved, with around 65 per cent of the spending and around 90 per cent of the tax consolidation in place. As set out in Table 1.4, 80 per cent of the total consolidation in 2015-16 will be delivered by lower spending; o by the end of April 2013, the Government will have implemented measures to deliver over 90 per cent of the total savings expected from reforms to the welfare system; and o the majority of tax consolidation measures announced before Budget 2013 will have been legislated by 6 April 2013.18 1.41 As a result, the Government has made significant progress in reversing the unprecedented rise in borrowing between 2007-08 and 2009-10: o public sector net borrowing is forecast to fall by a third over the three years from 2009-10, from 11.2 per cent of GDP in 2009-10 to 7.4 per cent of GDP in 2012-13 (as shown in Table 1.5); o cyclically-adjusted general government net borrowing - a measure of the deficit that excludes the effects of the cycle, and so illustrates the structural fiscal position - is forecast by the IMF to fall by 4.3 percentage points of GDP between 2009 and 2012, which is a larger reduction than any other country in the G7; o Total Managed Expenditure (TME) is planned to be ?10.2 billion lower in 2012-13 than forecast at Budget 2012, ensuring the deficit continues to fall; and o cumulative debt interest payments from 2010-11 to 2015-16 are forecast to be ?31 billion lower than expected at the June Budget 2010.19 Reducing risks 1.42 The UK's fiscal vulnerabilities argue strongly in favour of maintaining a credible path of deficit reduction. Despite significant progress since 2010, the UK is forecast to have the largest deficit in the EU in 2013.20 Among the G7, only the US and Japan are forecast to have larger deficits in 2013.21 Uncertainty in the global outlook reinforces the case for stability in the Government's plans for fiscal consolidation. Based on net savings in 2014-15. This estimate is consistent with Table 1.4. Fiscal Monitor, IMF, October 2012. 20 European Economic Forecast Winter 2013, European Commission, February 2013. 21 Fiscal Monitor, IMF, October 2012. 18 19 20 Budget 2013 Chart 1.8: General government cyclically-adjusted deficit in 2007 6 Per cent of potential GDP 5 4 3 2 1 0 -1 UK US Italy France Japan Germany Canada Source: International Monetary Fund. Chart 1.9: 10-year government bond yields 8 Per cent 7 6 5 4 3 2 1 0 Jan-10 Apr-10 Jul-10 Oct-10 Germany Jan-11 US Apr-11 Jul-11 France Oct-11 Jan-12 Italy Apr-12 Jul-12 Spain Oct-12 Jan-13 UK Source: Bloomberg. Budget 2013 21 1.43 In February Moody's downgraded the UK sovereign credit rating from Aaa to Aa1 with stable outlook, reflecting "the anticipated slow growth of the global economy and the drag on the UK economy from the ongoing public and private sector deleveraging process". Moody's highlighted a number of factors that could lead them to downgrading the UK further, including "reduced political commitment to fiscal consolidation" and "additional material deterioration in the country's economic prospects".22 Among the G7, only Canada and Germany are now rated AAA by all three major credit rating agencies; Canada and Germany had the lowest pre-crisis structural deficits in 2007, while Chart 1.8 shows that the UK had the largest pre-crisis structural deficit in 2007.23 1.44 The credit rating is one of many important benchmarks, but near historic low gilt yields continue to reflect the market-tested credibility earned by the Government's economic strategy. As Chart 1.9 shows, UK long-term interest rates were around the same level as those of Italy and Spain in May 2010. Italy and Spain now face long-term interest rates of around 5 per cent, compared with near record lows of around 2 per cent for the UK. 1.45 Clear and credible consolidation plans remain essential for reducing the risk of a costly loss of market confidence in the UK. As noted by the OECD, "global developments have shown that the consequences of losing market confidence can be sudden and severe and a sharp rise in interest rates would be particularly damaging to an economy with the United Kingdom's level of indebtedness".24 Table 1.3 shows that a 1 percentage point increase in government bond yields would add around ?8.1 billion to annual debt interest payments by 2017-18. A 1 percentage point rise in effective mortgage rates would add ?12 billion a year to households' mortgage interest payments. Table 1.3: Impact of higher interest rates on debt interest payments ? billion Annual increase in debt interest payments 2013-14 Increase in interest rates 1 percentage point 2 percentage points 3 percentage points 4 percentage points 5 percentage points 2014-15 2015-16 2016-17 2017-18 Total 0.8 1.6 2.5 3.3 4.1 2.6 5.1 7.7 10.3 12.9 4.4 8.8 13.3 17.9 22.4 6.2 12.6 19.0 25.6 32.4 8.1 16.4 25.0 33.8 42.8 22.1 44.6 67.5 90.8 114.6 1 1 Above market gilt rates, consistent with the OBR's March 2013 Economic and fiscal outlook. Increases are applied to each gilt maturity from 2013Q2 and are assumed to continue throughout the forecast period. Source: HM Treasury. 1.46 Fiscal consolidation also reduces the risk of adverse feedback between weak public finances and a strained financial sector. This feedback can be very damaging, as evidenced by recent events in the euro area. Globally, the UK has one of the largest financial systems relative to the size of its economy, meaning that any loss of investor confidence in the UK's fiscal position would not only affect the UK, but also the global economy. As the IMF has stated, "the UK financial system thus serves as a global public good".25 It is the IMF's view that the UK's economic and financial sector policies have a systemic impact on the global economy. Press notice: Moody's downgrades UK's government bond rating to Aa1 from Aaa; outlook is now stable, Moody's, 22 February 2013. 23 Fiscal Monitor, IMF, October 2012. 24 OECD Economic Survey: United Kingdom 2013, OECD, February 2013. 25 2012 Spillover Report, IMF, July 2012. 22 22 Budget 2013 Spending consolidation Spending control 1.47 Public spending control is central to the Government's commitment to reduce the deficit. Since 2010 the Government has taken firm action to ensure good financial management in departments and to improve spending control by: o delivering ?6.2 billion of in-year efficiency savings in 2010-11; o establishing the Cabinet Office Efficiency and Reform Group in 2010 and introducing tighter spending controls over areas of corporate spending including procurement, property and information communications technology; o taking a zero-based approach to capital spending at Spending Review 2010 to prioritise those projects with the highest economic value; o tightening in-year spending control by departments, including through the guidance published in Improving Spending Control; and o as a result of the Government's successful negotiation, agreeing the new Multi-annual Financial Framework at the February European Council, which reduces the UK's contributions to the EU by ?3.5 billion over the forecast period to 2017-18.26 1.48 Action to improve financial management and spending control has continued this year. Analysis of spending patterns has demonstrated that there is a longstanding trend of departmental spending rising in the final few months of the year, partly because departments seek to avoid losing access to funds. This year there has been a strengthened cross-government effort to scrutinise end-of-year spending to address this trend and ensure that value-for-money criteria around departmental spending are upheld. In addition increased focus has been placed on departments making payments at the appropriate time. Chart 1.10: Current spending on public services in real terms 36 ? billion in 2011-12 prices 35 34 33 32 31 30 29 28 Monthly average April to January 2009-10 Monthly average February to March (implied for 2012-13) 2010-11 2011-12 2012-13 Source: Office for Budget Responsibility, Office for National Statistics and HM Treasury. 26 Available on the Treasury website at www.hm-treasury.gov.uk. Budget 2013 23 1.49 Over the last three years departments have underspent against plans by an average of ?4.0 billion across total Departmental Expenditure Limits (DEL). This has been spread across a number of departments. For example, the forecast underspend for the Department of Health is ?2.2 billion in 2012-13 compared to an average of ?2.1 billion against original provision over the last Parliament.27 Faster progress in delivering savings, combined with the improvements to spending control set out above, mean that departmental underspends in 2012-13 are higher than usual and above the ?7.5 billion included in the OBR December 2012 forecast. Departments are collectively expected to spend ?11.5 billion less in total DEL in 2012-13 than in the plans set out at Budget 2012. Details of this are set out in Table 2.5. 1.50 Departments are ahead of their consolidation targets. As set out in Table 1.4, by the end of 2012-13 around 65 per cent of the ?80 billion of spending reductions planned by 2014-15 will have been delivered, compared to around 50 per cent at the time of the 2010 Spending Review. To reflect this, and in line with the Government's commitment to ensuring that borrowing continues to fall, Budget 2013 announces a reduction in RDEL by ?1.1 billion in 2013-14 and ?1.2 billion in 2014-15. This is equivalent to a 1 per cent reduction for most departments. The schools and health budgets remain unchanged. Local Government and police allocations that have been set out for 2013-14 will not be changed. HM Revenue and Customs (HMRC) will be excluded, to ensure that they are able to focus on delivering the additional revenue target set out at Autumn Statement 2012. The budget of the Department for International Development will be reduced by ?135 million in 2013-14 and ?165 million in 2014-15 to reflect the downward revisions to nominal Gross National Income set out in the OBR forecast. There is also a reprofiling of funding for broadband programmes, to support local delivery. These savings will be used to help support housing in the short term and contribute to the overall savings required from current spending in 2015-16. The 2015-16 Spending Round 1.51 This Budget sets out the next steps in the UK's fiscal consolidation by fixing an envelope for TME for 2015-16. The Government has set this envelope in line with the assumption that total spending will continue to fall in 2015-16 at the same rate as over the Spending Review 2010 period. The Government will make savings from current spending of ?11.5 billion in 201516. As set out in Table 2.3, the envelope for current spending in 2015-16 is therefore set at ?694.2 billion. Individual departmental budgets will be published in the 2015-16 Spending Round to be announced on 26 June 2013. Health, schools and Official Development Assistance (ODA) will be protected. 1.52 As a result of these savings, Budget 2013 announces that the Government will increase capital spending plans by ?3 billion a year from 2015-16 onwards, maintaining the temporary increases to capital announced at Autumn Statement 2011 and Autumn Statement 2012. The capital envelope for 2015-16 will be ?50.4 billion. As the IMF has stated, "Deeper budget-neutral reallocations could also support recovery. Such reallocations within the current overall fiscal stance could include greater investment spending".28 As a result of this increase, public investment as a percentage of GDP will now be higher on average over this Parliament and the next Parliament collectively than it was under the previous government. The Government will take a long-term approach to capital as part of the 2015-16 Spending Round, setting plans out to 2020-21 for the most economically valuable areas of capital expenditure. 1.53 Public sector pay restraint has been a key part of the fiscal consolidation so far. Budget 2013 announces that public sector pay awards in 2015-16 will be limited to an average of up to 1 per cent. It will be for departments and Pay Review Bodies to determine the level of award based on affordability and individual recruitment and retention needs. 27 28 24 All underspends are in 2011-12 prices. United Kingdom: Staff Report for the 2012 Article IV Consultation, IMF, July 2012. Budget 2013 1.54 Although the majority of the public sector has been subject to pay restraint, some have continued to receive annual pay increases of 7 per cent or more due to progression pay arrangements. In some workforces reforms are already under way. The Government will seek significant further savings through reforms to progression pay in the Spending Round. The Armed Forces will be excluded due to the unique nature of their careers. 1.55 The Government's themes for the 2015-16 Spending Round will be growth, efficiency and public service reform, including localism and fairness. The increase to capital spending plans and long-term approach to capital planning set out above will strengthen UK infrastructure and support growth in the economy. The Spending Round will require a continued focus on delivering higher-quality services and better outcomes at lower cost. This will be achieved both through further operational efficiencies in central government and the wider public sector, and ongoing reform of public services - including strengthened joint working at a local level and across services. The Government is committed to ensuring that decisions on public spending are as transparent, accountable and fair as possible, and will again publish analysis of the distributional impact of the Spending Round. 1.56 The 2015-16 Spending Round will extend the efficiency programme into 2015-16, with the expectation of generating a further ?5 billion of savings. Departments saved ?5.5 billion in 2011-12, supported by the Efficiency and Reform Group, through efficiencies and reducing wasteful expenditure.29 Departments are expected to deliver comparable additional efficiency savings in each of the succeeding years including 2015-16. Moving transactional services online will save ?1.2 billion in this Parliament and the Government's programme for improving back-office shared services across departments and Arm's Length Bodies will deliver savings of around ?250 million in 2015-16.30 Further savings will come from the review of projects announced at the Autumn Statement 2012, further centralisation of the procurement of common goods and services, and reducing the cost of information technology.31 1.57 In the wider public sector, the Department for Education will conduct a review of the level of efficiency in the schools system to report alongside the 2015-16 Spending Round, and the Government will publish an action plan in May with measures to improve the efficiency and effectiveness of the Criminal Justice System. Her Majesty's Inspectorate of Constabulary (HMIC) data suggests that one-sixth of policing will be delivered collaboratively across forces by 201415, but there is further to go to maximise savings whilst protecting the service to the public.32 1.58 Ongoing reform of public services will also be required. The four areas that participated in the recent Whole Place Community Budget pilots estimate that they can save ?800 million over five years by implementing their plans.33 To support the local adoption of similar approaches, the Government is establishing a new multi-agency network and will announce plans to extend the benefits of this approach across the country at the 2015-16 Spending Round. Spending beyond 2015-16 1.59 Budget 2013 updates the fiscal assumption for 2016-17 and 2017-18. In line with previous policy, this Budget sets a fiscal assumption that TME in 2016-17 and 2017-18 will continue to fall in real terms at the same rate as over the Spending Review 2010 period.34 Fiscal consolidation for 2016-17 and 2017-18 is expressed as a reduction in TME. It would, of course, be possible to do more of this further consolidation through tax instead. Available on the Government website at www.gov.uk. Available on the Cabinet Office and Government websites at www.cabinetoffice.gov.uk and www.gov.uk. 31 Available on the Government website at www.gov.uk. 32 Increasing efficiency in the Police Service: the role of collaboration, HMIC, July 2012. 33 Cabinet Office and HM Treasury - Integration across Government, National Audit Office, March 2013. 34 The Government's fiscal assumption excludes the effect of measures announced at Budget 2013 and Autumn Statement 2012, all capital measures announced at Autumn Statement 2011, and the OBR's underspends forecast. 29 30 Budget 2013 25 Reform of the spending framework 1.60 Annually Managed Expenditure (AME) typically consists of large, demand-led programmes. Under the current public spending framework, AME accounts for around half (some ?350 billion) of total public expenditure, the largest component of which is welfare spending. However, AME is not subject to fixed spending controls. 1.61 The Government has already taken action to manage AME spending pressures, including through the delivery of significant welfare reforms. As a result, working-age welfare expenditure is projected to fall in real terms over the current spending review period. Despite this, as shown by Chart 1.11, rapid growth in AME spending is reducing the resources available for other key public services. These pressures are set to persist over the longer term. Chart 1.11: Cumulative changes to Resource AME and implied Resource DEL 60 ? billion 50 40 30 20 10 0 -10 -20 2014-15 2015-16 2016-17 2017-18 Resource AME Resource AME excluding debt interest payments Implied Resource DEL Source: HM Treasury and Office for Budget Responsibility. 1.62 It is important that the Government can manage increases in spending and make trade-offs across different areas of expenditure, ensuring that limited resources are directed toward public spending priorities. To deliver this, a more robust public spending framework is required. Budget 2013 announces that the Government will strengthen the spending framework by introducing a firm limit on a significant proportion of AME, including areas of welfare expenditure. This will be designed in a way that allows the automatic stabilisers to operate to support the economy. Action to improve control over AME spending will support the delivery of fiscal consolidation. An update will be provided at the Spending Round. 1.63 As set out in Autumn Statement 2012, the Government is also developing a framework for managing liabilities that do not appear in the fiscal aggregates and a control total for the commitments arising from off-balance sheet Private Finance Two (PF2) contracts signed. The Government will provide further details in the 2015-16 Spending Round. 26 Budget 2013 Composition of consolidation 1.64 As a result of the plans set out in Budget 2013, public spending is projected by the OBR to fall from 47.4 per cent of GDP in 2009-10 to 40.5 per cent of GDP by 2017-18, around the same level as 2004-05 and close to its long-run average. Public sector current receipts are projected to rise from around 36.2 per cent of GDP in 2009-10 to around 38.3 per cent of GDP by 2017-18. 1.65 As set out in Table 1.4, 80 per cent of the total consolidation in 2015-16 will be delivered by lower spending. This is consistent with OECD and IMF research, which suggests that fiscal consolidation efforts that are focused on spending are more likely to be successful.35 Table 1.4: Total consolidation plans over this Parliament ? billion 2011-12 Policy inherited by the Government Spending1,2 Tax2 Spending share of consolidation (per cent) Total discretionary consolidation Spending1,2,3,4 Tax2,3 Spending share of consolidation (per cent) 1 2012-13 2013-14 2014-15 2015-16 25 14 11 57 41 23 18 56 40 25 15 62 74 53 21 72 54 37 17 69 84 58 25 70 68 48 20 71 103 80 23 77 130 105 25 80 Spending consolidation is attributable to three factors: (a) reductions in DEL are calculated by assessing nominal DEL totals against a counterfactual of growing DEL from 2010-11 in line with general inflation in the economy, as set out in Table 4.8 of the OBR's pre-Budget forecast (June 2010); (b) reductions in AME due to the net effect of policy changes announced since the June Budget 2010; and (c) estimated debt interest savings, updated for market interest rates consistent with the OBR's March 2013 Economic and fiscal outlook. 2 This takes account of the latest costings. 3 Where costings do not go out to 2015-16, they have been grown in line with general inflation in the economy. 4 The Government will set DEL budgets for 2015-16 at the Spending Round. Figures shown for 2015-16 are based on overall Resource and Capital DEL envelopes, as set out in Table 2.3. Source: Office for Budget Responsibility and HM Treasury. Fiscal forecast 1.66 The establishment of the OBR has placed the UK at the forefront of institutional reform internationally. It has significantly enhanced the credibility of the UK's fiscal framework by ensuring that the Government's fiscal policy decisions are based on independent forecasts for the economy and public finances. 1.67 The deficit forecasts in Budget 2013 are presented excluding the effect of the transfer of assets from the Royal Mail Pension Plan to the public sector, except where otherwise indicated. On this basis, public sector net borrowing is forecast to continue to fall from its post-war peak of 11.2 per cent of GDP in 2009-10 to: o 5.0 per cent of GDP in 2015-16, the end of this Parliament; and o 2.2 per cent of GDP in 2017-18. 1.68 Public sector net debt as a percentage of GDP is forecast to: o be 5.1 percentage points higher in 2015-16 than forecast at Autumn Statement 2012; and o peak at 85.6 per cent of GDP in 2016-17, before falling to 84.8 per cent of GDP in 2017-18. See Economic Outlook, OECD, June 2007; OECD Economic Survey: United Kingdom 2011, OECD, March 2011; and UK Article IV consultation, IMF, May 2009. 35 Budget 2013 27 Table 1.5: Overview of the OBR's central fiscal forecast Per cent of GDP Outturn Forecast 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Deficit Public sector net borrowing 9.5 7.9 7.4 6.8 5.9 5.0 3.4 2.2 Surplus on current budget -6.9 -6.0 -6.0 -5.2 -4.3 -3.5 -1.9 -0.9 Primary balance -6.8 -5.1 -5.3 -4.8 -3.8 -2.6 -0.6 0.9 Cyclically-adjusted net borrowing 7.3 6.0 5.4 4.3 3.3 2.7 1.3 0.6 Cyclically-adjusted surplus -4.7 -4.2 -4.0 -2.8 -1.7 -1.2 0.1 0.8 on current budget Cyclically-adjusted primary balance -4.6 -3.2 -3.3 -2.3 -1.2 -0.3 1.4 2.5 Treaty deficit1 9.6 7.8 7.4 6.8 6.0 5.2 3.5 2.3 Cyclically-adjusted Treaty deficit 7.4 5.9 5.4 4.4 3.4 2.8 1.5 0.7 Memo: Public sector net borrowing including Royal Mail Pension Plan transfer 9.5 7.9 5.6 6.8 5.9 5.0 3.4 2.2 Memo: Treaty deficit including Royal Mail Pension Plan transfer1 9.6 7.8 5.6 6.8 6.0 5.2 3.5 2.3 66.5 79.9 71.8 86.0 75.9 90.7 79.2 94.9 82.6 98.6 85.1 100.8 85.6 100.8 84.8 99.4 -2.8 -2.7 -2.9 -3.7 -3.6 -3.3 -2.7 -2.1 0.1 -0.1 -0.2 0.1 0.1 Debt Public sector net debt2 Treaty debt ratio3 Output gap Memo: total policy decisions 4 Note: Deficit figures exclude the effect on public sector net investment in 2012-13 of transferring assets from the Royal Mail Pension Plan to the public sector, which reduces net borrowing by ?28 billion (1.8 per cent of GDP) in that year, unless otherwise stated. 1 General government net borrowing on a Maastricht basis. 2 Debt at end March; GDP centred on end March. 3 General government gross debt on a Maastricht basis. 4 Equivalent to the 'Total policy decisions' line in Table 2.1. Source: Office for Budget Responsibility, Office for National Statistics and HM Treasury. 1.69 The structural position of the public finances remains on a sustainable path. The Government's plans ensure a sustained decline in the structural deficit. Chart 1.12 shows that cyclically-adjusted net borrowing - a measure of the deficit that excludes the effects of the cycle and so illustrates the structural fiscal position - is forecast to fall below the pre-crisis level by the end of this Parliament. Cyclically-adjusted net borrowing falls by an annual average of around 1 per cent of GDP over the forecast period, in line with the structural consolidation set out in Autumn Statement 2012. 28 Budget 2013 Chart 1.12: Cyclically-adjusted net borrowing until the end of this Parliament1 10 Per cent of GDP Forecast 9 8 7 6 5 4 3 2 1 0 2002-03 2004-05 2006-07 2007-08 level 2008-09 2010-11 2012-13 2014-15 Cyclically-adjusted net borrowing 1 Cyclically-adjusted net borrowing excluding the effect on public sector net investment in 2012-13 of transferring assets from the Royal Mail Pension Plan to the public sector. Source: Office for Budget Responsibility, Office for National Statistics and HM Treasury. The fiscal mandate 1.70 As announced in the June Budget 2010, the Government's fiscal strategy is underpinned by a forward-looking fiscal mandate to achieve cyclically-adjusted current balance by the end of the rolling, five-year forecast period. The fiscal mandate guides fiscal policy decisions over the medium term, ensuring that the Government sets plans consistent with a reduction in the structural deficit. The fiscal mandate is based on: o a cyclically-adjusted aggregate, to allow some fiscal flexibility at times of economic uncertainty and to allow the automatic stabilisers to operate; o a rolling five-year forecast period, to ensure that fiscal consolidation is delivered over a realistic and credible timeframe; and o the current balance, to protect the most productive public investment expenditure. 1.71 The Government's fiscal mandate is supplemented by a target for public sector net debt as a percentage of GDP to be falling at a fixed date of 2015-16. Performance against the mandate 1.72 Including all measures set out in this Budget, the OBR's March 2013 Economic and fiscal outlook concludes that the Government remains on course to meet the fiscal mandate. The OBR's judgement is that the Government's policies are consistent with a roughly 70 per cent chance of achieving the fiscal mandate in 2017-18. The OBR's forecast is for the fiscal mandate to be achieved a year early, in 2016-17. 1.73 The OBR has also forecast that public sector net debt as a percentage of GDP will be falling in 2017-18, two years later than set out in the supplementary debt target. Budget 2013 29 1.74 The Government's judgement is that significant changes to the path of consolidation in the short term would constrain the operation of the automatic stabilisers, limiting their ability to support the economy. The Government's response is in line with the recommendations of international organisations. The OECD stated that "the Government's decision in the December 2012 Autumn Statement to continue with its existing consolidation plans and not override the automatic stabilisers in order to meet the supplementary debt target is appropriate."36 At this time of rising debt, the Government remains committed to restoring debt to a sustainable, downward path and will retain the existing supplementary debt target. 1.75 As set out in the June Budget 2010, once the public finances are closer to balance, the period over which cyclically-adjusted current balance must be achieved could safely be shortened in order to create a tighter constraint. In addition, once the exceptional rise in debt has been addressed, a new target for debt as a percentage of GDP will be set, taking account of the OBR's assessment of the long-term sustainability of the public finances. 1.76 Charts 1.13 and 1.14 show performance against the Government's fiscal mandate and the supplementary debt target. The cyclically-adjusted current balance in 2017-18 is broadly unchanged from the OBR's December 2012 forecast. Chart 1.13: Consolidation in the cyclically-adjusted current budget 2 Per cent of GDP 1 0 -1 -2 -3 -4 -5 -6 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Consolidation in the cyclically-adjusted current budget (Autumn Statement 2012) Consolidation in the cyclically-adjusted current budget (Budget 2013) Cyclically-adjusted surplus on current budget (Autumn Statement 2012) Cyclically-adjusted surplus on current budget (Budget 2013) Source: Office for Budget Responsibility, Office for National Statistics and HM Treasury. 36 30 OECD Economic Survey: United Kingdom 2013, OECD, February 2013. Budget 2013 Chart 1.14: Public sector net debt 90 Per cent of GDP 85 80 75 70 65 60 55 50 2009-10 2010-11 2011-12 2012-13 2013-14 Autumn Statement 20121 2014-15 2015-16 2016-17 2017-18 Budget 2013 Autumn Statement 2012 excluded the reclassification of Northern Rock (Asset Management) and Bradford and Bingley plc between 2009-10 and 2011-12. Source: Office for Budget Responsibility, Office for National Statistics and HM Treasury. 1 Performance against EU targets 1.77 The Government remains committed to bringing the UK's Treaty deficit in line with the 3 per cent target set out in the Stability and Growth Pact (SGP). The UK is forecast to meet the EU SGP target for the Treaty deficit in 2017-18. Debt management 1.78 The Government's financing plans for 2013-14 are set out in full in the Debt and reserves management report 2013-14, published alongside the Budget and summarised in Annex A. It is anticipated that the net financing requirement of ?162.9 billion will be met through gilt issuance of ?151.0 billion and an increase of ?11.9 billion in the stock of Treasury bills. 1.79 The financing arithmetic provides for ?6 billion of sterling financing for the Official Reserves in 2013-14. The Government continues to envisage sterling financing being held at a similar level in 2014-15. This additional financing, announced at Budget 2011, is intended to meet potential calls on the Official Reserves that may arise and ensure that the level of foreign currency reserves held is sufficient. Budget 2013 31 RPI indexation 1.80 The National Statistician's announcement in January, which confirmed that the Retail Prices Index (RPI) would remain unchanged, stated that a method of calculation used in the RPI would not be chosen were the Office for National Statistics (ONS) to construct a new price index. The Government will keep the use of RPI for indexation purposes under evaluation until after the UK Statistics Authority has concluded reviewing the governance arrangements and structures supporting the production of price indices and how best to ensure that these statistics best meet the needs of users in future. This will allow sufficient time for new ONS price indices, Consumer Prices Index including Housing and Retail Prices Index Jevons, to become established. For gilt investors, their future cash flows on existing index-linked gilts will continue to be calculated by reference to the RPI in accordance with the terms and conditions of those gilts. The Government will continue to issue new index-linked gilts linked to the RPI. Reform of the financial system 1.81 As set out in February 2013, this is the year that the Government's financial sector reforms will reset the banking system. 1.82 Following the London Inter-Bank Offered Rate (LIBOR) rate-fixing and other recent scandals, the Government intends to reform the culture and ethics of the banking industry to improve the way that banks work for their customers. In summer 2012, the Government proposed the establishment of the Parliamentary Commission on Banking Standards, which completed its pre-legislative scrutiny work on the Draft Financial Services (Banking Reform) Bill in December. The Commission has said it will produce a final report in mid-May, and is expected to produce far reaching proposals to improve professional standards and culture in the banking industry. 1.83 The Government is also undertaking ambitious reform to create a more resilient, stable and competitive banking sector, based on the recommendations of the Independent Commission on Banking (ICB), chaired by Sir John Vickers. The Financial Services (Banking Reform) Bill was introduced into the House of Commons in February 2013 and has had its second reading. The Government will be bringing forward further measures in the Bill, in line with recommendations from the Parliamentary Commission on Banking Standards, to create a powerful new tool for the regulator to ensure the independence of the ring-fence bank. The Government will seek to amend the Bill to include provisions giving the regulator the power to enforce full separation between retail and wholesale banking in a specified group, subject to approval from the Treasury. 1.84 The Government continues to implement its plans to overhaul the tripartite system of financial regulation. The Financial Services Act 2012 comes into force on 1 April 2013. It provides the Bank of England with control of macro-prudential regulation, through the FPC, and with the establishment of the Prudential Regulation Authority (PRA) as a subsidiary of the Bank of England, creates a new micro-prudential regulator of deposit-takers, insurers and large investment firms. The new Financial Conduct Authority (FCA) will be responsible for ensuring the markets it regulates function well and in a way that supports consumer protection, market integrity and competition with strong statutory objectives. 32 Budget 2013 Growth 1.85 The Government is delivering an ambitious programme of structural reform to equip the UK to succeed in the global race and support aspiration. Reflecting these reforms, the UK was ranked eighth overall in the World Economic Forum Global Competitiveness Report in 201213, up from twelfth in 2010-11.37 A full implementation update on the Government's Plan for Growth has been published alongside this Budget.38 1.86 Budget 2013 sets out further action the Government will take to help UK businesses create jobs and to help people buy their own home. The Budget announces reforms to: o improve the UK's infrastructure with a commitment to increase capital spending by ?3 billion a year from 2015-16; o help those who want to buy a home and increase the number of new homes being built with ?5.4 billion of additional financial support. This includes a ?3.5 billion investment in a Help to Buy: equity loan scheme in England open to all those who aspire to own a new build home, and the creation of a major new Help to Buy: mortgage guarantee to increase the availability of mortgages for new or existing properties for those with small deposits. To further support the supply of new housing, the Build to Rent and affordable homes guarantee programmes will also both be significantly expanded; o support small business, including those looking to take on their first employee, by introducing a new ?2,000 Employment Allowance to reduce employer National Insurance contributions (NICs) for all businesses; o achieve the Government's ambition for the UK tax system to be the most competitive in the G20, cutting corporation tax to 20 per cent from April 2015; o build on the UK's strengths, with ?1.6 billion of funding to support long-term strategies for 11 sectors where the UK can be world-leading, including funding for a new Aerospace Technology Institute; and o devolve significant funding to Local Enterprise Partnerships (LEPs), in response to Lord Heseltine's review, enabling them to tackle the barriers to growth that hold back the private sector in their areas. 37 38 The Global Competitiveness Report 2012-2013, World Economic Forum, 2012. Plan for Growth implementation update, HM Treasury, March 2013. Budget 2013 33 Figure 1.1: Implementation of growth commitments39 COMPETITIVE TAX SYSTEM COMMITMENTS Make the UK the best location for corporate headquarters in Europe PROGRESS TO DATE FORTHCOMING IMPLEMENTATION o Main rate of corporation tax cut to 24 per o By 2015, main rate will fall to 20 per cent cent, the lowest in the G7 o By 2015, a single, unified rate at 20 per cent o Corporation tax for smaller companies cut o From April 2013, new tax reliefs for the to 20 per cent o Reform of Controlled Foreign Company rules o research and development (R&D) tax credit increased to 225 per cent Personal allowance to rise to ?9,440 from April taking 1.1m people out of income tax Threshold for employer NICs raised, with 650,000 employees taken out of employer NICs The largest rail investment since the Victorian era with support for ?9.4bn of enhancements Seven national and eighteen local major roads complete UK Guarantees to support ?1bn for the Northern Line Extension and ?75m for Drax conversion A tripling of support for low carbon generation, providing up to ?7.6bn by 2020 Support for 32,000 SMEs to export in 2012-13 Support for UK exporters to win contracts worth over ?3.2bn since 2011-12 o o Small and medium-sized enterprises (SME) Reduce tax on employment and work o Develop UK infrastructure o o o o INVESTMENT AND EXPORTS 40 o o o o o o o o o Encourage investment across sectors and regions BEST PLACE FOR BUSINESS Promote exports and inward investment o Annual Investment Allowance increased to o o 24 Enterprise Zones established, creating o Improve access to finance and support to new and growing businesses Reduce burdens on businesses o o o ?250,000 for two years from January 2013 o o o o EDUCATED, FLEXIBLE WORKFORCE o 39 40 34 Radical reform to every stage of education and skills provision UK as a world leader on science and technology o o o o o o 1,700 jobs and almost ?156m of investment 39 banks and building societies signed up to the Funding for Lending Scheme ?1.7bn of funding raised so far through the Business Finance Partnership New Seed Enterprise Investment Scheme and expanded Venture Capital Trusts and Enterprise Investment Scheme New emphasis on sustainable growth in planning policy, and approvals at a 10-year high Deregulation to save businesses ?840m a year Qualifying period for unfair dismissal increased from one year to two 2,724 Academies and 80 free schools open Almost 1m apprenticeship starts this Parliament Five University Technical Colleges (UTCs) open Pupil Premium benefitting 1.3m deprived pupils Four Catapult Centres opened including high-value manufacturing and cell therapy 14 science and innovation capital projects from the Research Partnership Investment Fund o o o o o o animation, high-end television and video games industries40 From April 2013, a Patent Box worth ?700m a year From April 2013, an 'above the line' R&D credit at a headline rate of 10 per cent Personal allowance to ?10,000 by April 2014 From April 2014, ?2,000 Employment Allowance for businesses and charities From April 2013, top rate of income tax of 45 per cent Completion in 2013 of major projects worth over ?2bn, including major upgrades to roads Consulting on the route for the second phase of High Speed Two in 2013 From April 2013, a new carbon price floor Legislation to provide certainty in energy infrastructure and bring forward investment From April 2013, ?140m over two years to support more SME exporters and attract overseas investment Financial Services Trade and Investment Board to open up trade opportunities and investment From April 2013, ?5.4bn on housing including Help to Buy and Build to Rent From 2015, a Single Local Growth Fund to give local areas control over growth-related spending Business Bank will start investing in 2013, and will be fully operational from 2014 By summer 2013, further investments by the Business Finance Partnership From April 2013, a limited extension of the capital gains tax relief for the Seed Enterprise Investment Scheme Reforms to employment law saving employers an estimated ?40m a year by 2015 By 2015, at least 3,000 regulations abolished or reduced through the Red Tape Challenge o In 2013, 100 free schools expected to open o 30 UTCs expected to be open by September 2014 o In 2013-14, up to ?240m of skills funding will be directed to employers o Three more Catapult Centres to open by June 2013 o A new Aerospace Technology Institute, providing ?2.1bn of R&D support to the aerospace sector For further details and data sources see Plan for Growth implementation update, HM Treasury, March 2013. Subject to state aid approval. Budget 2013 Infrastructure 1.87 Following years of historic underinvestment in UK infrastructure, the Government has made infrastructure a key economic policy priority. The UK's first ever National Infrastructure Plan, published in 2010, set out a comprehensive approach to strengthening the nation's infrastructure.41 An update on delivery of the Top 40 Projects identified in the National Infrastructure Plan 2011 is published alongside Budget 2013.42,43 As Chart 1.15 shows, annual investment in infrastructure has grown since 2010. Chart 1.15: Average annual infrastructure investment in the UK, public and private Average annual infrastructure investment 40 ? billion in 2011-12 prices 35 ?33 billion 30 ?29 billion 25 20 15 10 5 0 2005-2010 2010-2012 Source: HM Treasury estimates using data from company accounts, regulators, Office for National Statistics and government departments, including private and public investment. Government investment 1.88 Budget 2013 announces that capital investment plans will be increased by ?3 billion a year from 2015-16, to lock in recent increases in capital spending over the Spending Review 2010 period, funded through reductions in current spending. This will mean ?18 billion additional capital spending over the next Parliament. Together with the additions to infrastructure spending announced at Spending Review 2010, Autumn Statement 2011, and Autumn Statement 2012, this means that public investment as a share of GDP will be higher on average over this Parliament and the next Parliament collectively than under the previous government. 1.89 The Government will set out how this capital spending will be allocated at the 201516 Spending Round. The Spending Round will take a long term approach to capital planning, including setting planning assumptions out to 2020-21 for key areas of capital expenditure. The Spending Round will set social rental policy until 2025. This will provide the long-term policy certainty necessary to attract private investment today. Support for private investment in infrastructure 1.90 The Government is acting to give private investors the confidence to invest in the UK's energy sector. From April 2013 the carbon price floor announced at Budget 2011 will come National Infrastructure Plan 2010, HM Treasury and Infrastructure UK, October 2010. National Infrastructure Plan 2011, HM Treasury and Infrastructure UK, November 2011. 43 Infrastructure Delivery Update, HM Treasury and Infrastructure UK, March 2013. 41 42 Budget 2013 35 into effect, providing a clear and credible long-term signal to support investment in low carbon electricity generation. 1.91 The Energy Bill, currently making its passage through Parliament, will introduce Electricity Market Reform. By providing stable revenues for investors at a fixed level known as a strike price, Contracts for Difference, as set out in the Bill, will provide long-term certainty for investors in low carbon generation. This will lower the cost of capital and help developers secure the large upfront amounts of capital investment required. Support available for low carbon electricity investment through the Levy Control Framework up to 2020 will rise to ?7.6 billion a year (in 2012 prices), more than triple the ?2.35 billion available in 2012-13. Together with the Government's Energy Bill and Gas Generation Strategy, published in 2012, this will provide the framework needed for new energy investment.44 1.92 The Government intends to take forward two Carbon Capture and Storage projects to the detailed planning and design stage of the competition. This represents the next step in the ?1 billion Carbon Capture and Storage commercialisation programme and follows a period of intensive commercial negotiations with a number of bidders. The Department for Energy and Climate Change will set out the details of the preferred bidders, next steps on these front end engineering and design studies, and the process to final investment decision. 1.93 A successful UK shale gas industry has the potential to provide new employment and support UK energy security, benefiting the economy, taxpayers and communities. The Government will: o introduce a new shale gas field allowance and extend the ring-fence expenditure supplement from six to ten years for shale gas projects to promote investment in this industry at an early stage of its development. The Government will consult on the detail of these reforms, including whether they should be extended to other forms of onshore unconventional gas; o produce technical planning guidance on shale gas by July 2013 to provide clarity around planning for shale gas during the important exploration phase for the industry. As the shale gas industry develops the Government will ensure an effective planning system is in place and by the end of the year will produce guidance for the industry to ensure the planning system is properly aligned with the licensing regime and regulatory regimes principally: health and safety; and environmental protection. The Government will keep under review whether the largest shale gas projects should have the option to apply to the major infrastructure regime; o develop proposals by summer 2013 to ensure that local communities will benefit from shale gas projects in their area; and o provide detail of the objectives, remit and responsibilities of the Office of Unconventional Gas and Oil. 1.94 In addition, the Government is acting to support investment in offshore oil and gas. At Budget 2012, the Government committed to introducing a new contractual approach to provide further certainty on decommissioning relief on the UK Continental Shelf. Following successful consultation, Budget 2013 announces that contracts will be signed later in 2013, providing the certainty needed to unlock billions of pounds of additional investment. 44 36 Gas Generation Strategy, Department of Energy and Climate Change, December 2012. Budget 2013 Figure 1.2: Range of projects and programmes from the Top 40 priority investments Energy Railways Flood defence Super-connected cities Ports Airports Roads Water NORTHERN IRELAND Devolved responsibilities include: rail, roads, local transport, water, flood and waste n Super-connected city: Derry/Londonderry n SCOTLAND Devolved responsibilities include: rail, roads, local transport, water, flood and waste n Super-connected city: Aberdeen n Super-connected city: Perth n Super-connected city: Edinburgh n Onshore wind: Whitlee n Biomass: Rothe n Scottish Caledonian Sleeper Service n NORTH WEST NORTH EAST Sunderland Strategic Corridor Morpeth Nothern Bypass n Offshore wind: Teesside n n YORKSHIRE AND THE HUMBER M60 Junction 12-15 Salford, Greater Manchester n Mersey Gateway Bridge n High Speed 2 (Manchester) n Rail: Northern Hub n Container terminal project: Liverpool Port M62 Junction 25-30 Morley, West Yorkshire M1 Junction 39-42 Wakefield, West Yorkshire n North Doncaster Chord n High Speed 2 (Leeds) n Renewable energy: Port of Hull n Super-connected city: York n n n EAST MIDLANDS WEST MIDLANDS M1 Junction 28-31 Chesterfield, Derbyshire A14 Kettering Bypass n Nottingham Tram Extension n Flood defence: Nottingham M6 Junction 5-8 Gravelly Hill, Birmingham Birmingham New Street upgrade n Evesham Bridge n High Speed 2 (Birmingham) n Biomass: Ironbridge n n n n WALES EAST OF ENGLAND Devolved responsibilities include: roads, local transport, water, flood and waste n Super-connected city: Newport n Super-connected city: Cardiff n Nuclear: Wlyfa Power Station A11 Fiveways to Thetford A14 corridor n Peterborough station enhancements n Nuclear: Sizewell n n n SOUTH WEST Kingskerswell Bypass n Intercity Express: Stoke Gifford (Bristol) n Nuclear: Hinkley Point n Flood defence: Truro n A30 (Temple) SOUTH EAST M3 Junction 2-4a Staines, Surrey Great Western Electrification n Reading station upgrade n Container terminal project: Southampton Port n n n LONDON Thames Tideway Tunnel Crossrail n London Underground upgrade n Heathrow Investment Programme n n Budget 2013 37 1.95 The sale of 4G mobile spectrum will enable the delivery of competitive high speed mobile broadband from summer 2013 onwards, bringing benefits to businesses and consumers. However, the public sector still holds a large amount of valuable spectrum. In order to meet the commitment to release 500MHz of spectrum by 2020, the Government will look to introduce further financial incentives to ensure more efficient use and management of public sector spectrum holdings. Infrastructure planning and delivery 1.96 Following Lord Deighton's assessment of Whitehall's ability to deliver infrastructure, which was announced at Autumn Statement 2012 and undertaken with Infrastructure UK (IUK) and the Major Projects Authority, the Government will implement a series of reforms to effect a step change in its approach to infrastructure delivery. Using the experience of delivering the Olympic and Paralympic Games and drawing on private sector best practice, these reforms include creating an enhanced central cadre of commercial infrastructure specialists in IUK who will be deployed into infrastructure projects across government, and the establishment by the summer of tough new Infrastructure Capacity Plans to drive forward progress in key government departments. These reforms will be undertaken in conjunction with Cabinet Officeled efforts to strengthen Whitehall's commercial capability and Lord Browne's work to improve the Government's management of major projects including through an enhanced Major Projects Authority. 1.97 The Government is committed to ensuring that investors have the confidence to make long-term decisions on major infrastructure projects, based on a policy framework that is informed by an objective and evidence-based assessment of the UK's infrastructure needs and priorities. The Government will therefore consider options for making more use of independent expertise in shaping its infrastructure strategy. Housing and planning 1.98 The Government is committed to making the aspiration of home ownership a reality for as many households as possible. The Government wants the next generation to experience the benefits of owning their own home, in the same way their parents and grandparents were able to. 1.99 The Government has already committed to invest over ?11 billion during the 2010 Spending Review period in housing. This Budget announces major reforms, including ?5.4 billion of financial support, of which ?1.3 billion is in 2013-14. This will tackle long-term problems in the housing market and support those who want to get on or move up the housing ladder, while also ensuring an increased number of new homes get built both now and in the future. This includes Barnett consequentials for the Scottish Government, Welsh Government and Northern Ireland Executive. Support for home ownership 1.100 Since the financial crisis in 2007, increased requirements for larger deposits and falling equity values have meant many credit-worthy households cannot get a mortgage, or are trapped in their existing homes unable to take the next step. The Government will support these households through Help to Buy, a package of measures that will increase the supply of low-deposit mortgages for credit-worthy households, increase the supply of new housing and contribute to economic growth. 1.101 From 1 April 2013, building on the success of First Buy, Help to Buy: equity loan will be opened up to all those who aspire to own a new build home. The Government will: 38 Budget 2013 o provide an equity loan worth up to 20 per cent of the value of a new build home, repayable once the home is sold; o significantly widen the eligibility criteria to ensure as many people as possible are able to benefit. The maximum home value will be ?600,000 and there will be no income cap constraint; and o ensure that the scheme is open not only to first-time buyers but also to all those looking to move up the housing ladder. 1.102 Help to Buy: equity loan will be open for the next three years, providing ?3.5 billion of investment in England, supporting up to 74,000 more home buyers as well as providing a boost to the construction sector. 1.103 The Government will create a major new Help to Buy: mortgage guarantee to increase the availability of mortgages on new or existing properties for those with small deposits. The Help to Buy: mortgage guarantee, a temporary scheme that will run for three years from January 2014, will: o increase the supply of high loan-to-value mortgages by offering a government guarantee to lenders who offer mortgages to people with a deposit of between 5 per cent and 20 per cent; o be open not only to first-time buyers but also to existing homeowners; o have no income cap constraint; and o be available on homes with a value of up to ?600,000. 1.104 Help to Buy: mortgage guarantee will, subject to the final design, make available up to ?12 billion of government guarantees, sufficient to support ?130 billion of high loan-to-value mortgages. 1.105 The Government wants to give more social housing tenants the opportunity to benefit from home ownership. Since its introduction in the 1980s Right to Buy has helped almost 2 million households to experience the benefits of home ownership. In April 2012 the Government reinvigorated the scheme by increasing the maximum discount to ?75,000. To broaden opportunity the Government will: o look at ways to simplify the application process to ensure applicants are not hampered by a burdensome administrative process; o reduce the qualifying period before tenants become eligible for Right to Buy from five years to three years; and o from 25 March raise the maximum discount cash cap in London to ?100,000 where the current cap is most keenly felt. 1.106 The additional receipts from increased sales will be used to pay down housing debt and support the Government's commitment to 1:1 replacement of all additional homes sold. Support for new development 1.107 The Government wants to ensure that there is a long-term supply of housing that is better matched to demand. 1.108 The ?200 million Build to Rent fund announced at Autumn Statement 2012 was significantly oversubscribed. Budget 2013 announces that this fund will be expanded to ?1 billion to support the development of more homes in England. The fund will provide equity or loan finance to support the development finance stage of building new homes for private rent. Budget 2013 39 1.109 The Government is committed to implementing 'zero carbon homes' from 2016. The Department for Communities and Local Government (DCLG) will publish a detailed plan, setting out its response to the 2012 consultation on the energy efficiency requirements in building regulations, by May 2013. The Government will then consult on next steps, including on the means of delivering allowable solutions, by Summer Recess. 1.110 In London, the Mayor will work with the Homes and Communities Agency to support new build home purchases through Help to Buy: equity loan and new private rented homes through Build to Rent. This will involve a minimum of ?750 million of funding up to 2015-16. Support for affordable housing 1.111 Affordable housing plays an important part in the Government's overall drive to boost housing supply and stimulate economic growth. The Government has recently issued a prospectus to support affordable homes delivered through the guarantee programme. The Government now wants to go further and will double the existing affordable homes guarantee programme, providing up to an additional ?225 million to support a further 15,000 affordable homes starting in England by 2015. 1.112 The Government also recognises the concerns of social landlords regarding uncertainty on social rents after 2014-15. Certainty is important to help landlords plan future housing development, providing affordable housing and boosting the construction sector. At the 201516 Spending Round the Government will therefore set out a social rental policy that gives social landlords certainty until 2025. 1.113 The Government also wants to make sure that affordable housing is available to those who need it most. The Government recently consulted on 'Pay to Stay' proposals to ensure that those social housing households on high incomes make a fairer contribution. The Government will shortly take steps towards allowing social landlords to charge market rents to tenants with income of over ?60,000. The Government intends to require these tenants to declare their income to ensure they make a fair contribution, with all additional income reinvested in housing. Reform of the planning system 1.114 Alongside measures to increase home ownership the Government is reforming the planning system to ensure that reforms will increase housing supply. Planning constraints have depressed the supply of new homes. Over the last 10 years, there have been an average of only 161,000 net additions to the housing stock a year while the number of households in England is projected to grow to 27.5 million in 2033, an increase of 232,000 households a year. 1.115 The National Planning Policy Framework, published in March 2012, is already having an effect.45 The proportion of planning applications being approved is at a ten year high and the pace of local plan making has increased, with 70 per cent of councils now with at least a published plan. The Government will continue with the reform of the planning system to ensure the regime is simple to access, supports growth and is responsive to housing need. The Government will: o publish significantly reduced planning guidance by this summer, in line with Lord Matthew Taylor's recommendations, providing much needed simplicity and clarity. The Government will make greater use of information on prices to ensure that sufficient land is allocated to meet housing and employment need; o ask local areas to put in place bespoke pro-growth planning policies and delivery arrangements, as part of new Local Growth Deals, pursued in response to Lord Heseltine's review, and through City Deals; and 45 40 National Planning Policy Framework, Department for Communities and Local Government, March 2012. Budget 2013 o consult on allowing further flexibilities between use classes to support change of use from certain agricultural and retail uses to residential use to increase responsiveness within the planning system. 1.116 In addition, DCLG is progressing a public sector land auctions model and will work with HM Treasury to conduct a feasibility study into wider use of the model. 1.117 The Government believes judicial reviews have created unacceptable delays to the development of crucial infrastructure and housing projects. The Ministry of Justice has already consulted on shortening the time limits for bringing a planning judicial review and will set out its plans in the spring. The Government will also develop further measures to streamline the process for planning judicial reviews by summer 2013. A competitive tax system 1.118 The Government's Corporate Tax Roadmap, published in 2010, set out major reforms to the tax system designed to support UK businesses and ensure the UK is an attractive location for foreign investment.46 1.119 At the heart of the reform package was a commitment to reduce the main rate of corporation tax. So far the Government has cut the main rate from 28 per cent to 24 per cent, and announced further reductions to come, to 23 per cent from April 2013 and 21 per cent from April 2014. 1.120 The Government's reforms to the corporate tax system have been welcomed by businesses. For example, Chart 1.16 shows the dramatic improvement in the UK's performance in KPMG's Annual Survey of Tax Competitiveness. Chart 1.16: Results of KPMG Annual Survey of Tax Competitiveness 1 100 Per cent 90 80 70 60 50 40 30 20 10 0 Ireland Netherlands 2007 Switzerland 2008 Luxembourg 2009 UK 2011 US 2012 1 Chart shows percentage of respondents mentioning country in response to: overall, which of the following countries do you think a) has the most competitive tax regime? b) and which is second? c) and third (any mention). Source: KPMG. Corporate Tax Reform: delivering a more competitive system, HM Treasury and HM Revenue and Customs, November 2010. 46 Budget 2013 41 1.121 At Budget 2013 the Government announces it will go further, and will reduce the main rate of corporation tax by an additional 1 percentage point in April 2015, so it will reach 20 per cent. In the process, the Government will unify the small profits rate and the main rate so there is a single rate of corporation tax, simplifying the tax system. 1.122 This means that by the end of this Parliament the UK will have the joint lowest rate of corporation tax in the G20, as shown in Chart 1.17 - and a rate that is significantly lower than key competitors, including the US, Japan, France and Germany. This will support British businesses and encourage investment. It will also show that Britain is open for business. Chart 1.17: Main corporation tax rates in the G20 (2015 based on announced plans) UK Turkey Saudi Arabia Russia South Korea Indonesia China Canada South Africa Mexico Germany Australia Italy India France Brazil Argentina Japan United States 0 5 10 15 20 25 30 35 40 45 Main corporation tax rate (per cent) G7 G20 Sources: International Bureau of Fiscal Documentation, Deloitte, KPMG and PwC. 1.123 To take account of the benefit to the banking sector of the additional reductions in corporation tax, the rate of the Bank Levy will increase to 0.142 per cent from 1 January 2014. The levy ensures that banks make a fair contribution and reflects the risks they pose to the financial system and the wider economy. 1.124 The Government is also delivering on the other aspects of the Roadmap. In January 2013, the UK implemented a modernised Controlled Foreign Companies regime that strikes the right balance between making the corporate tax system more competitive and providing adequate protection of the UK tax base. From April 2013, the Patent Box will give a reduced 10 per cent rate of corporation tax on profits from patents, driving growth and investment in UK innovation. 1.125 Research and development (R&D) incentives recognise the importance of business investment in new ideas and technologies and form a key part of the Government's commitment to an internationally competitive tax system. As announced at Autumn Statement 2011, the Government will introduce a new 'above the line' (ATL) credit for large company R&D investment from April 2013. The ATL credit is designed to make R&D relief more visible to those making investment decisions and provide greater cash flow support to companies with no corporation tax liability. 42 Budget 2013 1.126 The headline rate of the ATL credit will be 10 per cent, increased from the 9.1 per cent rate proposed at Budget 2012. This will make the UK a more attractive location for large company R&D activity by further reducing the after tax cost of investment. The introduction of the ATL credit follows an increase in the rate of the small and medium-sized enterprises (SME) R&D tax credit from 175 per cent to 225 per cent at Budget 2011, which continues to provide targeted support for early stage companies and start-ups investing in R&D in the UK. 1.127 Alongside reforms to increase the competitiveness of the tax system, the Government is acting both nationally and internationally to ensure that all businesses pay their fair share of tax. Additional reforms are set out in the next section. Support for enterprise 1.128 The Government's ambition is for the UK to be the best place in Europe to start, finance and grow a business. Small businesses report that costs of employment are one of the biggest barriers to success they face. Budget 2013 announces that from April 2014 every business and charity will be entitled to a ?2,000 Employment Allowance towards their employer NICs bill.47 A new Employment Allowance for every business and charity From April 2014, all businesses and charities will be eligible for a new ?2,000 Employment Allowance. This will reduce their employer NICs bill. Up to 1.25 million employers will benefit, with over 90 per cent of the benefit going to small businesses. The scale of the allowance means that 450,000 of the UK's small businesses will no longer pay any employer NICs. On average, employers with fewer than 10 employees over the course of the year will see their employer NICs bill reduced by 80 per cent. The Employment Allowance will reduce the cost of taking on new staff for small businesses; supporting those with an ambition to grow by hiring their first employee or expanding their workforce. Every business will be able to employ one worker on a salary of ?22,400, or four employees working full time on the adult National Minimum Wage, without paying any employer NICs at all. The Employment Allowance will be introduced from April 2014, delivered through standard payroll software and HMRC's Real Time Information system. To ensure maximum take-up, it will be simple to administer: employers will only need to confirm their eligibility through their regular payroll processes. This confirmation will ensure that up to ?2,000 will be deducted from their employer NICs liability over the course of the year's PAYE payments. The Government will engage with business representative bodies on the details of the design and operation of the new allowance, in order to ensure the system is as simple and effective as possible. 1.129 This builds on action taken at Autumn Statement 2012 to help businesses succeed, including: o the increase of the Annual Investment Allowance limit from ?25,000 to ?250,000 for two years from January 2013 to help businesses invest; and o the doubling of the Small Business Rate Relief scheme for a further 12 months from April 2013, benefiting over half a million small businesses. 47 Estimated impacts from HMRC analysis based on PAYE administrative data grown in line with OBR determinants. Budget 2013 43 1.130 As in previous years, the Small Business Rate Relief scheme will be considered at Autumn Statement 2013. Budget 2013 also announces wider action that will help businesses, including on fuel duty, as set out in the next section. 1.131 In addition, the Seed Enterprise Investment Scheme, launched at Budget 2012, offers 50 per cent income tax relief on investments made into small, early-stage companies. The Government has decided to provide a limited extension of the capital gains tax holiday to continue to encourage investors to take up the new scheme. Any investors making capital gains in 2013-14 will receive a 50 per cent capital gains tax relief when they reinvest those gains into seed companies in either 2013-14 or 2014-15. The recent expansions to Venture Capital Trusts (VCTs) and the Enterprise Investment Scheme, alongside the new Seed Enterprise Investment Scheme, mean that the UK now offers generous enterprise tax reliefs to support small and growing businesses. The Government is committed to ensuring that these schemes are effective and has sought to maintain stability by not making major changes. However, following a number of representations from investors, the Government is concerned that VCTs offering enhanced buy-backs are not operating within the spirit of the legislation. The Government will continue to monitor particular aspects of the venture capital schemes to ensure that they remain well-focused and supportive of businesses needs. 1.132 Long-term economic success depends on today's small and high growth companies being able to access affordable long term financing to grow into the large businesses of tomorrow. On 13 March 2013 the Government launched a consultation on extending Individual Savings Account (ISA) eligibility to include a wider range of small company shares. To further support these companies, the Government will abolish Stamp Tax on Shares for companies listed on growth markets including the Alternative Investment Market (AIM) and the ISDX Growth Market, from April 2014. This will directly benefit hundreds of smaller quoted UK firms, lowering their cost of capital, helping to promote jobs and growth across the UK. 1.133 The Government is legislating to introduce a new employee shareholder status that will give staff a stake in their firms' future success and give firms greater choice about the contracts they can offer to individuals. Employee shareholders will have different employee rights and shares worth a minimum of ?2,000 in the firm they work for. As already announced, the Government will exempt gains on up to ?50,000 of shares acquired by employee shareholders from capital gains tax. The Government has also decided that the first ?2,000 of share value that anyone receives under the new status will be free from income tax and NICs. This will be of particular benefit to anyone receiving the minimum amount of shares, as it will ensure that no tax is due when they receive their shares. This will take effect from 1 September 2013, when the new status comes into force. 1.134 The Government supports employee ownership as a business model and welcomes work by the Implementation Group on Employee Ownership to take forward the recommendations of the Nuttall Review. In order to further incentivise growth of the sector, the Government is providing ?50 million annually from 2014-15. This will be used to respond to recommendations from the Nuttall Review and other relevant organisations who aim to encourage employee ownership. It will also be used to fund the introduction of a capital gains tax relief on the sale of a controlling interest in a business into an employee ownership structure. Consultation on this measure will take into account the progress of work by the Department for Business, Innovation and Skills (BIS) and the Implementation Group to develop an 'off the shelf' employee owned company model, with the intention that the new capital gains tax relief will be introduced in Finance Bill 2014. The Government will also look at further incentives in this area, including measures targeted at employees through indirect ownership models. 1.135 Social enterprises play an important role in growing the economy, reforming public services and promoting social justice. The Government will introduce a new tax relief to 44 Budget 2013 encourage private investment in social enterprise. The tax relief will complement the Government's other recent measures to help social enterprises access the capital they need, such as the launch in 2012 of Big Society Capital. The Government will consult formally on the details of the relief by summer 2013 and the relief will be introduced in Finance Bill 2014. 1.136 Each year over 130 million working days are lost to sickness absence.48 The Government believes that more can be done to support employees to return to work, and commissioned Dame Carol Black and David Frost to conduct an independent review of sickness absence. Following their recommendations, as announced in January 2013, the Government will abolish the Percentage Threshold Scheme and recycle funding into creating the health and work assessment and advisory service for those in danger of long-term sickness absence. The Government will also introduce a targeted tax relief so that amounts up to a cap of ?500 paid by employers on health-related interventions recommended by the service are not treated as a taxable benefit in kind. The Government will consult on implementation later in 2013. Partnership between government and industry 1.137 As well as providing the conditions for private sector growth, both central and local government can engage more directly in supporting UK businesses to succeed in global markets, through strategic partnerships between the public and private sectors. Chart 1.18 shows that the UK currently only captures a small share of high growth import markets. These partnerships will enhance the UK's ability to compete in the global race by identifying and addressing barriers to growth including those specific to particular industries and local areas. Chart 1.18: International comparisons of projected growth of import demand 2010-2017 and current UK share of import market 140 7 Per cent 120 6 100 5 80 4 60 3 40 2 20 1 0 0 China Brazil India Russia Italy Germany USA France Projected growth in import demand 2010-2017 (left-hand axis) Current UK share of import market (right-hand axis) Sources: HM Treasury calculations using International Monetary Fund, Office for National Statistics and United Nations Conference on Trade and Development data. 48 Sickness Absence in the Labour Market, April 2012, ONS, 2012. Budget 2013 45 Support for industry at national level 1.138 The Government's Industrial Strategy, announced in September 2012, aims to maintain and enhance the UK's global position in 11 key sectors: automotive, aerospace, life sciences, agri-tech, professional business services, information economy, construction, education, nuclear, oil and gas, and offshore wind. The Government is working with industry to create sector strategies that identify long-term opportunities and address barriers to growth. Each strategy will set out actions for both industry and the Government, such as bridging skills gaps or strengthening supply chains. The Government will also create or strengthen sector councils as a long-term platform for engagement with business, ensuring that policy making is informed by business needs. The life sciences and aerospace sector strategies have been published. The remaining sector strategies will be published during 2013. 1.139 The Government will provide ?1.6 billion of funding to support these strategies. This funding will be allocated over the course of 2013. 1.140 From this fund the Government, in partnership with industry, will create an Aerospace Technology Institute (ATI). This will provide ?2.1 billion of R&D support to the aerospace sector over seven years, with Government and industry contributing equal shares. The ATI will also set a strategic direction for R&D in the sector and secure additional funding from external sources. Providing certainty on government support will give the sector the stability it needs to develop the next generation of aircraft technologies in the UK. The UK currently has the second largest aerospace sector in the world (after the US), and the Government is determined to maintain the UK's position as a global leader in this growing market. 1.141 In addition, the Government is providing further support for the creative industries. The UK represents a global centre of excellence in digital media production, including visual effects. To further support this high-tech and export-oriented sector, build capacity and support growth: o the Technology Strategy Board will design and launch a new competition of up to ?15 million inviting consortia bids to support digital content production through partnerships with industry, including specialist SMEs, educational research facilities and training providers; o funding for the Skills Investment Fund will be increased to ?8 million each year over the next two years, with Government match-funding voluntary industry contributions to support skills development in the UK digital content sectors; and o the Government will launch a public consultation on options to provide further support for the visual effects industry through the tax system. 1.142 The UK financial services industry plays a central role in the UK economy, contributing ?129 billion to the economy, ?63 billion in tax, a trade surplus of ?47 billion, and over 1 million jobs, two-thirds of which are outside London.49 To strengthen the competitiveness of the industry, it is critical that UK firms can secure access to markets around the world and that government creates the right environment and provides the right support to allow firms to win market share - especially in emerging market economies where new investors, savers and markets are appearing. 1.143 To support these efforts, the Government has created a new Financial Services Trade and Investment Board (FSTIB), chaired by a senior Treasury official and comprising senior representatives from UK Trade and Investment (UKTI), HM Treasury, and TheCityUK, and representing financial institutions. This will have the authority and expertise to identify trade and investment priorities, and to support UK firms in pursuing these vigorously across the globe. 49 46 Economic Contribution of UK Financial and Professional Services, TheCityUK, 2013. Budget 2013 1.144 The Government is also creating a new unit within UKTI, led by an industry expert, to drive this work forward. By co-ordinating action across key departments, industry and UKTI, the FSTIB will work with partner jurisdictions to help open up opportunities for trade; advance the interests of UK financial institutions - large and small; bring new investment from global financial institutions to the UK's cities and regions; and find ways to support jobs and growth not only in the UK, but across the entire global economy that London serves. 1.145 The UK is the leading centre in Europe for asset management, but many of the funds managed here are based overseas. This Budget announces a targeted package of measures to improve the competitiveness of the UK as a location for fund domicile covering regulation, marketing and tax. This will bring tax revenues, stimulate growth, and create jobs across the country. At the heart of the package is the abolition of the Schedule 19 (Finance Act 1999) charge on funds, which will be included in Finance Bill 2014. Schedule 19 has been consistently cited by the industry as one of the chief obstacles to establishing new funds in the UK. 1.146 Businesses, especially early stage companies, often struggle to fund the feasibility and prototyping stages of the development of new technologies and government departments can find it difficult to engage with these companies. The Small Business Research Initiative (SBRI) aims to address this barrier to innovation and help departments meet their objectives by bringing fresh ideas to bear. Under the SBRI, businesses compete for government contracts to develop new ideas with the potential to tackle public sector challenges. The Government will substantially expand SBRI among key departments so that the value of contracts through this route increases from ?40 million in 2012-13 to over ?100 million in 2013-14 and over ?200 million in 2014-15. An evaluation will be carried out alongside this expansion to ensure departments are making best use of the scheme and review whether a further expansion is possible. The evaluation will produce an interim report in autumn 2014 and a final report in February 2015. Exports 1.147 Winning business abroad and attracting global talent and investment to the UK are central to the UK's future prosperity. At Autumn Statement 2012 the Government announced ?70 million in additional funding for UKTI, along with additional flexibilities, to enable it to deliver improved services and refocus its activities on the highest value opportunities and emerging markets. UKTI has moved quickly to mobilise this extra support, and has already: o doubled the number of companies included in its Strategic Relationship Management model to 76, as set out in Autumn Statement 2012. These key companies have been drawn from sectors with high growth potential identified in the Government's Industrial Strategy, such as education, digital and advanced manufacturing; o increased the number of projects being pursued by its High Value Opportunity (HVO) programme to 100. UKTI have identified HVOs with a total of ?80 billion (up from ?51 billion), of contracts potentially available to UK firms over the next two years which UKTI will help firms to win; and o scaled up its successful work with leading Industry Associations to increase the number of SMEs that attend overseas trade exhibitions. More than 8,000 companies are expected to benefit from this programme in 2013-14. Lord Heseltine's review 1.148 The Government welcomes Lord Heseltine's review on economic growth, No Stone Unturned, which reported on 31 October 2012. His review makes a powerful case for increasing the devolution of economic powers from central government to LEPs, and for a stronger voice and role for the private sector in promoting growth. Autumn Statement 2012 set out the Budget 2013 47 Government's initial response to the review. The Government has published a full response, Government's response to the Heseltine review,50 addressing his wide-ranging recommendations on all aspects of government policy that affect economic growth. The Government can confirm that the overwhelming majority of his recommendations have been accepted. 1.149 Building on announcements made at Autumn Statement 2012, the Government confirms its endorsement of Lord Heseltine's recommendation on the creation of a Single Local Growth Fund, devolved to the local level through new Local Growth Deals. This represents a step-change in decentralisation, so that the responsibility for decisions on how funding should be spent is taken by those with knowledge of, and a stake in, the local area. Funding will be allocated to LEPs on the basis of strategic multi-year plans for local growth. In developing these plans, LEPs and their partners will be challenged by government to leverage private and local funding and commit to governance reform - those that offer the most will be more likely to benefit in terms of funding and flexibilities. The competitive tension in this something-for-something approach will incentivise LEPs to offer more, and drive improvements in local areas. The Single Local Growth Fund will be operational by April 2015 and further detail will be set out at the 2015-16 Spending Round. Business environment 1.150 The quality of the business environment is essential to the UK's success in the global race. The Government is acting to ensure that UK businesses are competitive in both domestic markets and important overseas markets, and that the UK is attractive to inward investors. The UK's overall competitiveness is improving, but further reform is needed in key areas. Access to Finance 1.151 Following the financial crisis, access to finance remains challenging, particularly for SMEs. Progress has already been made through the FLS and the Business Finance Partnership. 1.152 The introduction of the Business Bank will make a significant difference to both the level and diversity of finance provision while also improving competition in the market and supporting SME growth. It will simplify and improve the finance and support landscape for businesses. The Government is publishing the first strategy for the Business Bank which sets out an accelerated timetable for how the Business Bank will deploy ?1 billion of new capital, improve existing schemes and develop a lasting new institution to support SME growth by the end of 2014. 1.153 In addition, Budget 2013 announces that the Business Bank will: o launch a ?300 million investment scheme this spring to invest alongside private investors in financial institutions and non-bank lending channels to help diversify and expand the supply of lending to SMEs and mid-sized businesses; o provide ?75 million of new funding for venture capital through an extension to the Enterprise Capital Fund programme and an expanded Business Angel Coinvestment Fund to support start ups and early stage companies; and o support more lenders to increase SME lending through the Enterprise Finance Guarantee by maintaining the generous guarantee cap introduced at Budget 2012. Through the trade credit pilot, Kingfisher aims to support an additional ?30 million of credit to SMEs. Government's response to the Heseltine review, Department for Business, Innovation and Skills and HM Treasury, March 2013. 50 48 Budget 2013 1.154 To provide further support for SMEs, the Government will provide ?30 million for a Growth Vouchers programme in England. This programme will test a variety of innovative approaches to helping SMEs overcome barriers to achieving growth, such as limited use of external advice. It will target a number of specific areas of advice such as making a successful loan application to a bank or taking on an employee. 1.155 Across the entire regulatory system, the Government is taking action to shift the balance of regulation in favour of private sector investment and growth. This is particularly important for the regulation of defined benefit (DB) pensions as recent economic conditions have put companies sponsoring DB schemes under significant financial pressure. The Government will provide the Pensions Regulator (TPR) with a new objective to support scheme funding arrangements that are compatible with sustainable growth for the sponsoring employer and fully consistent with the 2004 funding legislation. The precise wording of this new objective will be set out in legislation that the Department for Work and Pensions (DWP) will publish later in spring 2013. Implementation of the new objective will be subject to review after 6 months and TPR will revise is Code of Practice to reflect their forthcoming new objective as soon as possible in 2013. The Government is also consulting on a new growth duty for non-economic regulators and is attracted, subject to the results of that consultation, to applying such a new duty to TPR. 1.156 DWP's call for evidence on asset and liability smoothing did not reveal a strong case for changing legislation to permit smoothing. The Government will therefore not be pursuing this measure. Competition in the banking sector 1.157 The Government is committed to fostering a strong, diverse and competitive banking sector to ensure that the banks are driven to offer better products and services, based on the needs of consumers. The Government demonstrated this commitment by asking the Independent Commission on Banking (ICB) to consider competition as part of its remit. Having accepted the competition recommendations of the ICB in full, the Government is currently delivering an extensive programme of reform. A major part of the reform is being legislated in the Financial Services (Banking Reform) Bill, which will substantially reduce the perceived implicit government guarantee that benefits the large incumbents in the banking sector. The Government is also driving the banking industry to deliver a new seven-day switching service from September 2013 to make it easier for people to switch their current account provider. In addition to the existing reform programme, Budget 2013 announces: o that the Government will shortly issue a consultation document on bringing payment systems into a competition-focused regulatory regime. The regulator will have strong powers to ensure that challenger banks have the opportunity to compete on a level playing field with their larger competitors by requiring that challengers can access the payments infrastructure fairly and transparently. Subject to the outcome of the consultation, the Government intends to legislate for the new regime in the Financial Services (Banking Reform) Bill; and o that the Financial Services Authority will shortly publish a government commissioned review on barriers to entry and expansion in banking. As a result of the review, the FCA and PRA will make major changes to the way they deal with new and existing small banks. The authorisation process for becoming a bank will be quicker and easier and there will be a comprehensive series of changes to the capital and liquidity rules to level the playing field for new banks. The changes will make a significant difference to the ease with which challengers can enter the UK banking system. Competition and Regulation 1.158 The Government is driving down the burden of red tape on business. The One-In OneOut policy on new regulation, which has already reduced costs to business by almost ?840 Budget 2013 49 million a year, increased to a One-In Two-Out policy in January 2013. The Red Tape Challenge has already implemented reforms that will save businesses over ?155 million a year. By the end of 2013 the first phase of the Red Tape Challenge will have identified three thousand regulations to be abolished or simplified. 1.159 To further improve the efficiency and effectiveness of regulation, the Government will: o launch a second phase of the Red Tape Challenge. Alongside implementing the Red Tape Challenge and Focus on Enforcement reforms, this second phase will look at the whole regulatory system - including laws, guidance, compliance, and enforcement, through short targeted reviews. The reviews will look at areas such as infrastructure, key stages in the growth of companies, and business activities where negotiating the system is overly complex. The Government will seek views from business on what specific problems should reviewed before the launch in summer 2013; o drive efficiency and reduce fees charged to businesses through additional budgeting controls placed on regulators in the 2015-16 Spending Round. This will reduce the costs imposed by regulators of doing business in the UK, without reducing the effectiveness of regulatory enforcement; and o make economic regulator appeals quicker, simpler and more efficient. A consultation on a new framework will begin by summer 2013. 1.160 The Government has asked the economic regulators to develop a coordinated and streamlined approach to charging and conditions on new infrastructure where it crosses existing infrastructure. The economic regulators have agreed to investigate this. A coordinated approach has the potential to simplify the UK's infrastructure landscape for investors, making the UK more welcoming to new investment and building on our world class infrastructure regulatory environment. 1.161 The Government is committed to supporting competition to deliver better value for money to consumers. The Government has made a renewed commitment to accept Office of Fair Trading (OFT) and Competition Commission recommendations and will also extend this commitment to the Competition and Markets Authority. As part of this, following recent OFT recommendations, the Government will work with motorway service areas and other relevant bodies to improve the availability of fuel price information to motorway users. Apprenticeships 1.162 This Government recognises the vital role apprenticeships play in promoting growth, improving skills and providing individuals with real opportunities. The Government has demonstrated its commitment to the apprenticeship programme with nearly a million apprenticeship starts since 2010. 1.163 Doug Richard's review on behalf of BIS, published in November 2012, was a thorough review of the quality of apprenticeships and the best way for employers to interact with the skills system. The Government has launched a consultation on implementation of the Richard Review, to put employers at the centre of the apprenticeship system and raise standards. 50 Budget 2013 Fairness 1.164 The Government's economic and fiscal strategy is underpinned by its commitment to fairness and its desire to support those who want to work hard and get on. Budget 2013 builds on announcements made at Autumn Statement 2012 with further action to make the tax and welfare system fairer, support aspiration and keep costs down for households and businesses: o the income tax personal allowance will increase by ?1,335 to ?9,440 in April 2013 - the largest ever cash increase. Budget 2013 announces that from April 2014 the personal allowance will rise to ?10,000, meeting the Government's objective one year early; o the planned January 2013 fuel duty increase was cancelled, and the April 2013 increase was deferred to September. Budget 2013 announces further support for motorists through the cancellation of the fuel duty increase that was planned for 1 September 2013; o from April 2013, local authorities that decide to freeze or reduce council tax in 2013 will be provided with a grant; o Budget 2013 announces a new Tax-Free Childcare Scheme which will support around 2.5 million working families with 20 per cent of their childcare costs; and o Budget 2013 announces further measures to ensure that all individuals and businesses pay their fair share of tax, raising ?4.6 billion over five years. Supporting households and rewarding work 1.165 The Government is committed to promoting aspiration, rewarding work and supporting households' standard of living. Budget 2013 announces policies that cut income tax for those on low and middle incomes, and reduce pressures on the cost of living. In total, Budget 2013 provides an additional ?7 billion of support for households over the forecast period. Supporting low and middle incomes Personal allowance 1.166 In May 2010, the Coalition Agreement set out the Government's commitment to make the first ?10,000 of income free from income tax. The ambition was to reach this level by the end of the Parliament. Budget 2013 announces that this commitment will be met a year ahead of schedule: the personal allowance will be increased by ?560 to ?10,000 in 2014-15. Meeting the commitment earlier will benefit an estimated 24.5 million individuals in 2014-15. The Government believes this is the most effective way to support those on low and middle incomes, because it enables people to keep more of the money they earn. Reducing the amount of income tax that people pay also rewards those who want to work hard and progress. 1.167 In each year of this Parliament, the Government has taken significant steps towards meeting this objective. In 2010, the personal allowance was just ?6,475, but successive aboveinflation increases totalling ?3,525 will mean that it has risen by more than 50 per cent in just four years. Budget 2013 51 1.168 As a result of this Government's actions, by April 2014 2.7 million low income individuals under 65 will have been lifted out of income tax altogether. This includes anyone whose income would have been in the 10 per cent starting rate band in 2007-08.51 1.169 The Government's increases to the personal allowance have also helped middle income households affected by rising prices and low average earnings growth. From April 2014, the typical basic rate taxpayer will pay ?705 less income tax per year in cash terms, leaving them ?493 better off than under the previous government's plans as Chart 1.19 shows. Chart 1.19: Cumulative cash benefit for a typical basic rate taxpayer from personal allowance changes since 2010-11 ?800 ?700 ?600 ?500 ?400 ?300 ?200 ?100 ?0 2011-12 2012-13 Pre-2010 plans 2013-14 2014-15 Post-2010 plans Source: HM Revenue and Customs analysis. 1.170 As set out in Budget 2011, once the personal allowance has reached ?10,000 in 201415 it will increase by CPI in future years, starting from 2015-16. 1.171 Table 1.6 shows the reduction in the amount of income tax paid by most individuals at each income level as a result of the Government's personal allowance increases since 2010, up until the point at which the personal allowance is removed for high earners. The National Minimum Wage for full-time employees is ?12,070, so these individuals will have benefitted from a substantial cut in the amount of income tax they pay once the personal allowance reaches ?10,000 in 2014-15.52 Based on an individual with an income in 2007-08 of up to ?7,455, equal to the personal allowance plus the starting rate threshold, and adjusted in line with earnings growth to ?8,520 in 2014-15. 52 Income on National Minimum Wage based on 37.5 hours per week. 51 52 Budget 2013 Table 1.6: Illustration of income tax and National Insurance contributions paid per year, by income level in nominal terms1 Gross income (?) 7,500 10,000 15,000 20,000 30,000 40,000 50,000 75,000 100,000 150,000 1 2010-11 (?) 2011-12 (?) 2012-13 (?) 2013-14 (?) 2014-15 (?) Change over period 400 1,180 2,730 4,280 7,380 10,480 14,190 24,440 34,690 57,780 40 840 2,440 4,040 7,240 10,440 14,390 24,890 35,390 59,380 0 670 2,270 3,870 7,070 10,270 14,220 24,720 35,220 59,460 0 380 1,980 3,580 6,780 9,980 14,040 24,540 35,040 59,810 0 250 1,850 3,450 6,650 9,850 13,860 24,360 34,860 59,860 -100.0% -78.8% -32.2% -19.4% -9.9% -6.0% -2.3% -0.3% 0.5% 3.6% Calculations are based on announced parameters of the tax system up to 2014-15. The table is also based on an individual born after 5 April 1948 paying employee NICs (not contracted out). Gross income refers to earnings only (i.e. all gross income is subject to income tax and Class 1 NICs). Income tax calculations assume no other allowances or deductions. NICs are calculated on a weekly basis and then annualised. All figures are rounded to the nearest ?10. Source: HM Revenue and Customs calculations. Supporting households Fuel duty 1.172 The Government has taken extensive action to support households and businesses with the high cost of fuel by abolishing the fuel duty escalator, cutting fuel duty and introducing the fair fuel stabiliser (FFS). The FFS ensures that when oil prices are high, fuel duty will increase by no more than inflation. Under the FFS, fuel duty would only increase by inflation in 2013. 1.173 Nevertheless, in recognition of the impact that persistently high pump prices have on the cost of living, Budget 2013 announces that the 1.89 pence per litre fuel duty increase that was planned for 1 September 2013 will be cancelled. This means that fuel duty will have been frozen for nearly three and half years, the longest duty freeze for over 20 years. 1.174 In total, the Government's actions on fuel duty will have eased the burden on motorists by ?21.5 billion over the Parliament to 2015-16. From April 2013, pump prices will be 13 pence per litre (ppl) lower than under the previous government's plans, and are forecast to be 18 ppl lower by the end of the Parliament. This means that it will cost the typical motorist ?7 less to fill up their tank every time they visit the pump from April, and ?10 less by the end of the Parliament. In addition, a small business could have saved ?340 in total over the last two years and will continue to save at least ?340 a year.53 1.175 As a direct result of this Government's actions, fuel duty is forecast to fall over this Parliament by 11 per cent in real terms. Had the Government implemented the fuel duty escalator, rates would have increased by 7 per cent as Chart 1.20 shows. Pump price and total saving for a private motorist driving a typical family car and business motorist driving a typical van by May 2015 assumes that fuel duty increases by RPI in September 2014. The final fuel duty rate will be confirmed in Budget 2014 according to the FFS. 53 Budget 2013 53 Chart 1.20: Real terms fuel duty rates (pence per litre) 69 65 61 57 53 49 2008-09 2009-10 2010-11 2011-12 Pre-2010 plans 2012-13 2013-14 2014-15 Post-2010 plans Notes: Pre-2010 plans based on the previous government's legislated increases and planned increases up to 2014-15. Post-2010 plans based on this Government's policy. Plans expressed in 2012-13 prices. Source: HM Revenue and Customs analysis. Alcohol duty 1.176 The Government is committed to supporting communities as well as individual households. The Government has already taken action to support community pubs through the reduction in both the small profits rate and the corporation tax rate, and regulatory changes to make it easier for pubs to play live music. 1.177 To provide further support to community pubs, Budget 2013 announces that general beer duty will be reduced by 2 per cent from 25 March 2013. The Government will then cancel the escalator for beer duty next year and instead increase it by inflation thereafter. Tax on average strength beer will be 1 penny lower after Budget 2013, saving beer drinkers 4 pence a pint in 2013-14 compared to the previous government's plans. Duty on high and low strength beer will also be adjusted to reduce the tax on a typical product by 1 penny a pint from 25 March 2013. The Government will shortly respond to its alcohol consultation, including with proposals to deal with deeply-discounted alcohol in supermarkets and other stores. Supporting parents Childcare 1.178 High quality, affordable childcare is essential to improving children's life chances and supporting parents who want to get back into work. The Government has already prioritised investing in early education, in particular for the most disadvantaged families, through: o increasing the free entitlement to 15 hours a week of free early education for all three and four year olds; and o extending 15 hours of free early education a week to 40 per cent of two year olds by 2014-15. 54 Budget 2013 1.179 However, for some parents the high cost of childcare is still a significant disincentive to work. The Government therefore announces a new Tax-Free Childcare Scheme for working families. The Government will provide 20 per cent of working families' childcare costs, up to ?1,200 for each child. This is equivalent to basic rate tax relief on childcare costs up to ?6,000 a year. The scheme will ultimately be open to around 2.5 million working families in the UK. Households in which all parents work but do not receive support through tax credits (or Universal Credit, once it is established) will be eligible, so long as neither parent earns over ?150,000 a year. 1.180 The Tax-Free Childcare Scheme offers support to more parents than the current Employer Supported Childcare (ESC) system, which is only available to some employees. The Government will therefore phase out ESC. Existing members of this scheme will be able to choose whether to remain on their current scheme or move to the new scheme (if they are eligible). The tax exemption available for workplace nurseries will remain. 1.181 This new system will be phased in from autumn 2015, partly funded by the phasing out of the ESC system. From the first year of operation, all children under five will be eligible. Disabled children up to age 16 will also be eligible, in line with existing ESC rules. The scheme will then build up over time to include children under 12. 1.182 The Government will also increase assistance for parents who receive childcare support through Universal Credit, which in due course will replace tax credits. Households eligible for tax credits already receive support for 70 per cent of their childcare costs up to a cap. Budget 2013 announces that an additional ?200 million will be provided to increase childcare support in Universal Credit. This is equivalent to covering 85 per cent of childcare costs for households qualifying for the Universal Credit childcare element (where either a lone parent or both parents in a couple pay income tax). This will improve work incentives and ensure that it is worthwhile for low and middle income earners to work up to full-time hours. This additional ?200 million is planned to be phased in from April 2016 as childcare support moves from tax credits into Universal Credit and it will be funded from within social security budgets at the time. 1.183 The Government will consult shortly on the detailed design and operation of the Tax-Free Childcare Scheme, including on how employers can continue to play a role in supporting their employees with childcare costs and to ensure it operates effectively with Universal Credit. Children's savings 1.184 In November 2011, the Government introduced Junior ISA, a new tax-advantaged savings account for children under the age of 18. Children who have a Child Trust Fund (CTF) are currently ineligible for Junior ISA, although the Government has ensured that children with CTF accounts are not disadvantaged by increasing the CTF subscription limit to equal the Junior ISA limit (?3,600 in 2012-13 and ?3,720 in 2013-14). 1.185 The Government wants to support parents by ensuring that there continues to be a clear and simple way to save for all children, and will therefore consult on options for transferring savings held in CTFs into Junior ISA. Providing certainty on support for older people 1.186 The Government wants to give people clarity and security about what they can expect when they retire or reach old age. The current State Pension system is highly complicated and the existing social care funding system exposes individuals to catastrophic care costs, making it difficult for people to plan and prepare for their future. The Government has announced two major long-term reforms, the single-tier State Pension and social care funding reform, which together represent a comprehensive new deal for pensioners and people who want to plan and save for old age. Budget 2013 55 Single-tier State Pension 1.187 In January 2013, the Government set out its plans for the single-tier State Pension, as a cost-neutral reform set above the basic level of means-tested support. Budget 2013 confirms that the single-tier State Pension will begin in 2016-17. 1.188 The current State Pension system is highly complicated. The majority of individuals do not know what pension they will get from the state and the level of means-testing discourages people to save for their retirement. Introducing the single tier for newly-retired pensioners in 2016-17 will bring clarity and confidence to the State Pension system. This will provide a firm foundation to support people who want to take responsibility for their retirement income by saving, particularly alongside automatic enrolment (the Government's recent workplace pensions reform). The single tier will particularly benefit women, the low paid and the self-employed, who have tended to build up low amounts of Additional State Pension under the current system. Compared to the current system, by 2040, around 1.25 million of the lowest income pensioners will have higher retirement incomes. 1.189 A necessary consequence of the single-tier State Pension system is the closure of the State Second Pension, because everyone will have access to the same single-tier State Pension. As a result, Budget 2013 confirms that from 2016-17 the ability for members of a defined benefit occupational pension scheme to 'contract out' of the State Second Pension will end. They and their employers will therefore no longer be entitled to pay a lower NICs rate. 1.190 To alleviate the impact on private sector employers, the Government has committed to legislating for a statutory override, which will allow private sector employers to cover the costs of additional NICs payments through changes to contribution rates or benefits for their existing pension schemes. 1.191 For employees, single tier will make the State Pension system fairer by ensuring that, from 2016-17 onwards, everyone except for the self-employed will pay the same rates of NICs and build up access to the same single-tier State Pension. This means that those who are contracted out in 2016-17 will contribute more in National Insurance, and in return they will get a more generous State Pension. 1.192 The effects of the single tier introduction will vary between individuals, but 90 per cent of employees affected by the end of contracting-out who reach State Pension age in the first 20 years after the single tier's introduction will be better off over their lifetimes. An individual who is 40 years old when single tier is introduced in 2016 would contribute an extra ?6,000 of NICs before reaching State Pension age in 2043. But they would gain ?24,000 in extra State Pension over the course of their retirement. An individual who is 30 years old when single tier is introduced in 2016 would contribute an extra ?7,000 in NICs before reaching State Pension age in 2054. But they would gain ?18,000 in extra State Pension over their retirement.54 1.193 None of the additional employee and private sector employer NICs will be used for net revenue-raising. Overall, the Budget constitutes a net reduction in taxation for non-wealthy households, and a net reduction in NICs for private sector employers. Social care funding reform 1.194 Drawing on the Dilnot Commission's recommendations, the Government has announced that it will introduce a cap on reasonable care costs. This will give a level of financial protection to those with the greatest care and support needs. In addition, the residential care means test will be extended to give more people access to financial support for their residential care costs. For an individual contracted-out over their whole career, with average life expectancy and median earnings (2012-13 earnings terms rounded to the nearest ?1,000). 54 56 Budget 2013 Taken together, these reforms should help an extra 100,000 people who would not receive any support under the current system. The reforms will help people who want to work hard and save for old age, by providing peace of mind that the savings they want to leave to their children will not be at risk of being wiped out by catastrophic care costs. 1.195 The Government has made clear that it would not implement these reforms without finding a way to pay for them. The Government has set out that the higher employer NICs revenue that arises from the end of contracting-out for members of defined benefit occupational pension schemes will help cover the costs of social care reform for the duration of the next Parliament. As the single-tier State Pension will begin in 2016-17, Budget 2013 announces that the Government will introduce a ?72,000 cap on reasonable care costs and extend the means test from April 2016. 1.196 The new social care cap will protect the assets of those who face the highest social care costs, and will particularly benefit older people who have worked and saved all their lives to build up assets. As announced in February 2013, the Government will freeze the inheritance tax threshold for three years until April 2018, providing a simple and fair way of ensuring that those with the largest estates, who are more likely to benefit from social care reform, help to fund it. The Government has set out that the inheritance tax freeze will contribute to the costs of social care reform in the next Parliament. Equitable Life 1.197 Budget 2013 announces that the Government will make an ex-gratia payment of ?5,000 to those policyholders who bought their Equitable Life With-Profits Annuity before 1 September 1992, and are living at the time of this announcement. A further ?5,000 will be available to those policyholders who meet the above criteria and are in receipt of Pension Credit. These one-off payments are in recognition of the resulting pressures this very elderly group face, having not received the income they hoped for from their Equitable Life annuity. Payments will be made in 2014-15 or earlier if possible. Affordable public spending 1.198 Budget 2013 maintains the Government's policy of setting clear and credible consolidation plans by fixing the envelope for Total Managed Expenditure in 2015-16. The Government confirms that health, schools and ODA will be protected in 2015-16. These protections will be of greatest benefit to households on lower incomes, who benefit from health and school spending by around ?2,700 a year more than those on the highest incomes.55 An affordable welfare system 1.199 Welfare spending must remain affordable, help those who need it most and provide the right incentives for people to work. Welfare spending rose by 20 per cent in real terms in the decade before the financial crisis, leaving reduced resources available for other public services.56 Reforming the welfare system will not only put welfare spending on a more sustainable footing, but will also reduce pressures on public services. 1.200 As previously announced, a package of welfare reforms will be implemented from April 2013 which will meet these key objectives. It includes: o the introduction of Universal Credit, the biggest change to the welfare system in a generation which will ensure that it always pays to be in work; o the Household Benefit Cap, which will ensure no family will receive more on benefits than the average family in work; 55 56 Based on comparison of income quintiles one and two against quintile five, HM Treasury analysis. Public sector net social benefits, Office for National Statistics. Budget 2013 57 o the phased introduction of Personal Independence Payments to replace working-age Disability Living Allowance, which will ensure a more accurate assessment of needs so that support is reaching those who need it most; o uprating a wide range of benefits and tax credits by 1 per cent in each of the next three years, as announced at Autumn Statement 2012. This recognises that benefits have risen faster than average earnings in recent years, while protecting the most vulnerable; and o a number of measures to help reduce the ?23 billion cost of Housing Benefit, while increasing fairness and efficiency in the system. 1.201 By the end of April 2013, the Government will have implemented measures to deliver over 90 per cent of the total savings expected from reforms to the welfare system announced to date. As set out earlier in this chapter, to help manage spending pressures the Government will strengthen the spending framework to improve control of AME, including areas of welfare expenditure. A fair contribution from individuals and businesses 1.202 The Government is committed to a fair tax system in which those with the most contribute the most. As set out in Chart 1.21, over a quarter of all income tax is paid by just 1 per cent of taxpayers, with the top 5 per cent paying around half of all income tax. Chart 1.21: Population, income and income tax share of individuals in 2012-13 Income levels at percentile boundaries 0% Top 1 per cent: ?150,000 5 per cent: ?67,700 20% 10 per cent: ?49,900 40% Bottom 10 per cent: ?11,070 Median: ?21,400 60% 80% Share of taxpayers Share of total income Share of total tax Top 1 per cent 1 per cent to 5 per cent 5 per cent to 10 per cent Remaining 90 per cent Notes: Data expressed in terms of non-equivalised gross income of individual taxpayers; projected estimates. Source: HM Revenue and Customs personal tax statistics. 58 Budget 2013 100% 1.203 Since 2010, the Government has raised taxes on the rich in every Budget: Budget 2010 increased higher rate capital gains tax; Budget 2011 tackled avoidance through disguised remuneration; Budget 2012 raised stamp duty on high-value homes; Autumn Statement 2012 took action to reduce the cost of pensions tax relief; and Budget 2013 announces further measures that tackle offshore tax evasion by high earners. The revenue raised from these measures will offset many times over the small cost of just over ?100 million from the reduction in the additional rate of income tax from 50 per cent to 45 per cent. Tackling tax evasion and avoidance 1.204 The vast majority of individuals and businesses pay their fair share of tax. Budget 2013 takes action against those who do not by announcing a significant crackdown on offshore tax evasion, tax avoidance and aggressive tax planning in four key areas: o offshore tax evasion; o avoidance of employment taxes; o tax avoidance schemes; and o corporation tax. 1.205 Collectively, these announcements will raise over ?4.6 billion in new revenue over the next five years and protect against the loss of billions of pounds of revenue through the immediate closure of 10 loopholes. Further detail on these loophole closures is included in Chapter 2. Offshore tax evasion 1.206 Following the Autumn Statement 2012 announcement that the Government would look to conclude further agreements based on its groundbreaking agreement with the US, the Isle of Man, Guernsey and Jersey have agreed to enter automatic tax information exchange agreements with the UK. These agreements will significantly increase the amount of information on potentially taxable income that is automatically exchanged, in order to further clamp down on tax evasion. HMRC has also put disclosure facilities in place to allow investors with accounts in the Isle of Man, Guernsey or Jersey to settle their past tax affairs in advance of the information being automatically exchanged. These agreements are expected to raise over ?1 billion over the next five years. 1.207 The Government will look to sign similar agreements with other jurisdictions and is already in discussions with the Overseas Territories. Those, like the Crown Dependencies, who demonstrate their commitment to transparency and to tackling tax evasion will see their reputations enhanced. This forms a key part of the Government's offshore evasion strategy, published alongside Budget 2013 by HMRC's new centre of excellence on offshore evasion. Avoidance of employment taxes 1.208 The Government is committed to reforming areas of the tax system where avoidance behaviour is widespread or where there are opportunities to level the playing field in the tax treatment of compliant and non-compliant businesses. Following Budget 2011 reforms to combat disguised remuneration, and the success of the Employee Benefit Trust Settlement Opportunity which has brought in over ?600 million in the last 18 months, Budget 2013 announces new action to tackle avoidance of employment taxes. Budget 2013 59 1.209 The misuse of the partnership rules has been a feature of many avoidance schemes closed down in recent years, and the Government announced on 5 December 2012 that HMRC would consider the taxation of partnerships. As a result of this work, the Government will consult on measures to: o remove the presumption of self-employment for limited liability partnership (LLP) partners, to tackle the disguising of employment relationships through LLPs; and o counter the artificial allocation of profits to partners (in both LLPs and other partnerships) to achieve a tax advantage. 1.210 Autumn Statement 2012 also announced that HMRC would review the use of offshore employment intermediaries. As a result of that review, the Government will strengthen obligations to ensure the correct income tax and NICs are paid by offshore employment intermediaries, with consultation on the details. As part of its ongoing compliance work, HMRC will continue to gather evidence about other forms of employment tax avoidance in order to inform future policy and operational decisions. Tax avoidance schemes 1.211 The Government is taking further action to tackle tax avoidance schemes: o the UK's first General Anti-Abuse Rule will be introduced in Finance Bill 2013 to provide a significant new deterrent to abusive avoidance schemes and strengthen HMRC's means of tackling them; o the Government will shortly consult on new proposals to target the promoters of tax avoidance schemes, intending to tackle both the supply and demand of these schemes. HMRC will consult on new "naming and shaming" proposals alongside a range of targeted disclosure requirements and associated penalties; o the Government will act on the warning made at Budget 2012 to introduce retrospective legislation to address aggressive Stamp Duty Land Tax avoidance schemes. This action will tackle schemes exploiting 'transfer of rights' rules; o suppliers bidding for contracts will be required to declare specified non- compliance with tax obligations, allowing government departments to exclude bidders that have not been compliant. The Government will review the effectiveness of the policy within a year and amend the rules if necessary to secure compliance; and o a progress report on tackling avoidance and evasion is being published alongside Budget 2013. Corporation tax 1.212 Alongside reforms to increase the competitiveness of the tax system, the Government is determined to take steps to ensure that domestic and multinational companies pay their fair share of tax and do not engage in aggressive tax planning. The Government has been at the forefront of the calls for collective action to strengthen international tax standards. 1.213 At the G20 meeting of Finance Ministers and Central Bank Governors in Moscow in February 2013, the OECD presented a report on Addressing Base Erosion and Profit Shifting which underlined the importance of international cooperation in tackling these issues.57 The OECD has identified three main clusters of work: a review of ways to counter base erosion, looking at how to determine tax jurisdiction in particular in relation to the development of the digital economy, and an examination of how the transfer pricing rules allocate profits between different countries. The UK will use its involvement in these groups to work towards reform of 57 60 Addressing Base Erosion and Profit Shifting, Organisation for Economic Co-operation and Development, February 2013. Budget 2013 the international tax standards. These issues will be examined by the OECD, which will present a comprehensive action plan to the G20 in July 2013. 1.214 The Government will take immediate action to prevent the growing practice of 'loss buying', where companies pass the potential to gain access to corporation tax loss relief to unconnected third parties. The Government will introduce new rules to prevent such behaviour in the future and raise just over ?1 billion in new revenue as a result. Tax debt collection 1.215 The Government announces that it will enable HMRC to increase the amount of tax debt collected via the Pay As You Earn system from individuals on higher incomes. The Government will consult on how this process will be designed. The Government will also introduce operational measures to increase HMRC's efficiency in collecting tax debts and make it easier for people to pay off a tax debt. Budget 2013 61 2 Budget policy decisions 2.1 Chapter 1 explains how the measures announced in this Budget advance the Government's long-term goals. This chapter provides a brief description of all Budget policy decisions. These are decisions on tax measures, National Insurance contributions (NICs), measures that affect Annually Managed Expenditure (AME), changes to Departmental Expenditure Limits (DEL), and supply-side reform measures. Unless stated otherwise, measures in this chapter are measures announced at this Budget. The tables in this chapter set out the cost or yield of all Budget policy decisions with a fiscal impact in the years up to 2017-18.1 Fiscal impacts of Budget policy decisions 2.2 Alongside this Budget, the Office for Budget Responsibility (OBR) has published an independent forecast of the public finances and the economy incorporating Budget policy decisions. To produce the Budget forecast, the OBR has certified the Government's assessment of the direct cost or yield of Budget policy decisions that affect the economy and public finance forecasts and has made an assessment of the indirect effects of Budget measures on the economy. 2.3 Table 2.1 shows the cost or yield of all new Budget decisions with a direct effect on public sector net borrowing (PSNB). This includes tax measures, NICs measures, measures affecting AME and changes to DEL. 2.4 Consistent with its commitment to transparency, the Government is also publishing the methodology underlying the calculation of the fiscal impact of each Budget policy decision. This is included in the supplementary document Budget 2013 policy costings, published alongside this Budget.2 The numbers or lower-case letters in brackets after each measure refer to the line in Table 2.1 or Table 2.2 where its cost or yield is shown. 2 Budget 2013 policy costings, HM Treasury, Department for Work and Pensions, and HM Revenue and Customs (HMRC), March 2013. 1 Budget 2013 63 Table 2.1: Budget 2013 policy decisions1 Head 2014-15 2015-16 0 0 -65 -65 -65 -40 -45 -50 -55 -55 -20 -30 -25 -40 -40 -40 -45 -40 -45 -45 +25 0 0 +5 +5 0 +50 +20 0 -10 0 +60 +20 0 -15 -35 +50 +20 * -20 -35 +35 +20 +5 -25 -30 +30 +30 +30 -25 0 +25 +25 +25 +25 0 0 0 -20 -10 -10 -10 -10 -10 -10 +5 -10 -10 +5 +5 -5 -10 +5 +5 -5 -10 +5 +5 -5 -5 +5 +5 -5 0 * 0 0 0 0 0 0 0 0 0 0 0 0 +3,325 +1,365 +570 +235 +3,285 +1,350 +565 +235 0 0 +20 +80 +170 0 0 0 -1,000 -1,000 0 0 -400 -750 -750 Tax 0 -1,255 -1,370 -1,595 -1,725 Tax 0 -5 -400 -785 -865 0 0 -5 0 +5 0 -125 +45 -145 -170 -3,000 0 +40 -145 -170 -3,000 0 +50 -150 -170 -3,000 0 +50 -160 -175 0 -5 * 0 0 0 -20 -15 -80 -45 -85 -65 -90 -75 -95 Previously announced (Mid Term Review) Single Tier: introduce from 2016-17: 18 Contracting out NICs: public sector employers Tax 19 Contracting out NICs: public sector employees Tax 20 Contracting out NICs: private sector employers Tax 21 Contracting out NICs: private sector employees Tax Other Mid Term Review: 22 Inheritance tax: threshold freeze for 3 years Tax from 2015-16 23 Social Care funding reform: introduce Spend Dilnot cap from 2016-17 24 Childcare additional funding 2 Spend 64 Budget 2013 2016-17 2017-18 2013-14 Previously announced (smaller measures) 1 Carbon Reduction Commitment: Tax exclude schools 2 Government response to OTS review Tax of share schemes 3 Carbon price floor: Northern Ireland exemption Tax 4 Annual charge and SDLT 15% rate: reliefs Tax for commercial businesses 5 Capital Gains Tax on disposals of high value Tax residential property: extension to UK non-natural persons 6 Universal Credit: exempt from income tax Tax 7 Debt Cap: tightening of rules Tax 8 Building Societies: capital instruments Tax 9 Employee shareholder status: CGT changes Tax 10 Enterprise Management Incentive: Tax qualification for CGT entrepreneurs' relief 11 Lorry road user levy and offsetting Tax VED reduction 12 Income tax: transfer of assets abroad Tax 13 Cap on reliefs: exemption for EIS share Tax loss relief and overlap relief 14 Carbon price floor: non rate changes Tax 15 Disincorporation relief Tax 16 Vehicle Excise Duty: PIP disability exemption Tax 17 Pension Credit pass through Spend Growth and Enterprise 25 National Insurance: ?2,000 Employment Allowance 26 Corporation tax: reduce main rate to 20% from 2015-16 27 Capital Spending: maintain 2014-15 level 28 Affordable housing 29 Right to Buy changes 30 Stamp duty: abolish schedule 19 charge 31 Abolishing stamp duty on AIM and other junior shares 32 Seed Enterprise Investment Scheme: extend CGT holiday to 2013-14 33 Employee shareholder status: income tax 34 R&D Tax Credits: increase Above the Line credit to 10% ? million Spend Spend Spend Tax Tax Tax Tax Spend 35 36 37 38 39 40 Employee ownership: additional support Industrial Strategy Growth vouchers Tax relief: health interventions Health interventions Bank Levy (including offsetting CT changes) Personal Tax 41 Personal allowance: increase by an additional ?560 to ?10,000 in 2014-15 42 Pensions tax relief: individual protection Duties 43 Fuel Duty: cancel September 2013 increase 44 Alcohol: 1p off pint of beer and abolish escalator in 2014-15 Avoidance and Debt 45 Tax repatriation from Jersey, Guernsey, and Isle of Man 46 Offshore employment intermediaries 47 Partnerships 48 Corporation Tax: losses 49 Loans from close companies to participators 50 IHT: limiting deduction of liabilities 51 General Anti-Abuse Rule: non revenue protection 52 Stamp Duty Land Tax: subsales 53 Debt: improving coding out 54 Avoidance schemes: enhanced information powers 55 Penalties in avoidance cases Motoring and Environment 56 Capital allowances: Ultra Low Emission Vehicles 57 Company car tax: ULEVs 58 VED: freeze rates for HGVs in 2013-14 59 Aggregates levy: freeze in 2013-14 60 Capital allowances: energy and water efficient technologies 61 Capital allowances: energy saving plant & machinery in Northern Ireland Changes to spending forecasts 62 Spending total adjustment 63 Official Development Assistance: adjusting to meet 0.7% GNI target 64 Special Reserve 65 Equitable life TOTAL POLICY DECISIONS Total spending policy decisions Total tax policy decisions Total tax policy decisions excluding impact on Government departments Financial transactions 3: Help to Buy extension Build to Rent extension * - 0 -125 -10 0 0 0 -50 -160 -25 -10 +10 +195 -50 -180 0 -10 +10 +250 -50 -180 0 -10 +10 +245 -50 -180 0 -10 +15 +250 Tax 0 -1,075 -1,045 -1,060 -1,210 Tax 0 +100 +80 +50 0 Tax Tax -480 -170 -810 -215 -835 -210 -870 -205 -900 -205 Tax +395 +80 +1,025 +240 +1,395 +325 +1,075 +235 +1,020 +170 Tax Tax Tax Tax Tax Tax 0 0 +260 0 +5 0 +80 +125 +305 +65 +20 +60 +85 +365 +270 +75 +15 +50 +85 +300 +205 +70 +15 +40 +90 +285 +190 +60 +15 +85 Tax Tax Tax +45 0 0 +35 0 +5 +30 +45 +35 +25 +40 +35 +25 +45 +35 Tax 0 +55 +60 +5 +10 Tax 0 0 -5 -25 -35 Tax Tax Tax Tax 0 -10 -10 +5 0 -10 -15 +15 -10 -10 -15 +25 -15 -10 -15 +30 -15 -10 -15 +20 Tax 0 +5 +5 +10 +10 Spend Spend +1,325 +135 +1,085 +165 0 +200 0 +250 0 +305 Spend Spend +300 0 +1,315 +1,605 -290 -290 0 -45 -1,650 +1,055 -2,705 -2,705 0 0 -2,850 0 -2,850 -2,850 0 0 +1,740 0 +1,740 -1,585 0 0 +1,305 0 +1,305 -1,980 -1,150 -150 -1,430 -445 -1,550 -360 0 0 0 0 Spend Spend Spend Tax Spend Tax Negligible. Spending measures do not affect borrowing in 2015-16, 2016-17 and 2017-18 as they fall within the Total Managed Expenditure assumption. 1 Costings reflect the OBR's latest economic and fiscal determinants. 2 Additional funding for childcare will start in Autumn 2015. The Government is allocating ?750m per annum for this support. 3 Financial transactions impact on PSND and not PSNB so do not feed through to the bottom line. Budget 2013 65 Table 2.2: Measures announced at Autumn Statement 2012 or earlier which take effect from April 2013 or later1 Head 2014-15 2015-16 2016-17 2017-18 -5 -370 -705 -790 -825 -10 -475 0 0 -55 +40 -165 0 -50 +5 +25 * -30 0 -5 -15 -5 0 * -75 -5 -995 -25 -1,140 -45 -1,155 -60 -655 -65 -570 +515 +1,685 +2,680 +2,835 +2,935 0 +220 +360 +360 +380 0 +135 +280 +335 +375 0 +170 +680 +1,030 +1,215 0 +350 +960 +1,235 +1,260 0 0 +20 +40 +45 0 0 +10 +15 +15 0 +200 -10 +315 +300 -15 +185 +600 -10 +85 +1,000 -20 * +1,125 -30 0 -85 -65 -70 -75 Tax -3,465 -3,700 -3,720 -3,875 -3,240 Tax -60 -110 -110 -120 -140 Tax Tax * +75 +385 +75 +245 +80 +275 +90 +290 +100 Tax -695 -740 -765 -815 -850 Spend Spend Tax -10 -15 +140 -240 -50 +425 -165 -50 +365 -165 -55 +330 -170 -55 +480 Tax +120 +125 +150 +165 +185 Tax -65 -105 -170 -200 -240 Tax Tax Tax 0 * +315 +125 +25 +700 +405 +125 +1,040 +375 +225 +1,280 +395 +215 +1,520 * -20 -5 -20 -5 - -5 - -5 - Measures announced at Autumn Statement 2012 a Corporation tax: decrease main rate to Tax 21% from 2014-15 b Business rates: empty property relief Tax c Business rates: small business relief extension Tax d Cash basis for small businesses Tax e Capital gains tax (CGT) relief: employee Tax shareholder status f High end television: tax relief Spend g Personal allowance: increase by an Tax additional ?235 to ?9,440 in 2013-14, with equal gains to higher rate taxpayers h Working age discretionary benefits and Spend tax credits: increase by 1% for three years from 2013-14 i Child Benefit: increase by 1% for two Spend years from 2014-15 j Housing Benefit: increase Local Housing Spend Allowance by 1% for two years from 2014-15 with provision to high rent areas k Universal Credit impact of work allowance Spend measure and increase by 1% for two years from 2014-15 l Higher rate threshold: index by 1% for Tax two years from 2014-15 m Inheritance tax: increase nil rate Tax threshold by 1% in 2015-16 n CGT: increase annual exempt Tax amount by 1% for two years from 2014-15 o Tax credits: error and fraud Spend p Pensions: restrict tax relief Tax q Gift Aid Small Donation Scheme: Spend amendments r Amendments to cap on Income Tax reliefs Tax Measures announced at Budget 2012 s Personal allowance: increase by ?1,100 in 2013-14, with a proportion passed to higher rate tax payers t Income tax: reduce additional rate to 45p in 2013-14 u Income tax: cap on unlimited tax reliefs v Stamp Duty Land Tax: avoidance on residential property and associated CGT changes w Corporation tax: decrease main rate to 24% in 2012-13, 23% in 2013-14 and 22% from 2014-15 x R&D Tax Credits: Above the Line y Video games and animation: tax relief z North Sea oil & gas: decommissioning certainty aa Climate change levy: levy exemption certificates removal ab Carbon Price Floor: combined heat and power relief and other changes ac Company car tax ad Capital allowances: company cars ae Age-related allowances: freeze amount and restrict to existing receipts from 6 April 2013 af IHT: spouse relief ag Local authorities: Tax Increment Financing 66 Budget 2013 ? million 2013-14 Tax Spend ah ai aj ak Transfer of assets Insurance tax: Claims Equalisation Reserves Life assurance premium relief Stamp Duty Land Tax: area based reliefs Tax Tax Tax Tax * 0 0 +30 * +85 0 +35 * +90 +5 +35 * +80 +5 +40 * +80 +5 +40 +5 -15 +5 -20 +5 -20 +5 -20 +5 -20 -705 -740 -760 -805 -845 +975 +1,420 +2,025 +2,075 +2,200 -25 +120 -25 +125 -25 +125 -25 +130 -30 +135 +110 -45 +100 -75 +95 -95 +90 -100 +85 -100 +475 +475 +475 +475 +470 Spend +110 +185 +185 +185 +185 Spend +155 +160 +160 +160 +165 Spend 0 +260 +190 +80 +10 -1,720 -2,500 -2,970 -3,185 -3,335 +275 +140 +515 +660 +445 +1,190 +510 +2,000 +580 +2,870 +465 +465 +465 +470 +470 +155 +330 +340 +355 +370 -350 -640 -675 -740 -760 0 +65 +60 +60 +60 Measures announced at Autumn Statement 2011 al Air passenger duty: business jets Tax am Climate change levy: increase electricity tax -15 relief to 90 per cent Measures announced at Budget 2011 Tax an Corporation tax: decrease to 24% in 2013-14 and 23% in 2014-15 Tax ao Carbon price floor: introduce from 2013-14 with ?30 per tonne of CO2 target ap Climate change agreements: reform Tax aq Company car tax: adjustment to Tax rates for 2013-14 ar VAT: fraud on imported road vehicles Tax as Gift Aid: small donations scheme Spend Measures announced at Spending Review at Council Tax Benefit: 10% reduction in expenditure and localisation au Total household benefit payments capped on the basis of average take-home pay for working households from 2013-14 av Disability Living Allowance: remove mobility components for claimants in residential care from April 2013 aw Child and Working Tax Credits: use real time information 2010 Tax Measures announced at June Budget 2010 ax Corporation tax: decrease to 25% in Tax 2013-14 and 24% in 2014-15 ay Basic rate limit: freeze in 2013-14 Tax az Disability Living Allowance: reform Spend gateway from 2013-14 ba Social sector: limit working age entitlements Spend to reflect size of family from 2013-14 Measures announced before June Budget 2010 bb Alcohol duty: increase in rates in 2013-14 Tax and 2014-15 (March Budget 2010) bc Patent box from 2013-14 Tax (2009 Pre-Budget Report) bd Landfill tax: increase in 2014-15 Tax (2009 Pre-Budget Report) * Negligible 1 Costings reflect the OBR's latest economic and fiscal determinants. 2.5 The supplementary document Overview of tax legislation and rates, published alongside this Budget, provides a more detailed explanation of tax measures included in this chapter and a summary of their impacts.3 Public Spending Total Managed Expenditure 2.6 Spending in 2016-17 and 2017-18 - In line with previous policy, the Government has set a fiscal assumption that Total Managed Expenditure (TME) in 2016-17 and 2017-18 will continue to fall in real terms at the same rate as over the Spending Review 2010 period. Fiscal consolidation for 2016-17 and 2017-18 is expressed as a reduction in TME. It would, of course, be possible to do more of this further consolidation through tax instead. 3 Overview of tax legislation and rates, HM Treasury and HMRC, March 2013. Budget 2013 67 Table 2.3: Total Managed Expenditure1 ? billion 2012-132 CURRENT EXPENDITURE Resource AME Resource DEL excluding depreciation Ring-fenced depreciation Implied Resource DEL, including depreciation Public sector current expenditure CAPITAL EXPENDITURE Capital AME2 Capital DEL Implied Capital DEL3 Public sector gross investment Total Managed Expenditure Total Managed Expenditure (% GDP) 2013-14 Forecasts 2014-15 2015-16 317.4 317.6 22.2 334.1 320.7 18.1 345.1 315.7 19.3 657.2 672.9 680.0 -20.0 36.1 5.0 42.2 5.5 44.9 16.1 673.3 43.6%2 47.2 720.0 45.2% 50.4 730.4 44.0% 1 2017-18 362.3 378.5 396.1 331.9 694.2 325.1 703.7 316.9 713.0 6.3 8.6 9.2 44.2 50.4 744.7 43.1% 42.7 51.3 754.9 41.8% 42.9 52.1 765.1 40.5% 744.7 754.9 Beyond SR10 period: 765.1 -0.4% 744.7 Envelope for 2015-16 Spending Round of which Current spending envelope Capital spending envelope Memo: TME baseline for years beyond 2014-154 Average annual real growth SR10 period 2016-17 694.2 50.4 735.9 -0.4% Budgeting totals are shown net of the OBR's forecast Allowance for Shortfall. Resource DEL excluding ring-fenced depreciation is the Treasury's primary control within resource budgets and is the basis on which Spending Review 2010 settlements were agreed. The OBR publishes public sector current expenditure in DEL and AME, and public sector gross investment in DEL and AME. A reconciliation is published by the OBR. 2 In 2012-13, TME is temporarily reduced by a ?28 billion effect on public sector net investment resulting from the transfer of assets from the Royal Mail Pension Plan to the public sector. For budgeting purposes, income from this transaction is treated as Capital AME. Excluding the effect of Royal Mail TME would be 45.4 per cent of GDP . 3 Implied Capital DEL reduces in 2016-17 as measures set out in table 2.6 come to an end. This does not affect the public sector gross investment forecast as it is offset by a corresponding adjustment to the Capital AME forecast. 4 TME is lower in the baseline for calculating the assumption for the years beyond 2014-15 as a result of excluding the effect of all measures announced at Budget 2013 and Autumn Statement 2012, capital measures announced at Autumn Statement 2011, and the OBR's Allowance for Shortfall forecast. Departmental Expenditure Limits 2.7 Reduction in departmental spending in 2013-14 and 2014-15 - Resource DEL will be reduced by ?1.1 billion in 2013-14 and ?1.2 billion in 2014-15. This is equivalent to a 1 per cent reduction for most departments. The schools and health budgets remain unchanged. Local Government and police allocations that have been set out for 2013-14 will not be changed. HM Revenue and Customs will also be excluded, to ensure that they are able to focus on delivering the additional revenue targets set out at Autumn Statement 2012. The budget of the Department for International Development (DFID) will be reduced by ?135 million in 2013-14 and ?165 million in 2014-15 to reflect the downward revisions to nominal Gross National Income set out in the OBR forecast. There is also a reprofiling of funding for broadband programmes to support local delivery. The Government will reduce the Special Reserve provision to reflect progress made by the Afghans in taking on responsibility for their security. This funding is held over and above the Ministry of Defence budget. (62) (63) (64) 68 Budget 2013 Table 2.4: Departmental Expenditure Limits ? billion Estimate 2012-13 Plans 2013-14 2014-15 Departmental Programme and Administration Budgets (Resource DEL excluding depreciation1) Education 51.4 53.1 NHS (Health)2 102.9 106.9 Transport 4.4 4.8 CLG Communities 1.4 2.0 CLG Local Government 24.0 23.9 Business, Innovation and Skills3 15.4 14.9 Home Office 7.9 8.0 Justice 8.1 7.2 Law Officers' Departments 0.6 0.6 4 Defence 27.1 26.5 Foreign and Commonwealth Office 2.0 1.8 International Development 6.1 8.8 Energy and Climate Change 1.2 1.4 Environment, Food and Rural Affairs 1.9 1.9 Culture, Media and Sport5 1.9 1.2 Work and Pensions 7.1 7.6 Scotland 25.0 25.3 Wales 13.3 13.5 Northern Ireland 9.5 9.5 Chancellor's Departments 3.3 3.7 Cabinet Office 2.1 2.1 Small and Independent Bodies 1.4 1.5 Reserve 0.0 2.2 Special Reserve 0.0 0.4 Adjustment for Budget Exchange6 0.0 -1.7 Green Investment Bank 0.0 1.0 Total Resource DEL excluding depreciation 317.8 328.3 53.8 109.8 4.4 1.3 21.7 13.8 7.4 6.8 0.5 24.5 1.1 8.3 1.1 1.7 1.1 7.4 25.3 13.5 9.5 3.5 2.3 1.4 2.8 1.8 -1.2 0.0 323.6 Adjustment for DEL/AME switches7 OBR Allowance for Shortfall OBR Resource DEL excluding depreciation forecast 0.0 -0.3 317.6 -6.4 -1.2 320.7 -6.9 -1.0 315.7 Capital DEL Education NHS (Health) Transport CLG Communities CLG Local Government Business, Innovation and Skills Home Office Justice Law Officers' Departments Defence Foreign and Commonwealth Office International Development Energy and Climate Change Environment, Food and Rural Affairs Culture, Media and Sport Work and Pensions Scotland Wales Northern Ireland Chancellor's Departments Cabinet Office Small and Independent Bodies Reserve Special Reserve Adjustment for Budget Exchange Green Investment Bank Total Capital DEL plans 4.5 3.7 7.8 2.5 0.0 1.1 0.4 0.3 0.0 7.4 0.1 1.7 2.1 0.4 0.3 0.4 3.0 1.4 0.8 0.2 0.3 0.1 0.0 0.0 0.0 0.2 38.6 4.0 4.4 8.7 4.2 0.0 1.8 0.4 0.3 0.0 9.8 0.1 1.9 2.2 0.4 0.2 0.4 2.6 1.3 0.9 0.2 0.4 0.1 0.9 0.1 -1.1 0.5 44.6 4.6 4.6 8.9 4.8 0.0 2.1 0.5 0.3 0.0 9.0 0.1 2.0 2.2 0.5 0.3 0.2 2.9 1.4 1.0 0.1 0.4 0.1 1.1 0.3 -0.4 0.0 46.9 Spectrum receipts OBR Allowance for Shortfall OBR Capital DEL forecast -2.3 -0.3 36.1 0.0 -2.3 42.2 0.0 -2.0 44.9 1 Resource DEL excluding ring-fenced depreciation is the Treasury's primary control total within resource budgets and the basis on which Spending Review 2010 settlements were made. 2 The health budget remains projected to grow in real terms every year from 2012-13 to 2014-15. 3 Spending on the Green Investment Bank is part of the Department for Business, Innovation and Skills' budget in 2012-13. However, consistent with previous Budgets, the Green Investment Bank is shown separately here. 4 The defence budget for 2013-14 reflects the likely initial drawdown of funding from the Special Reserve for the net additional cost of military operations at Main Estimates. No such allocation has yet been made for 2014-15; the funding in this year remains in the Special Reserve. 5 Includes the Olympics budget in 2012-13 only. 6 Departmental budgets in 2013-14 and 2014-15 include amounts carried forward from 2012-13 through Budget Exchange, which will be voted at Main Estimates. These increases will be offset by any deposits at Supplementary Estimates in future years so are excluded from spending totals. 7 Net aggregate adjustment to departmental plans for changes to local government funding for Business Rates Retention and Council Tax localisation. These changes will be voted at Main Estimates. Budget 2013 69 2.8 Date of the 2015-16 Spending Round - The Government will publish individual departmental budgets for 2015-16 in a Spending Round to be announced on 26 June 2013. 2.9 Spending envelope for 2015-16 - The Government has set envelopes for current and capital spending in 2015-16 of ?694.2 billion and ?50.4 billion. Health, schools and Official Development Assistance will be protected. 2.10 Capital spending plans - The Government has increased capital spending plans by ?3 billion a year from 2015-16. The Government will take a long-term approach to capital as part of the 2015-16 Spending Round, setting plans out to 2020-21 for the most economically valuable areas of capital expenditure. (27) 2.11 Efficiency programme in 2015-16 - The 2015-16 Spending Round will extend the efficiency programme into 2015-16, with the expectation of generating a further ?5 billion of savings. Table 2.5: Estimated underspends and Budget Exchange carried forward since Budget 20121 ? billion Resource DEL excluding depreciation Capital DEL TOTAL -7.6 2013-14 0.4 0.0 0.1 0.2 0.0 0.2 0.1 0.0 0.0 0.5 0.0 0.1 0.1 0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 2014-15 0.2 0.0 0.0 0.0 0.0 0.2 0.0 0.0 0.0 0.8 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Estimated underspend 2012-13 0.0 -0.8 -0.2 -0.3 0.0 -0.2 -0.1 0.0 0.0 -0.8 0.0 0.0 0.0 0.0 -0.4 0.1 0.4 0.2 -0.1 0.1 0.0 0.0 -0.6 0.6 1.7 1.2 -2.1 1.1 0.4 -1.7 Estimated underspend2 2012-13 Education -1.0 NHS (Health) -1.4 Transport -0.7 CLG Communities -0.5 CLG Local Government 0.0 Business, Innovation and Skills -0.6 Home Office -0.7 Justice 0.4 Law Officers' Departments 0.0 Defence4 -0.5 Foreign and Commonwealth Office 0.2 International Development -0.5 Energy and Climate Change -0.3 Environment, Food and Rural Affairs -0.2 Culture, Media and Sport -0.1 Work and Pensions -0.7 Scotland -0.2 Wales -0.1 Northern Ireland 0.0 Chancellor's Departments5 -0.1 Cabinet Office 0.0 Small and Independent Bodies 0.0 Green Investment Bank6 0.0 Other7 -0.7 0.0 0.0 0.4 0.4 Budget Exchange3 Single Use Military Equipment 4 Exceptional inter-period flexibility 8 0.4 0.4 Budget Exchange 2013-14 0.1 0.0 0.3 0.0 0.0 0.0 0.0 0.0 0.0 0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.5 0.0 2014-15 0.0 0.0 0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.2 0.0 0.0 0.0 0.0 0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 These figures exclude measures from this Budget and Autumn Statement 2012 to illustrate changes in departmental data that informed the OBR's Allowance for Shortfall judgement. In addition to underspends, departments' budgets also change as a result of inter-departmental transfers and classification decisions, as well as changes voted at Supplementary Estimates. 2 The difference between plans published at Budget 2012 and departments' latest estimates of their full-year position. 3 These are the amounts carried forward from 2012-13 through Budget Exchange, presented in the Supplementary Estimates. 4 The Capital DEL changes exclude spending on Single Use Military Equipment (SUME) from the defence budget. This better illustrates the PSGI changes that underpin the OBR's forecast as SUME scores as capital spending in budgets but current spending in the OBR's forecasts. 5 Excludes ?0.3 billion of income from London Inter-Bank Offered Rates (LIBOR) fines that was not present in Budget 2012 totals. 6 Spending on the Green Investment Bank scores as financial transactions spending and so does not directly affect the deficit. 7 Includes changes to the Reserve, Special Reserve and Budget Exchange adjustments. 8 Exceptional inter-period flexibilities identified after Supplementary Estimates; these figures are provisional. 1 70 Budget 2013 2.12 As described in Chapter 1, departmental underspends in 2012-13 are higher than in a typical year, which has informed the OBR's Allowance for Shortfall judgement. Table 2.5 sets out the underspends as well as changes to departmental budgets (for example, inter-departmental transfers and classification changes) that have emerged since Budget 2012, as well as the Budget Exchange amounts that departments are carrying into future years as a result. Financial transactions and contingent liabilities 2.13 A number of policy measures announced in the Budget do not directly affect PSNB in the same way as conventional spending or taxation. These include financial transactions that directly impact only on the central government net cash requirement (CGNCR) and public sector net debt, and transactions likely to be recorded as contingent liabilities. Table 2.6 shows the effect of financial transactions on CGNCR. Table 2.6: Financial transactions: impact on central government net cash requirement ? million Financial transactions - Housing Help to Buy Build to Rent extension TOTAL 2013-14 -1,150 -150 2014-15 -1,430 -445 2015-16 -1,550 -360 -1,300 -1,875 -1,910 All figures include Barnett consequentials. Pay and employment 2.14 Public sector pay - Public sector pay awards in 2015-16 will be limited to an average of up to 1 per cent. It will be for government departments and pay review bodies to determine whether a lower award is justified based on affordability and individual recruitment and retention needs. In 2014-15, pay awards for civil service departments who entered the 2010 pay freeze early will average at 1 per cent, aligning them with the rest of the public sector. 2.15 The Government will seek significant further savings through reform to progression pay in the 2015-16 Spending Round. The armed forces will be excluded due to the unique nature of their careers. 2.16 Military Pay - In addition to the recent 1 per cent increase in base pay for the armed forces, the X-Factor component of base pay will also be increased by half a percent, as recommended by the independent Armed Forces Pay Review Body, from 1 May 2013. By accepting the recommendations in full, armed forces personnel are receiving a total 1.45 per cent increase in base pay. Capital spending 2.17 M4 in south Wales - The Government is continuing to discuss options for funding improvements to the M4 in south Wales with the Welsh Government, alongside an assessment of the Silk Commission recommendations, and will be reporting in due course. Housing 2.18 Changes to pension investment rules to encourage the conversion of unused space in commercial properties - The Government will explore with interested parties whether the conversion of unused space in commercial properties in high streets and town centres to residential use could be encouraged by amending Investment Regulated Pensions Schemes rules. Any amendments would need to be consistent with sound public finances and the Government's wider pensions strategy. Budget 2013 71 2.19 Help to Buy: mortgage guarantee - The Government will create the Help to Buy: mortgage guarantee to increase the availability of mortgages for those with small deposits across the UK. 2.20 Help to Buy: equity loan - From 1 April 2013 Help to Buy: equity loan will be opened up to all those who aspire to own a new build home. The Government will: o provide an equity loan worth up to 20 per cent of the value of a new build home, repayable once the home is sold; o significantly widen the eligibility criteria for shared equity to ensure as many people as possible are able to benefit. The maximum home value will be ?600,000 and there will be no income cap constraint; and o ensure that the scheme is open not only to first time buyers but also to all those looking to move up the housing ladder. 2.21 Social Rental Policy - At the 2015-16 Spending Round, the Government will set out a social rental policy that gives social landlords certainty until 2025. 2.22 Pay to Stay - The Government will shortly take steps to allow landlords to charge market rents to those social housing households with incomes of more than ?60,000 a year and intends to make it the responsibility of these households to ensure they are making a fair contribution, with all additional income reinvested in housing. 2.23 Right to Buy: increase cap in London - From 25 March 2013 the maximum Right to Buy discount cash cap will be raised from ?75,000 to ?100,000 in London. (29) 2.24 Right to Buy: simplification - The Government will simplify the Right to Buy application process for both local authorities and prospective tenants. 2.25 Right to Buy: eligibility - The Government will reduce the time tenants have to wait before they are eligible for Right to Buy from five to three years. (29) 2.26 Build to Rent - The Government will expand the ?200 million Build to Rent fund announced at Autumn Statement 2012 to ?1 billion. 2.27 Zero Carbon Homes - The Department for Communities and Local Government (DCLG) will consult on next steps for Zero Carbon Homes. 2.28 Extension to affordable homes guarantee programme - The Government will double the existing affordable homes guarantee programme, providing up to a further ?225 million to support a further 15,000 affordable homes in England. (28) 2.29 Public Land Disposals - DCLG have invited bids from eligible public landholders for the ?290 million funding allocated to accelerate surplus public land disposals at Autumn Statement 2012. In addition, around 30 sites will transfer to the Howes and Communities Agency, who will dispose of them quickly. Other spending measures 2.30 Equitable Life with-profits annuitants - The Government will make flat rate lump sum payments to living with-profits annuitants aged over 60 who bought their annuity from Equitable Life Assurance Society before 1 September 1992. Payments will start in 2014 or earlier if possible. (65) 2.31 Whole Place Community Budgets - The Government will establish a new multiagency network to drive the transformation of local public services. The network will spread 72 Budget 2013 innovation from the Whole-Place Community Budget pilots and What Works Centres to support other places at key stages to provide advice and support on co-designing local public service transformation. 2.32 Social care funding reform - Drawing on the Dilnot Commission's recommendations, the Government will introduce a ?72,000 cap on reasonable care costs and extend the means test from April 2016. (23) Personal tax and welfare Income tax and National Insurance contributions 2.33 Income tax: personal allowance in 2013-14 - As announced at Autumn Statement 2012, from April 2013 the income tax personal allowance will be increased to ?9,440. The basic rate limit will be ?32,010. The higher rate threshold will be ?41,450 in 2013-14. The National Insurance upper earnings/profits limit will also be reduced to align it with the higher rate threshold. (Finance Bill 2013) (g) 2.34 Income tax: personal allowance in 2014-15 - The Government will increase the income tax personal allowance to ?10,000 in 2014-15. The basic rate limit will decrease to ?31,865 in line with the Autumn Statement 2012 decision to increase the higher rate threshold by 1 per cent to ?41,865. (Finance Bill 2014) (41) The personal allowance will then be increased by CPI from 2015-16. 2.35 Income tax rates - The basic and higher rates of income tax for 2013-14 will remain at their 2012-13 levels. As announced at Budget 2012 and legislated for in Finance Act 2012, the additional rate of income tax will be reduced from 50 per cent to 45 per cent from 2013-14. (Finance Bill 2013) (t) 2.36 Income tax: reliefs cap - As announced at Budget 2012, the Government will cap previously unlimited income tax reliefs at the greater of ?50,000 or 25 per cent of an individual's income. Charitable reliefs, share loss relief applying to Enterprise Investment Scheme or Seed Enterprise Investment Scheme (SEIS) and overlap relief will be exempt from this cap. (Finance Bill 2013) (u) (13) 2.37 Expenses of devolved administration members - The Government will legislate to formalise aspects of the income tax treatment of travel expenses incurred by members of devolved administrations on parliamentary or assembly duties. This will include a tax exemption for expenses incurred on travel by spouses or partners of devolved administration members where they share caring responsibilities for a dependent. (Finance Bill 2013) 2.38 Universal Credit - The Government will legislate to ensure that Universal Credit will be exempt from income tax. (Finance Bill 2013) (6) 2.39 Scottish rate of income tax - The Government will introduce legislation in Finance Bill 2014 to require the National Audit Office to report annually to the Scottish Parliament on HMRC's administration of the Scottish rate of income tax. (Finance Bill 2014) 2.40 Income tax exemptions for non-resident athletes - Legislation will be introduced to exempt from UK income tax any income arising to non-resident competitors in relation to the London Anniversary Games in 2013 or the Glasgow Commonwealth Games in 2014. (Finance Bill 2013) 2.41 National Insurance: ?2,000 Employment Allowance - The Government will introduce an allowance of ?2,000 per year for all businesses and charities to be offset against their employer NICs bill from April 2014. (25) Budget 2013 73 2.42 National Insurance administration for the self-employed - The Government will consult on options to simplify the administrative process for the self-employed by using Self Assessment to collect Class 2 NICs alongside income tax and Class 4 NICs. 2.43 SEIS: off-the-shelf companies - The Government will amend the qualifying conditions attached to the SEIS so that an investment on or after 6 April 2013 into companies established by corporate formation agents can qualify for the scheme. (Finance Bill 2013) 2.44 Community Investment Tax Relief (CITR) - As announced at Budget 2012, the Government will relax the CITR on-lending requirements that currently place conditions on the speed with which Community Development Finance Institutions must on-lend the funding they receive, and introduce new rules to allow investors to carry unused relief forward from April 2013. The Government will also place limits on the amounts of CITR tax relief an investor company can obtain in any three year period. (Finance Bill 2013) 2.45 Social investment tax relief - The Government will consult by summer 2013 on the introduction of a new tax relief to encourage investment into social enterprises. The outcome of the consultation will be confirmed at Autumn Statement 2013 with a view to introducing legislation in Finance Bill 2014. (Finance Bill 2014) 2.46 Employee shareholder status - To ensure that the first ?2,000 of share value received by those adopting the new employee shareholder status is free from income tax and NICs, the Government will legislate to deem that employee shareholders have paid ?2,000 for shares they receive from 1 September 2013, when the new status comes into force. (Finance Bill 2013) (33) 2.47 Non-domicile taxation - As announced on 6 December 2011, the Government will simplify the rules applying to the taxation of non-domiciles and remove minor anomalies. (Finance Bill 2013) 2.48 Statutory residence test and reform of ordinary residence - As announced on 6 December 2011, the Government will introduce a statutory definition of tax residence and abolish ordinary residence for most tax purposes from 6 April 2013. Overseas workday relief will be made available to any non-domiciled individual who arrives in the UK following a period where they have been non-resident for at least three tax years. (Finance Bill 2013) 2.49 Legislation of Statement of Practice 1/09 (SP1/09) - As proposed in a consultation document published in June 2011, the Government will introduce legislation to put SP1/09 on a statutory basis from 6 April 2013. SP1/09 provides an administrative easement for employees who claim overseas workday relief. (Finance Bill 2013) 2.50 Government response to Office of Tax Simplification (OTS) review of unapproved share schemes - The Government will consult shortly on a number of the recommendations of the OTS's review of non-tax advantaged ('unapproved') share schemes. (Finance Bill 2014) 2.51 Government response to OTS tax-advantaged employee share schemes review - As announced on 11 December 2012, the Government will introduce a package of simplification measures in response to the OTS's review of the tax-advantaged share schemes. (Finance Bill 2013 and Finance Bill 2014) (2) 2.52 Employer provided benefits in kind: beneficial loans - Legislation will be introduced in Finance Bill 2014 to increase the exempt threshold for the small loans exemption limit from ?5,000 to ?10,000. (Finance Bill 2014) Taxation of pensions and savings 2.53 Lifetime Allowance (LTA) for pensions contributions - As announced at Autumn Statement 2012, LTA for pension savings will reduce from ?1.5 million to ?1.25 million for 2014-15 and subsequent years. As part of this change, the Government will offer a fixed 74 Budget 2013 protection regime to individuals to prevent any retrospective tax charges following the reduction of the lifetime allowance. The Government will also consult on the detail of an individual protection regime in spring 2013. (Finance Bill 2013) (p) 2.54 Individual Protection - The Government will offer an individual protection regime, in addition to a fixed protection regime, for individuals with pension rights above ?1.25 million when the standard LTA is reduced from ?1.5 million to ?1.25 million for 2014-15 and subsequent years. The Government will consult on the detail in spring 2013 and legislation will be included in Finance Bill 2014. (Finance Bill 2014) (42) 2.55 Reduction in the Annual Allowance (AA) for pensions contributions - As announced at Autumn Statement 2012, the AA for pension savings will reduce from ?50,000 to ?40,000 for 2014-15 and subsequent years. (Finance Bill 2013) (p) 2.56 Restriction of pensions tax relief: closing loophole - As announced at Budget 2012, legislation will be included in Finance Bill 2013 to remove the tax and NICs incentives for employees and employers respectively from arrangements where an employer pays a pension contribution into a registered pension scheme for an employee's spouse or family member as part of their employee's flexible remuneration package. (Finance Bill 2013) 2.57 Overseas transfers of UK pension savings - As announced at Budget 2012, qualifying recognised overseas pension schemes (QROPS) will need to re-notify HMRC every five years that they continue to meet the requirements to be QROPS. Former QROPS will also have to continue to report payments out of transfers received while they were QROPS and there will be additional reasons for excluding a pension scheme from being a QROPS. (Finance Bill 2013) 2.58 Tax relief on loans to purchase life annuities - As recommended by the OTS, the Government will consult on the impact of the future withdrawal of relief for interest on loans to purchase life annuities taken out by pensioners before 1999. 2.59 Pension drawdown - The Government will increase the capped drawdown limit for pensioners with these arrangements of all ages from 100 per cent to 120 per cent of the value of an equivalent annuity in Finance Bill 2013, from 26 March 2013. (Finance Bill 2013) 2.60 Pensions drawdown rates - The Government has commissioned the Government Actuary's Department to review the pensions drawdown table and the underlying assumptions used to provide drawdown rates to make sure they continue to reflect the annuity market. 2.61 Defined benefit pensions regulation - The Government will provide the Pensions Regulator with a new objective to support scheme funding arrangements, that are compatible with sustainable growth for the sponsoring employer and fully consistent with the 2004 funding legislation. The precise wording of this new objective will be set out in legislation that DWP will publish later in spring 2013. 2.62 Child Trust Funds - The Government will consult on options for transferring savings held in Child Trust Funds into Junior ISAs. (Finance Bill 2014) 2.63 Bridging pensions - Following the announcement at Budget 2012, legislation will be introduced with effect from April 2013 to align the tax rules on the payment of bridging pensions with DWP changes to State Pension Age. (Finance Bill 2013) 2.64 Income tax rules on interest - The Government will introduce legislation in Finance Bill 2013 on disguised interest and on deduction of income tax from interest on compensation payments, specialty debt, and interest in kind. (Finance Bill 2013) 2.65 Pensions tax consequentials of the abolition of contracting out (defined contribution schemes) - As announced in Budget 2012, legislation will be introduced in Finance Bill 2013 to bring tax legislation into line with DWP legislation which abolished Budget 2013 75 contracting out through a defined contribution pension scheme from 6 April 2012. (Finance Bill 2013) 2.66 LTA: fixed protection technical improvements - As announced at Budget 2012, a regulation-making power will be included in Finance Bill 2013 in order to amend the fixed protection legislation introduced in Finance Act 2011 and make it work as intended. (Finance Bill 2013) CGT and inheritance tax 2.67 Capital Gains Tax (CGT): residential property - The Government will apply CGT at 28 per cent to gains accruing on or after 6 April 2013 on disposals made by certain non-natural persons of UK residential property valued at over ?2 million that has been subject to the Annual Tax on Enveloped Dwellings. (Finance Bill 2013) (5) 2.68 SEIS: CGT relief - The Government will legislate to provide a 50 per cent relief against CGT chargeable on gains realised in 2013-14 which are reinvested in the SEIS in 2013-14 or 2014-15. (Finance Bill 2013) (32) 2.69 CGT: employee shareholder status - As announced on 8 October 2012 and confirmed at Autumn Statement 2012, the Government will exempt from CGT gains on up to ?50,000 of shares received by individuals adopting the new employee shareholder employment status. The CGT exemption will apply to shares received from 1 September 2013, when the new status comes into force. (Finance Bill 2013) (e) (9) 2.70 CGT: annual exempt amount (AEA) - As announced at Autumn Statement 2012, the AEA will increase by 1 per cent in 2014-15 and 2015-16. The AEA will rise to ?11,000 in April 2014 and ?11,100 in April 2015. (Finance Bill 2014) (n) 2.71 Employee ownership: additional support - The Government will provide ?50 million annual funding from 2014-15 to support employee ownership. This will include the introduction of a CGT exemption on qualifying disposals of a controlling interest in a business into an employee-owned structure from April 2014. (Finance Bill 2014) (35) 2.72 Entrepreneurs' Relief: Enterprise Management Incentives (EMI) shares - As announced at Budget 2012, the Government will extend Entrepreneurs' Relief to cover gains made on shares acquired through the exercise of EMI options, to apply to qualifying share disposals from 6 April 2013. (Finance Bill 2013) (10) 2.73 CGT: Heritage Maintenance Funds (HMFs) - As announced at Budget 2012, the Government will ease a restriction for trusts that are HMFs and which have deferred CGT charges arising from the re-settlement of assets from one HMF to another. This will have retrospective effect from 6 April 2012. (Finance Bill 2013) 2.74 Inheritance tax (IHT): investments in open ended investment companies (OEICs) and authorised unit trusts (AUTs) - As announced at Autumn Statement 2012, the Government will legislate to ensure that the switching of UK assets in a trust settled by a non-UK domiciled individual to investments in OEICs and AUTs is exempt from IHT. This will ensure that the changes introduced in Finance Act 2003 work as intended. Consequently, these changes have effect from 16 October 2002. (Finance Bill 2013) 2.75 IHT: periodic charges on trusts - The Government will consult further on simplifying the calculation of IHT charges to which trusts are subjected at ten-yearly intervals and when property is transferred out of the trust. (Finance Bill 2014) 2.76 IHT: nil-rate band - As announced on 11 February, the Government will partly fund reforms to the funding of social care by extending the freeze on the IHT nil-rate band of ?325,000 until 2017-18. (Finance Bill 2014) (22) 76 Budget 2013 2.77 IHT: spouses and civil partners domiciled outside the UK - As announced at Budget 2012, the Government will legislate to increase the IHT-exempt amount that a UK-domiciled individual can transfer to their non-UK domiciled spouse or civil partner. The Government will also allow individuals who are domiciled outside the UK and who have a UK-domiciled spouse or civil partner to elect to be treated as domiciled in the UK for the purposes of IHT. (Finance Bill 2013) (af) Gift Aid and charitable giving 2.78 Gift Aid - The Government will consult on proposals to make it easier to claim Gift Aid through a wide range of digital giving channels, including options for enabling donors to complete a single Gift Aid declaration to cover all their donations through a specific channel. 2.79 Community Amateur Sports Clubs (CASCs) - As announced on 4 March 2013, the Government will consult on measures to clarify the eligibility conditions for CASCs. (Finance Bill 2013) Welfare 2.80 Single-tier State Pension - The Government will introduce the single-tier State Pension from April 2016-17. As announced in the White Paper in January 2013, the State Second Pension will close and contracting-out of National Insurance will be abolished. The current value of the contracting-out rebate is 3.4 per cent for employers and 1.4 per cent for employees on earnings between the lower earnings limit and the upper accruals point. (18, 19, 20, 21) 2.81 Tax reliefs and Personal Independence Payments (PIP) - Through Finance Bill 2013 and amending other regulations, the Government will legislate to ensure tax reliefs currently available for claimants of Disability Living Allowance (DLA) will be available for those eligible to receive PIP, which will begin to replace DLA for working age claimants from April 2013 and those in receipt of Armed Forces Independence Payments (AFIP). 2.82 Finance Bill 2013 will introduce legislation to: treat for tax purposes assets held in trusts for vulnerable beneficiaries in a similar way as if held directly by the vulnerable person; extend the qualifying age for a child under employer supported childcare if the child is in receipt of DLA; ensure beneficial capital allowance treatment for lessors of cars to the disabled; and grant a Vehicle Excise Duty (VED) exemption for those in receipt of higher rate mobility and a 50 per cent discount for those in receipt of standard rate mobility. (Finance Bill 2013) 2.83 The Government will also make consequential changes to VAT and insurance premium tax rules. 2.84 Pension Credit pass-through - As announced by the DWP in December 2012, the standard minimum income guarantee in Pension Credit will rise by 1.9 per cent in April 2013 to match the cash increase in the basic State Pension. This will mean that no single pensioner need live on less than ?145.40 a week, and no pensioner couple on less than ?222.05 a week. The threshold for the Savings Credit will increase to ?115.30 for single pensioners and ?183.90 for pensioner couples. The net effect of these two measures is broadly cost neutral. (17) 2.85 Sickness absence - The Government will abolish the Percentage Threshold Scheme and recycle funding into creating the health and work assessment and advisory service for those at danger of long-term sickness absence. The Government will also introduce a targeted tax relief so that amounts up to a cap of ?500 paid by employers on health-related interventions recommended by the service are not treated as a taxable benefit in kind. The Government will consult on implementation later in 2013. (38) (39) 2.86 Childcare vouchers - The Government will introduce a new Tax-Free Childcare Scheme to support working families with the costs of childcare. Once fully in place, support will be worth 20 per cent of childcare costs up to ?6,000 per child each year, for children under 12. Budget 2013 77 This new system will be phased in from autumn 2015, with all children under five eligible from the first year of operation. Disabled children up to age 16 will also be eligible in line with existing Employer Supported Childcare Rules. Tax-Free Childcare will be available to families where all parents are working, who are not already receiving support through tax credits or Universal Credit and where neither parent earns over ?150,000 a year. Alongside the new scheme, the current Employer Supported Childcare will be phased out for new applicants from autumn 2015. 2.87 The Government will also increase childcare support within Universal Credit, to improve work incentives and ensure that it is worthwhile to work up to full-time hours for low and middle income parents. An additional ?200 million of support for childcare will be provided, which is equivalent to covering 85 per cent of childcare costs for households qualifying for the Universal Credit childcare element where the lone parent or both earners in a couple pay income tax. The details of how to provide this support will be determined as part of the consultation on the Tax-free Childcare scheme, to ensure the two schemes operate effectively together. The new element of support in Universal Credit will be funded from within social security budgets at the time. (24) Corporate taxes Corporation tax 2.88 Corporation tax: main rate - The Government will reduce the main rate of corporation tax to 21 per cent from April 2014, as announced at Autumn Statement 2012. (Finance Bill 2013) Budget 2013 announces an additional 1 percentage point reduction to 20 per cent from April 2015. (Finance Bill 2013) (a) (26) 2.89 Single rate of corporation tax - The small profits rate and the main rate of corporation tax will be unified in 2015, when the main rate is reduced to 20 per cent. (Finance Bill 2014) 2.90 Corporation tax: small profits rate - The small profits rate of corporation tax will remain at 20 per cent from April 2013. (Finance Bill 2013) 2.91 Annual Investment Allowance (AIA) - As announced at Autumn Statement 2012, the Government will increase the AIA limit from ?25,000 to ?250,000 for two years for all qualifying investments in plant and machinery made on or after 1 January 2013. (Finance Bill 2013) 2.92 Research and Development (R&D) tax credit: 'Above the Line' (ATL) - As announced at Autumn Statement 2011, the Government will introduce an ATL credit for large company R&D expenditure incurred on or after 1 April 2013. Budget 2013 increases the ATL credit to a rate of 10 per cent before tax. Companies with no corporation tax liability will be able to claim a payable credit. The ATL credit will be introduced alongside the existing superdeduction in April 2013, and will fully replace the super-deduction in April 2016. (Finance Bill 2013) (34) 2.93 Capital allowances for business cars: first year allowances (FYA) - As announced at Budget 2012, the 100 per cent FYA for businesses purchasing the lowest emissions vehicles will be extended until 31 March 2015. From April 2013, the carbon dioxide emissions threshold below which cars are eligible for the FYA will be reduced from 110 grams/kilometre to 95 grams/ kilometre and leased business cars will no longer be eligible for the FYA. (Finance Bill 2013) (ad) 2.94 The Government will extend the FYA for a further three years until 31 March 2018. From April 2015, the carbon dioxide emissions threshold will be reduced from 95 grams/kilometre to 75 grams/kilometre. (Finance Bill 2015) (56) 78 Budget 2013 2.95 The Government will review the case for going further with the FYA, and the appropriate emissions threshold, at Budget 2016. 2.96 Capital allowances for business cars: main rate - As announced at Budget 2012, the carbon dioxide emissions threshold below which cars are eligible for the main rate of capital allowances will be reduced from 160 grams/kilometre to 130 grams/kilometre from April 2013. (Finance Bill 2013) 2.97 The Government will review the main rate emissions threshold at Budget 2016, with any amendments taking effect from April 2018. (ad) 2.98 Capital allowances: gas refuelling equipment - As announced at Budget 2012, the existing 100 per cent FYA for business expenditure on gas refuelling equipment will be extended for a further two years to 31 March 2015. (Finance Bill 2013) 2.99 The Government will now extend the FYA for gas refuelling equipment for a further three years to 31 March 2018. (Finance Bill 2015) 2.100 Capital allowances: Mineral Extraction Allowances - The Government will consult informally on proposals to align the treatment of assets eligible for Mineral Extraction Allowances with that for assets eligible for Plant and Machinery Allowances, where profits are not taxed in the UK. 2.101 UK group relief rules - As announced on 11 December 2012, the Government will amend the restrictions on when companies resident in the European Economic Area can surrender losses from their UK branches as group relief from corporation tax in the UK. From 1 April 2013, these restrictions will be based on whether the losses are used elsewhere in any period, rather than on whether they could potentially be used elsewhere. (Finance Bill 2013) 2.102 Restrictions on corporation tax group loss relief - As announced on 11 December 2012, the Government will expand the types of commercial arrangements that are exempt from anti-avoidance rules affecting group loss relief. This will ensure the group loss relief antiavoidance rules are more effectively targeted for the future. (Finance Bill 2013) 2.103 Corporation tax reliefs for the creative sector - As announced at Budget 2012, the Government will introduce corporation tax reliefs for the animation, high-end television and video games industries. The Commission is expected to approve the animation and highend television tax reliefs shortly, to start on 1 April 2013. The video games tax relief will be introduced following state aids approval. (Finance Bill 2013) (y) 2.104 Disincorporation relief - The Government will introduce a disincorporation relief for five years from April 2013. The relief will allow a company to transfer goodwill and an interest in land to its shareholders so that no corporation tax charge arises on the company on the transfer. The relief will be available to businesses with total qualifying assets not exceeding ?100,000. (Finance Bill 2013) (15) 2.105 Lease premium relief: effective duration of a lease - As announced on 11 December 2012, the Government will limit the availability of lease premium relief where leases are of more than 50 years duration. The legislation will take effect for leases granted on or after 1 April 2013 for companies and on or after 6 April 2013 for individuals and partnerships. (Finance Bill 2013) 2.106 Controlled Foreign Companies (CFC) rules - As announced on 11 December 2012, legislation will be introduced to make four amendments to the new CFC rules introduced in Finance Act 2012. In addition to those previously announced, four minor additional amendments will be made to ensure the CFC rules operate as intended. All the amendments, Budget 2013 79 subject to one transitional rule, will have effect from 1 January 2013 in line with the commencement date for the new CFC rules. (Finance Bill 2013) 2.107 World wide debt cap rules - As announced on 11 December 2012, with effect from that date, changes to the debt cap rules will revise the way in which the group treasury company election operates. (Finance Bill 2013) (7) 2.108 Corporation tax: deferral of exit charges - As announced on 11 December 2012, the Government will introduce legislation to enable companies to opt for deferred payment arrangements in respect of exit charges. (Finance Bill 2013) 2.109 Manufactured payments - As announced on 15 September 2011 and consulted on during 2012, legislation will be introduced to simplify the rules for manufactured payments and make them less vulnerable to avoidance. The new rules will have effect from 1 January 2014. (Finance Bill 2013) 2.110 Corporation tax simplification: foreign currency assets and chargeable gains - As announced at Budget 2012 and following consultation over the summer, the Government is introducing legislation requiring relevant companies to compute their chargeable gains and losses on disposals of ships, aircraft, shares and interests in shares in their functional currency. This measure has effect from a day appointed by Treasury order, shortly after Royal Assent. (Finance Bill 2013) 2.111 Review of loan relationships and derivative contracts legislation - The Government will consult on a package of proposals to modernise the corporation tax rules governing the taxation of corporate debt, with a view to legislating in Finance Bill 2014 and Finance Bill 2015. This will include measures both to clarify and strengthen the structure of the legislative regime and to update aspects of the detailed rules. (Finance Bill 2014 and Finance Bill 2015) 2.112 Loans to participators (wider reform) - The Government will consult on options to reform the structure and operation of the tax charge on loans from close companies to make the rules fairer and simpler. 2.113 Chief constables' exemption from corporation tax - As set out in a Written Ministerial Statement published on 17 January 2013, the Government will amend the Corporation Tax Act 2010 to exempt chief constables and the Commissioner of Police of the Metropolis from corporation tax, with effect from 16 January 2012 and 22 November 2012 respectively. (Finance Bill 2013) Taxation of the financial services sector 2.114 Bank Levy rate - As announced at Autumn Statement 2012, the Government will legislate in Finance Bill 2013 to set the full rate of the Bank Levy at 0.130 per cent from 1 January 2013. From 1 January 2014, the Government will legislate in Finance Bill 2013 to set the full rate of the Bank Levy at 0.142 per cent. (Finance Bill 2013) (40) 2.115 Corporation tax and foreign banks levies - As announced at Autumn Statement 2012, the Government will legislate in Finance Bill 2013 to ensure that, from 1 January 2013, foreign bank levies paid by a foreign banking group trading in the UK cannot be claimed as a deduction against UK corporation tax and income tax. Transitional arrangements will also make clear that a claim to double taxation relief in respect of a foreign bank levy will prevent that foreign bank levy from being deducted against corporation tax and income tax. (Finance Bill 2013) 2.116 Tax treatment of regulatory capital - As announced on 26 October 2012, legislation will be introduced in Finance Bill 2013 to clarify that the coupon on Tier 2 debt capital which is 80 Budget 2013 already in issue, or yet to be issued, will be deductible for the purposes of a bank computing its profits for corporation tax purposes. (Finance Bill 2013) 2.117 In addition, the Government will legislate to clarify that banks' Additional Tier 1 debt capital instruments already in issue or yet to be issued will be similarly deductible for the purposes of a bank computing its profits for corporation tax purposes. 2.118 Tax treatment of building societies' capital instruments - Following consultation, regulations have been made so that the tax treatment of new Basel III compliant building society capital instruments 'Core Capital Deferred Shares' will be the same as equivalent share capital from 1 March 2013. (8) 2.119 Life insurance: time apportionment relief - The Government will introduce legislation in order to provide greater alignment between the treatment of life insurance policies issued by insurers inside and outside the UK, while ensuring that the rules provide a more appropriate reduction to chargeable event gains. (Finance Bill 2013) 2.120 Life Insurance Qualifying Policies - The Government will limit the premiums that can be paid into Qualifying Policies to ?3,600 a year from 6 April 2013, with transitional arrangements for policies issued before that date. (Finance Bill 2013) 2.121 Stamp tax on shares: growth markets - Following consultation, the Government will abolish stamp tax on shares in companies quoted on growth markets such as the Alternative Investment Market and the ISDX Growth Market. (Finance Bill 2014) (31) 2.122 Investment Trust amendments - The Government will address two unintended consequences of previous changes to the tax rules for investment trust companies. One change will be made through secondary legislation, the other in Finance Bill 2013. (Finance Bill 2013) 2.123 Offshore Funds (Tax) Regulations: amendments - The Government will make changes to address issues in the operation of the Offshore Funds (Tax) Regulations 2009. Regulations will be introduced to close an avoidance loophole with effect from today. Further Regulations to help ensure that investors in offshore reporting funds are taxed on the correct proportionate share of income will be published in draft form for comment. Investment management package 2.124 Investment management marketing and regulation - The Government will introduce a marketing strategy to promote the UK as a centre of fund management and domicile, and will also act to improve the process whereby new funds are authorised in the UK. The Government will also make changes to limited partnerships to more effectively accommodate their use for private equity investments. These follow on from previously announced policies, including the launch of authorised contractual schemes and the establishment of an Islamic Finance Taskforce. 2.125 Investment Management Exemption - The Government will consult on minor changes to the White List of permitted investment transactions. 2.126 Extension of s.363A Taxation (International and Other Provisions) Act 2010 (TIOPA) - The Government will consult on proposals to widen the scope of s.363A of TIOPA to provide certainty that locating fund management activities of certain offshore non Undertakings for Collective Investments in Transferrable Securities funds will not lead to a risk of that fund being deemed to be tax resident. (Finance Bill 2014) 2.127 Withholding tax rules on interest distributions from bond funds - The Government will consult on a proposal to remove the requirement to withhold tax on interest distributions on UK domiciled bond funds when sold via reputable intermediaries and marketed only to non-UK investors. Budget 2013 81 2.128 Schedule 19 - The Government will abolish the stamp duty reserve tax charge in Schedule 19 Finance Act 1999 on surrenders of units in collective investment schemes from 1 April 2014. (Finance Bill 2014) (30) Oil and gas taxes 2.129 Shale gas - The Government will introduce a new field allowance for shale gas and extend the Ring Fence Expenditure Supplement for shale gas projects from 6 to 10 years. The Government will consult on the detail of these measures, including whether they should be extended to other forms of unconventional onshore gas. (Finance Bill 2014) 2.130 The Government will produce technical planning guidance on shale gas by July 2013 to provide clarity around planning for shale gas during the important exploration phase for the industry. As the shale gas industry develops, the Government will ensure an effective planning system is in place and by the end of the year will produce guidance for the industry to ensure that the planning system is properly aligned with the licensing regime and regulatory regimes, principally: health and safety, and environmental protection. The Government will keep under review whether the largest shale gas projects should have the option to apply to the major infrastructure regime. 2.131 The Government will develop proposals by summer 2013 to ensure that local communities will benefit from shale gas projects in their area. 2.132 Budget 2013 announces the scope, responsibilities and objectives of The Office for Unconventional Gas and Oil. 2.133 Carbon Capture and Storage (CCS) - The Government intends to take forward two CCS projects to the detailing planning and design stage of the competition. This represents the next step in the ?1 billion CCS commercialisation programme. 2.134 Decommissioning certainty - The Government will enter into contracts (decommissioning relief deeds) with companies operating in the UK and UK Continental Shelf, to provide certainty on the relief they will receive when decommissioning assets. A model decommissioning relief deed will be published alongside Finance Bill 2013 and placed in the House of Commons Library. The first contracts with industry are expected to be signed later in the year. To support the introduction of decommissioning relief deeds the Government will introduce measures in Finance Bill 2013 to: o extend the availability of decommissioning relief for onshore terminals of offshore installations; o allow HMRC to release taxpayer information where this is necessary to support operation of decommissioning relief deeds; o amend the subsidy rules for decommissioning security settlements to allow for post-tax securitisation; and o limit decommissioning relief between connecting parties. (Finance Bill 2013) 2.135 Decommissioning security arrangements - The Government will remove IHT charges for property held in decommissioning security settlements. (Finance Bill 2013) Other business taxes 2.136 Simpler income tax: cash basis - As announced at Budget 2012, the Government will introduce a new cash basis for small, unincorporated businesses to calculate their income tax from April 2013. Businesses with annual receipts up to ?79,000 will be eligible and will be able to continue to use the cash basis until receipts reach ?158,000. (Finance Bill 2013) (d) 82 Budget 2013 2.137 Simpler income tax: simplified expenses - All unincorporated businesses will be eligible to use flat rates to calculate certain business expenses, rather than having to calculate their actual business usage, from April 2013. (Finance Bill 2013) 2.138 OTS review of partnerships - The Government will ask the OTS to carry out a review of ways to simplify the taxation of partnerships. This will include an initial scoping exercise to identify which areas are most complex for taxpayers. Further details will be provided by the OTS shortly. Indirect taxes Alcohol duties 2.139 Alcohol duty rates - The general beer duty rate will be reduced by 2 per cent from 25 March 2013. Duty rates on low strength beer will be reduced by 6 per cent and on high strength beer by 0.75 per cent in total from 25 March 2013. All beer duty rates will then increase by the Retail Prices Index (RPI) thereafter. As announced at the March Budget 2010, wine, spirits, and cider duty rates will increase by 2 per cent above RPI from 25 March 2013. (Finance Bill 2013) (44) Tobacco duties 2.140 Tobacco duty rates - As announced at the March Budget 2010, duty rates on tobacco products will increase by 2 per cent above RPI. These changes will come into effect from 6pm on 20 March 2013. (Finance Bill 2013) 2.141 Tax treatment of herbal smoking products - As announced at Budget 2012, and following consultation on implementation, the Government will make legally available tobaccofree (herbal) smoking products liable to tobacco products duty. The change will come into effect on 1 January 2014. (Finance Bill 2013) Gambling duties 2.142 Gaming duty revalorisation - The Government will increase gaming duty bands in line with RPI for accounting periods starting on or after 1 April 2013. (Finance Bill 2013) 2.143 Combined bingo - The Government will relax the current bingo duty arrangements for combined bingo involving non-UK participants. This change will come into effect for accounting periods that begin on or after the date that the Finance Bill 2013 receives Royal Assent. (Finance Bill 2013) Fuel duties 2.144 Fuel duty - The 1.89 pence per litre fuel duty increase that was due to take effect on 1 September 2013 will be cancelled. (43) 2.145 Minor fuel duty rates - In 2015-16 the duty differential between the main rate of fuel duty and the rate for compressed natural gas will be maintained, and the duty differential for liquefied petroleum gas will be reduced by the equivalent of 1 penny per litre. (Future finance bill) Other transport taxes 2.146 VED rates and bands - From 1 April 2013 VED rates will increase in line with RPI, apart from VED rates for heavy goods vehicles (HGVs) which will be frozen in 2013-14. (Finance Bill 2013). The Government has no plans to make significant reforms to the structure of VED for cars and vans in this Parliament. (58) 2.147 VED: disabled drivers exemption - From 8 April 2013 the Government will extend the current VED exemption for disabled drivers to individuals receiving the enhanced mobility Budget 2013 83 PIP. The Government will also introduce a new 50 per cent VED discount for individuals receiving the standard mobility PIP. (Finance Bill 2013) (16) 2.148 VED: classic vehicle exemption - The Government will extend the cut off date from which classic vehicles are exempt from VED by one year. From 1 April 2014 a vehicle manufactured before 1 January 1974 will be exempt from paying VED. (Finance Bill 2014) 2.149 VED: HGVs - From 1 April 2014, the Government will reduce and re-structure VED rates for HGVs within the HGV Road User Levy scheme, as set out in Overview of tax legislation and rates. (Finance Bill 2014) (11) 2.150 VED: Reduced Pollution Certificates (RPCs) - RPC VED discounts for Euro VI vehicles are due to expire on 31 December 2016. The Government will replace RPC VED discounts with grants for Euro IV-VI vehicles within the HGV Road User Levy scheme, from 1 April 2014 to 31 December 2016. Details of the grants will be announced shortly by the Department for Transport. The Government will end RPC VED discounts for Euro I-III vehicles within the HGV Road User Levy scheme from 1 April 2014, and for all other Euro I-III vehicles from 1 April 2016. (Finance Bill 2014) 2.151 VED: tax disc display waiver - To reduce tax administration costs, the Government will put off-the-road declarations onto an indefinite basis. The Government will also extend the grace period to 14 days, following the payment of tax, on the non-display of the tax disc in a vehicle. (Finance Bill 2013) 2.152 Company Car Tax (CCT): ultra low emission vehicles (ULEVs) - From April 2015, two new CCT bands will be introduced at 0-50 grams/kilometre of carbon dioxide (g/km CO2) and 51-75 g/km CO2. (Finance Bill 2013) 2.153 The appropriate percentage of the list price subject to tax for the 0-50 g/km CO2 band will be 5 per cent in 2015-16, and 7 per cent in 2016-17. The appropriate percentage of the list price subject to tax for the 51-75 g/km CO2 band will be 9 per cent in 2015-16 and 11 per cent in 2016-17. In 2017-18 there will be a 3 percentage point differential between the 0-50 and 5175 g/km CO2 bands, and between the 51-75 and 76-94 g/km CO2 band. In 2018-19 and 201920 there will be a 2 percentage point differential between the 0-50 and 51-75 g/km CO2 bands and between the 51-75 and 76-94 g/km CO2 bands. (Finance Bill 2013 and future finance bills) (57) 2.154 In future years CCT rates will be announced three years in advance. The Government will review these incentives for ULEVs in light of market developments at Budget 2016, to inform decisions on CCT from 2020-21 onwards. 2.155 Fuel benefit charge (FBC) - From 6 April 2014 the FBC multiplier will increase by RPI for both cars and vans. 2.156 Van benefit charge (VBC) - The Government will freeze the VBC at ?3,000 in 201314 and will increase it by the RPI only from 6 April 2014. The Government commits to preannouncing the VBC one year ahead. 2.157 Air Passenger Duty (APD) rates - As announced at Budget 2012, APD rates for 201314 will rise in line with the RPI from 1 April 2013. (Finance Bill 2013) Budget 2013 announces that APD rates for 2014-15 will rise in line with RPI from 1 April 2014, as set out in Overview of tax legislation and rates. (Finance Bill 2014) The Government has no plans to vary APD rates by levels of airport congestion. 2.158 APD: annual accounting scheme - The Government will give HMRC the power to require operators of business jets to make payments of APD on account, should HMRC consider this is necessary to protect revenue. (Finance Bill 2013) 84 Budget 2013 Carbon Taxes 2.159 Climate change levy (CCL) rates - CCL rates will increase in line with RPI from 1 April 2014. (Finance Bill 2013) 2.160 Carbon price floor (CPF) rates - The Government will set 2015-16 carbon price support rates equivalent to ?18.08 per tonne of carbon dioxide in line with the carbon price floor set out at Budget 2011. The Government will continue to provide support to energyintensive industries to compensate for the indirect cost of the CPF in 2015-16. Further details will be announced at the next spending round. (Finance Bill 2013) 2.161 CPF: Northern Ireland - The Government will exempt electricity generators in Northern Ireland from the carbon price floor from 1 April 2013. (Finance Bill 2013) (3) 2.162 CCL: exemptions for metallurgical and mineralogical processes - The Government will introduce exemptions from the climate change levy for energy used in metallurgical and mineralogical processes from 1 April 2014. The Government will seek views from industry on these exemptions and will publish draft legislation at the time of Autumn Statement 2013. (Finance Bill 2014) 2.163 CPF: technical changes - As announced at Autumn Statement 2012, technical changes to the carbon price floor will be made to reduce administrative burdens. (Finance Bill 2013) (14) 2.164 Carbon Reduction Commitment: schools - The Government will exclude English state schools from the Carbon Reduction Commitment from April 2014. The cost of this measure in 2014-15 will be funded by a reduction in Resource DEL expenditure for relevant departments. (1) Waste and other environmental taxes 2.165 Aggregates levy - The aggregates levy rate will remain at ?2.00 per tonne in 20132014. (59) 2.166 Landfill tax rates - The Government will increase the standard rate of landfill tax by ?8 per tonne to ?80 per tonne from 1 April 2014. The lower rate of landfill tax will remain frozen at ?2.50 per tonne in 2014-15. (Finance Bill 2013) 2.167 Enhanced capital allowances: energy-saving and water-efficient technologies - The list of designated energy-saving and water-efficient technologies qualifying for enhanced capital allowances will be updated during summer 2013, subject to state aids approval. (60) 2.168 Capital allowances: railway assets and ships - Legislation will be introduced in Finance Bill 2013 to remove the general exclusion to first year allowances for expenditure incurred on railway assets and ships. These changes will have effect from 1 April 2013. (Finance Bill 2013) 2.169 Capital allowances for energy-saving plant and machinery in Northern Ireland - Legislation will be introduced in Finance Bill 2013 to ensure that expenditure on plant and machinery in Northern Ireland that qualifies for both first-year allowances for energy-saving technologies and the renewable heat incentive is treated in the same way as the rest of the UK. Further details will be published in Overview of tax legislation and rates. The legislation will also apply to any future Feed-In Tariff scheme that may be introduced in Northern Ireland. (Finance Bill 2013) (61) 2.170 Landfill communities fund - The value of the landfill communities fund for 201314 will remain unchanged at ?78.1 million. As a result, the cap on contributions by landfill operators will be amended to 6.8 per cent. Future decisions on the value of the fund will take into account the level of unspent funds held by environmental bodies. Budget 2013 85 2.171 Coalition commitment to increase the proportion of revenue from environmental taxes - Measures announced at this Budget will result in the proportion of revenue from environmental taxes increasing from 0.5 per cent to 0.8 per cent over this Parliament, in accordance with the Coalition commitment. VAT measures 2.172 VAT: refunds for NHS bodies - As announced at Budget 2012, following changes introduced by the Health and Social Care Act 2012, the Government will legislate in Finance Bill 2013 to exempt the following NHS bodies from corporation tax and include them within the Section 41 VAT Refund Scheme: o the NHS Commissioning Board; o clinical commissioning groups; o the National Institute for Health and Care Excellence; and o the Health and Social Care Information Centre. (Finance Bill 2013) 2.173 Following changes proposed by the Care and Support Bill, the Government will also legislate in Finance Bill 2014 to include the following bodies within the Section 41 VAT Refund Scheme: o the Health Research Authority; and o Health Education England. (Finance Bill 2014) 2.174 VAT: charitable buildings - As announced at Budget 2012, the Government will withdraw charitable buildings from the scope of the VAT reduced rate for the supply and installation of energy-saving materials, with effect from 1 August 2013. (Finance Bill 2013) 2.175 VAT: amendment to road fuel scale charges (RFSCs) - As announced at Budget 2012, the Government will amend the law relating to VAT RFSCs, bringing long standing concessions into law, withdrawing a concession relating to partially exempt businesses and simplifying the annual revalorisation. 2.176 VAT: revalorisation of RFSCs - The annual adjustment to the VAT RFSCs in line with current fuel prices will take effect from 1 May 2013. 2.177 VAT: changes to the place of supply rules and introduction of the Mini One Stop Shop - The Government will legislate to change the rules for the taxation of intra-EU business to consumer supplies of telecommunications, broadcasting and e-services. From 1 January 2015 these services will be taxed in the member state in which the consumer is located, ensuring these are taxed fairly and helping to protect revenue. (Finance Bill 2014) 2.178 To support these changes, the Government will also legislate for the introduction of a Mini One Stop Shop from 1 January 2015. This will give businesses the option of registering in just the UK and accounting for VAT due in other member states using a single return. (Finance Bill 2014) 2.179 VAT: revalorisation of registration and deregistration thresholds - From 1 April 2013 the VAT registration threshold will be increased from ?77,000 to ?79,000 and the deregistration threshold from ?75,000 to ?77,000. 2.180 VAT: Changes to zero-rating of exports from the UK - The Government will introduce amendments to secondary legislation in autumn 2013 to extend zero-rating to sales of goods to businesses that are registered for VAT but not established in the UK, where those businesses export the goods to a non-EU destination. 86 Budget 2013 2.181 VAT: treatment of refunds made by manufacturers - The Government will legislate to allow manufacturers to reduce their VAT payments to take account of refunds they make directly to final consumers. There will be a consultation during 2013 to gain a better understanding of industry practices, with a view to legislation in Finance Bill 2014. (Finance Bill 2014) 2.182 VAT: review of the VAT Retail Export Scheme (tax free shopping) - The Government will consult on options for re-designing the Retail Export Scheme to make it easier to use and understand, reduce the scope for error, improve compliance and protect revenue. 2.183 VAT: extension of the education exemption to for-profit providers of higher education - At Budget 2012 the Government announced a review of the VAT treatment of university degree level education. Responses to the subsequent consultation on whether to extend the existing exemption to commercial entities supplying such education identified a number of issues with the options proposed. The Government has listened to those who have responded and as a result will look to develop alternative options, including possible changes to the exemption for further education and will consult on these later in the year. 2.184 VAT: withdrawal of the exemption for business supplies of research between eligible bodies - In December 2012 the Government issued a consultation on the withdrawal of the VAT exemption for business research supplied by one eligible body to another. Subject to the outcome of the consultation, the Government intends to introduce secondary legislation withdrawing the exemption, with effect from 1 August 2013. Property taxes 2.185 Annual Tax on Enveloped Dwellings - As announced at Budget 2012 and following consultation, the Government will introduce an annual charge on residential properties valued at over ?2 million owned by certain non-natural persons, such as companies. Reliefs will apply for genuine commercial businesses and other limited categories. The charge, to be called the Annual Tax on Enveloped Dwellings, will take effect from 1 April 2013. (Finance Bill 2013) (v) (4) 2.186 Stamp Duty Land Tax (SDLT) rates - As announced in December 2012, the Government will introduce further reliefs to the 15 per cent rate of SDLT which applies to residential properties valued at over ?2 million purchased by certain non-natural persons. These will take effect from the date on which Finance Bill 2013 receives Royal Assent. (Finance Bill 2013) (v) 2.187 SDLT: reform of transfer of rights rules - As announced at Budget 2012 and following consultation, the Government will reform SDLT rules for "transfers of rights" with effect from the date on which Finance Bill 2013 receives Royal Assent. (Finance Bill 2013) 2.188 SDLT: avoidance - The Government will introduce legislation in Finance Bill 2013 to put beyond doubt that certain SDLT avoidance schemes that abuse the transfer of rights rules do not work. These changes will have retrospective effect to 21 March 2012. (Finance Bill 2013) (52) 2.189 SDLT: leases simplification - As announced at Budget 2012 and following consultation, the Government will simplify the SDLT rules that apply to certain non-standard lease transactions. The changes will have effect from the date on which Finance Bill 2013 receives Royal Assent. (Finance Bill 2013) 2.190 Real Estate Investment Trusts (REITs) - As announced in December 2012, the Government will legislate to allow a UK REIT to treat income from another UK REIT as income of its tax exempt property rental business. (Finance Bill 2013) The Government is further considering the case for REITs being included within the definition of "institutional investor". Budget 2013 87 Avoidance and evasion 2.191 High-risk areas of the tax code: taxation of unauthorised unit trusts - As announced at Budget 2011, the Government is undertaking a programme of work to improve areas of legislation that have been subject to repeated attempts at tax avoidance. Finance Bill 2013 will provide powers to enable secondary legislation to be introduced to reform the taxation of unauthorised unit trusts. The reforms will remove avoidance opportunities while simplifying the rules and reducing administrative burdens for exempt investors. (Finance Bill 2013) 2.192 IR35 - As announced at Autumn Statement 2012, the Government will make a small amendment to the existing IR35 provisions to equalise the tax and NICs treatment of office holders, and put beyond doubt that the legislation applies to office holders for tax purposes. (Finance Bill 2013) 2.193 IHT: limiting the deduction of liabilities - The Government will legislate to close an IHT loophole that allows a deduction from the value of an estate for an outstanding debt regardless of whether or not the debts are paid after death, or how the borrowed funds have been used. (Finance Bill 2013) (50) 2.194 Close company loans to participators - The Government will close three loopholes used to attempt to avoid the tax charge on loans from close companies to individuals with a share or interest in the company. This measure will have effect from 20 March 2013. (Finance Bill 2013) (49) 2.195 Transfer of assets abroad and gains on assets held by foreign companies - As announced on 5 December 2011, the Government will amend anti-avoidance legislation designed to protect the UK tax base. New exemptions from the regimes will have retrospective effect from 6 April 2012 but, exceptionally, in respect of the chargeable gains changes, a taxpayer may elect for the new rules to apply from 6 April 2013. Other changes to the transfer of assets abroad regime will take effect from 6 April 2013. (Finance Bill 2013) (12) 2.196 International agreements to improve tax compliance - The Government will include legislation in Finance Bill 2013 to implement the UK-US Agreement to Improve International Tax Compliance and to Implement FATCA. (Finance Bill 2013) Final Regulations will be issued shortly. The Isle of Man, Guernsey and Jersey have agreed to enter into similar automatic exchange agreements with the UK. HMRC has set up disclosure facilities with the Isle of Man, Guernsey and Jersey to allow investors to come forward and regularise their past tax affairs in advance of information being automatically exchanged. (45) 2.197 Offshore evasion strategy - HMRC's new centre of excellence on offshore evasion has published a new offshore evasion strategy. 2.198 Offshore employment intermediaries - The Government will consult on strengthening obligations to ensure the correct income tax and NICs are paid by offshore employment intermediaries. This is a result of the review announced at Autumn Statement 2012. (Finance Bill 2014) (46) 2.199 Making overpayment relief EU compliant - As announced in Autumn Statement 2012, the Government will legislate in Finance Bill 2013 to amend the current rules to ensure a consistent time limit for repayment penalties for all overpaid tax. (Finance Bill 2013) 2.200 Data-gathering from merchant acquirers - As announced in Autumn Statement 2012, the Government will legislate in Finance Bill 2013 to amend HMRC's data-gathering powers. (Finance Bill 2013) 88 Budget 2013 2.201 Modernising Customs civil penalties - Following consultation, the Government will legislate in Finance Bill 2014 to modernise Customs civil penalties to bring them into line with other HMRC penalties. (Finance Bill 2014) 2.202 Avoiders Unit - HMRC will go further in tackling tax avoidance by piloting new data to better understand the motivations of individuals engaging in tax avoidance. 2.203 Improving 'Coding Out' - The Government will consult on reforming HMRC's ability to collect debts via a tax debtor's tax code, known as 'Coding Out'. The current limit of ?3,000 per year for all tax debtors will be replaced with a graduated scale introducing higher limits for those with higher earnings - or up to ?17,000 limit for those earning ?90,000 or more. HMRC's information technology (IT) system will also be upgraded to allow splitting of debts across years for 'Coding Out'. (53) 2.204 Increasing the use of charging orders - HMRC will increase its use of charging orders, used to secure a tax debt against a debtor's assets. 2.205 Automated telephony - HMRC will update its telephone system to allow tax debts to be paid via an automated process. 2.206 Better data - HMRC will improve its ability to target resources in collecting tax debt by linking further datasets in the Department's systems. 2.207 Pay As You Earn (PAYE) penalties - As announced at Budget 2012, the Government will update the PAYE penalty regime to take account of the introduction of Real Time Information. (Finance Bill 2013) 2.208 Customs and Excise modernisation: fines on ships - As announced at Budget 2012, the Government will re-value fines on ships to ensure they remain appropriate disincentives. (Finance Bill 2013) 2.209 Customs and Excise modernisation: definition of goods - As announced at Budget 2012, the Government is clarifying the definition of goods under customs legislation. (Finance Bill 2013) 2.210 Customs and Excise modernisation: power to detain excise goods - As announced at Budget 2012, the Government will clarify HMRC's power to detain goods during customs and excise investigations. (Finance Bill 2013) 2.211 Criminal investigation powers - As announced at Budget 2012, the Government will make a minor legislative change allowing HMRC to exercise certain criminal asset recovery powers in-house instead of indirectly via police action. (Finance Bill 2013) 2.212 Self Assessment returns - As announced at Budget 2012, the Government will legislate to enable HMRC to withdraw a notice to file a Self Assessment tax return in appropriate cases. (Finance Bill 2013) 2.213 Using public procurement to deter avoidance and evasion - As announced at Autumn Statement 2012, the Government will publish and implement updated public procurement guidance on 1 April 2013 to require potential government suppliers to declare specified previous occasions of tax non-compliance. 2.214 Withdrawal of relief for payments of patent royalties - As announced at Autumn Statement 2012, the Government will legislate at Finance Bill 2013 to withdraw the relief for payments of patent royalties by individuals at section 448 of the Income Tax Act 2007, with effect from 5 December 2012. (Finance Bill 2013) Budget 2013 89 2.215 Avoidance schemes involving loan relationships and derivatives - As announced at Autumn Statement 2012, the Government will legislate to close down three corporation tax avoidance schemes involving financial products, with effect from 5 December 2012. (Finance Bill 2013) 2.216 Trade and property business deductions - As announced on 21 December 2012, the Government will introduce targeted anti-avoidance rules to the income tax and corporation tax provisions governing the relationship between rules prohibiting and allowing deductions, with effect from 21 December 2012. (Finance Bill 2013) 2.217 General Anti-Abuse Rule (GAAR) - As announced at Budget 2012, the Government will introduce a GAAR in this year's Finance Bill to tackle abusive tax avoidance schemes. (Finance Bill 2013) (51) 2.218 Corporation tax deductions for employee share acquisitions - This measure amends existing legislation to clarify a company's entitlement to corporation tax deductions for accounting expenses in connection with share options or awards granted to employees. This measure will have effect from 20 March 2013. (Finance Bill 2013) 2.219 Banking Code of Practice - Following consultation the Government will introduce legislation in Finance Bill 2014 to provide for HMRC to publish an annual report, from 2015, on the operation of the Code of Practice on Taxation for Banks. (Finance Bill 2014) This report may include the naming of any bank that HMRC considers not to be complying with the Code. The Government will consult on the governance process around determining non-compliance and the nature of the report to be published by HMRC. 2.220 Corporate 'loss buying' - The Government will introduce targeted anti-abuse rules, with immediate effect, to prevent companies entering into arrangements with unconnected third parties where the potential to create corporate losses are bought and then relieved against profits unconnected from the activity from which they arose. (Finance Bill 2013) (48) 2.221 Lifting the Lid on Tax Avoidance: next steps - As announced on 11 December 2012 legislation is being introduced in Finance Bill 2013 to improve the information collected under the Disclosure of Tax Avoidance Schemes regime. Regulations will be made later on in 2013. (Finance Bill 2013) 2.222 Review of two areas of partnership tax rules where tax is being lost - Following on from the announcement made at Autumn Statement 2012 to review partnerships as a high risk area of the tax code, this measure confirms consultation on legislation to counter the use of limited liability partnerships to disguise employment relationships and the artificial allocation of profit/loss to secure tax advantages. (Finance Bill 2014) (47) 2.223 Loopholes involving corporation tax loss relief rules - The Government will close down three loopholes, with immediate effect, within the corporation tax loss relief rules, which have enabled companies to access relief for losses either more quickly or in ways contrary to the underlying principles of the legislation. (Finance Bill 2013) (48) 2.224 Penalties in avoidance cases - This measure announces a consultation on a penaltiesbased approach to taxpayers who fail to settle with HMRC in circumstances where an avoidance scheme has been defeated in another party's litigation through the courts. (Finance Bill 2014) (55) 2.225 Compliance progress report - This measure announces the publication of a report highlighting the Government's successes in tackling tax avoidance and evasion and its strategy going forward. 90 Budget 2013 2.226 Enhanced information powers for tax avoidance schemes - Following on from the announcement made at Autumn Statement 2012, the Government will consult, after Budget 2013, on new powers to take tougher action against high risk promoters of tax avoidance schemes, including new information and penalty powers, and the possible use of 'naming and shaming'. (54) Tax administration 2.227 UK-Switzerland agreement: remittance basis - Legislation will be introduced to ensure that the policy objectives behind the original agreement are delivered in full. The changes took effect from the date that the agreement came into force, which was 1 January 2013. (Finance Bill 2013) 2.228 Technical assistance to developing countries - Budget 2013 announces ?3 million funding a year from DfID for a long-term programme of capacity building by HMRC to support developing countries' tax and customs administrations through a new Developing Countries Capacity Building Unit. The first partnership will be with South African Revenue Service, to support tax capacity of other revenue authorities in the region. 2.229 Memorandum of Understanding on Royal Taxation - The Memorandum of Understanding about how Her Majesty The Queen and His Royal Highness the Prince of Wales pay tax voluntarily on income that would otherwise not be taxable has been revised. Without making any material change, the text now takes account of the Sovereign Grant Act 2011. Supply-side reform of the economy Infrastructure 2.230 Infrastructure delivery - The Government will reform its approach to infrastructure delivery, including creating an enhanced central cadre of commercial specialists in Infrastructure UK who will be deployed into infrastructure projects across government, and by summer 2013 establishing new infrastructure capacity plans for key government departments. 2.231 Infrastructure strategy - The Government will consider options for making more use of independent expertise in further developing its infrastructure strategy, ensuring that investors have the confidence to make long-term decisions on infrastructure. 2.232 Communications infrastructure - The Government will look to introduce further financial incentives on public sector spectrum holdings to ensure that spectrum is more efficiently managed and used. 2.233 UK Guarantees Scheme - As part of the UK Guarantees Scheme, the Government has approved a guarantee of up to ?75 million which will help raise finance for the partial conversion of the Drax coal-fired power station to biomass. Deregulation 2.234 Red Tape Challenge: aviation regulation - The Government will scrap or improve 58 per cent of active aviation regulations that were identified under the Red Tape Challenge. The Civil Aviation Authority will update its IT systems to make it simpler for consumers, pilots and the aviation industry to use. The Government is also working with European partners towards a proportionate and risk-based approach to aviation regulation. 2.235 Red Tape Challenge: maritime regulation - The Government will scrap or improve nearly two thirds of the maritime regulations identified by the Red Tape Challenge. The Government is also introducing a new system to speed up the implementation of international maritime agreements into UK law. Budget 2013 91 2.236 Second phase of the Red Tape Challenge - The Government will launch a second phase of the Red Tape Challenge in summer 2013. This will look at areas such as infrastructure, key stages in the growth of companies, and business activities where negotiating the system is overly complex, through a series of short reviews. 2.237 Reforming appeals of economic regulator decisions - The Government will reform the regulatory and competition appeals framework to support more streamlined regulatory decision-making, while providing appropriate rights of appeal. By summer 2013, the Government will consult on reforms, including: o the grounds on which other regulatory appeals and appeals of competition decisions can be brought, to make them clearer and more consistent; o streamlined processes and strengthened governance arrangements for the Competition Appeal Tribunal (CAT) and Competition Service, and a full review of the CAT's rules; o bringing greater consistency across sectors, for instance, on which appeal body hears each type of appeal; o reducing opportunities to game the system, for instance by presenting new evidence during appeals; and o introducing fast-track procedures to achieve quicker judgments in simple cases. 2.238 Infrastructure charges and conditions - The Government has asked economic regulators to develop a coordinated and streamlined approach to charging and conditions on new infrastructure where it crosses existing infrastructure. The economic regulators have agreed to investigate this. 2.239 Fees for regulation - In the 2015-16 Spending Round, the Government will drive efficiency and reduce fees through additional budgeting controls placed on regulators, without reducing the effectiveness of regulatory enforcement. 2.240 Guidance for volunteer events - The Government will encourage volunteers to run events by improving the quality of the guidance and publishing it in a single document on www. gov.uk. Confusing guidance has previously deterred volunteers and obstructed events which are valuable to local communities. Planning 2.241 Judicial review - The Ministry of Justice has consulted on shortening the time limits for bringing a planning judicial review and will set out its plans in spring 2013. The Government will also develop further measures to streamline the process for planning judicial reviews by summer 2013. 2.242 Planning use class - The Government will consult on further flexibilities between use classes to support change of use from certain agricultural and retail uses to residential use to increase responsiveness within the planning system. 2.243 Planning guidance - The Government will publish significantly reduced planning guidance by this summer, in line with Lord Matthew Taylor's recommendations. This will strengthen the focus on using market signals to ensure land is allocated to support development. 2.244 Land auctions feasibility study - DCLG is progressing the public sector land auctions model and will work with HM Treasury to conduct a feasibility study into wider use of the model. 92 Budget 2013 Access to finance 2.245 Business Bank - The Government will: o publish the Business Bank's first business strategy on 22 March 2013. This will set out an accelerated timetable for how the Business Bank will deploy ?1 billion of new capital to improve existing access to small and medium-sized enterprise (SME) support schemes and develop a lasting new institution by the end of 2014 that will expand and diversify UK finance markets so that they serve the needs of SMEs; o launch a ?300 million investment scheme in spring 2013 to help diversify and expand the supply of lending to SMEs and mid-sized businesses; o provide an additional ?50 million for the Business Angel Co-investment Fund for SMEs; o extend the Enterprise Capital Fund programme to include a ?25 million venture capital Catalyst Fund for investment in SMEs; and o maintain the lenders' guarantee cap at 20 per cent for Enterprise Finance Guarantee loan portfolios for 2013-14. 2.246 Start Up Loans - As announced in January 2013, ?30 million additional funding has been given to expand the Start Up Loans scheme in England and increase the age limit to 30, up from 24. Payment systems 2.247 Regulator for payment systems - The Government will bring the payment systems into a competition-focused regulatory regime. It will formally consult on this shortly after this Budget. 2.248 Card payments for SMEs - The Government has secured a commitment from the payment card industry to reduce the time it takes for credit and debit card payments to reach SMEs' bank accounts by up to three days, by using the Faster Payments System to process payments. Competition 2.249 Competition recommendations - The Government has renewed its commitment to accept Office of Fair Trading (OFT) and Competition Commission recommendations and will extend this commitment to the Competition and Markets Authority. There will be a presumption that all recommendations will be accepted unless there are strong policy reasons not to do so. 2.250 Fuel price information - In response to OFT recommendations, the Government will work with motorway service areas and other relevant bodies to improve the availability and visibility of motorway fuel price information for motorway users. 2.251 Financial Services Authority review on barriers to entry - In the Banking Reform White Paper, published 14 June 2012, the Government asked the Financial Services Authority (FSA) to conduct a review of regulatory barriers to entry and expansion in UK banking. The FSA will publish its review shortly after Budget. Sector support 2.252 Industrial Strategy - The Government will provide ?1.6 billion to support a range of sectors as part of the Industrial Strategy. From this fund the Government, in partnership with industry, will create an Aerospace Technology Institute. This will provide ?2.1 billion of R&D support to the aerospace sector over seven years, with government and industry contributing equal shares. Funding for other sectors will be announced later in 2013. (36) Budget 2013 93 2.253 Visual effects industry investment - The Technology Strategy Board will launch a new competitive fund of up to ?15 million to support the digital content production industry. The Skills Investment Fund will be increased to ?8 million, up from ?3 million, each year over the next two years, with the Government matching voluntary industry contributions, to support skills development in the UK digital content sectors. In addition, the government will launch a public consultation to consider options to use the tax system to provide further support for the visual effects industry. 2.254 Growth Vouchers - The Government will provide ?30 million for an SME Growth Vouchers programme in England to test a variety of approaches to help SMEs overcome barriers to achieving growth. (37) Procurement 2.255 Small Business Research Initiative (SBRI) - The Government will substantially expand the SBRI among key departments so that the value of contracts through this route increases from ?40 million in 2012-13 to over ?100 million in 2013-14, representing 0.25 per cent of procurement budgets, and rising to over ?200 million in 2014-15, representing 0.5 per cent of procurement budgets. Other supply-side reforms 2.256 Lord Heseltine's Review - The Government has published a full response to Lord Heseltine's review which reported in October 2012. The response confirms that of his 89 recommendations, 81 have been accepted either in full or in part, 5 have been rejected and 3 will be considered as part of the Spending Round later this year. 2.257 The Government will create a Single Local Growth Fund of growth-related spending, which will be operational by April 2015. Funding will be allocated to Local Enterprise Partnerships on the basis of multi-year strategic plans. 2.258 Richard Review - As announced on 14 March 2013, the Government has launched a consultation on the implementation of the Richard Review of Apprenticeships. 2.259 SME credit database - The Government will investigate options for improving access to SME credit data to make it easier for newer lenders to assess loans to smaller businesses. 2.260 Co-operatives legislation - The Government will consult in summer 2013 on options for raising the limit on individual subscriptions for Withdrawable Share Capital in Industrial and Provident Societies (IPSs) and introducing insolvency procedures for IPSs and credit unions. 94 Budget 2013 A Financing A.1 This annex sets out details of the Government's financing plans for 2013-14. Further details can be found in the Debt and reserves management report 2013-14, published on HM Treasury's website at www.hm-treasury.gov.uk. Financing arithmetic A.2 The Office for Budget Responsibility's (OBR) forecast for the central government net cash requirement (CGNCR) in 2013-14 is ?113.9 billion. The relationship between public sector net borrowing (PSNB) and the CGNCR is set out in the OBR's March 2013 Economic and fiscal outlook. A.3 The net financing requirement (NFR) comprises the CGNCR, plus any financing required for gilt redemptions, additional Official Reserves and other adjustments, less the net contribution to financing from National Savings and Investments (NS&I). The NFR for 2013-14 is projected to be ?162.9 billion, reflecting: o the forecast for the CGNCR of ?113.9 billion. This includes the effect of cash which is expected to be transferred from the Asset Purchase Facility in 2013-14; o a -?2.9 billion adjustment for Northern Rock (Asset Management) (NRAM) and Bradford & Bingley plc (B&B) in 2013-14. As set out at Autumn Statement 2012, NRAM and B&B have been reclassified as part of central government and so their activities influence the CGNCR. However, there are additional cash flows, mostly from the repayment of loans into the Exchequer, which reduce the Exchequer's need to raise cash; o gross gilt redemptions of ?51.5 billion; o a planned short-term financing adjustment of -?5.6 billion resulting from unanticipated overfunding in 2012-13; o ?6.0 billion of financing for the Official Reserves; o a zero net contribution to financing from NS&I. A.4 As set out in Table A.1, the NFR for 2013-14 will be met by gilt sales of ?151.0 billion and an increase in the Treasury bill stock of ?11.9 billion relative to the level projected at end-March 2013 (?56.1 billion). Gilt issuance methods A.5 Auctions will remain the Government's primary method of gilt issuance. In addition, the Government has decided to continue the use of syndications and mini-tenders as supplementary methods of gilt issuance. A.6 Decisions on the skew of issuance are set annually with reference to the Government's debt management objective, as set out in the Debt and reserves management report 2013-14. Budget 2013 95 A.7 It is anticipated that for 2013-14: o ?121.0 billion (80.1 per cent of total issuance) will be issued by auction; o ?20.0 billion (13.2 per cent of total issuance) will be issued by syndication; and o ?10.0 billion (6.6 per cent of total issuance) will be issued by mini-tender. Gilt issuance by maturity and type A.8 It is anticipated that issuance by auctions and syndications will be split by maturity and type as follows: o ?42.6 billion of short conventional gilts (28.2 per cent of total issuance); o ?30.0 billion of medium conventional gilts (19.9 per cent of total issuance); o ?32.6 billion of long conventional gilts (21.6 per cent of total issuance); and o ?35.8 billion of index-linked gilts (23.7 per cent of total issuance). A.9 In addition, the Debt Management Office (DMO) plans to deliver sales via mini-tender of ?10.0 billion (6.6 per cent of total issuance). The mini-tender programme will continue to be used to support the syndication programme by providing flexibility to accommodate any variations in proceeds from syndicated offerings. The DMO determines the maturities and types of gilts to be issued by mini-tender, in consultation with the market during the year. A.10 As announced at Autumn Statement 2012, in 2013-14 the DMO will look to launch new issuance in the 50 to 60 year area, subject to demand and market conditions. Decisions on specific maturities for issuance during the year will be taken by the DMO after consultation with the market through the normal channels. National Savings and Investments A.11 NS&I is expected to make a zero net contribution to financing in 2013-14, within a range of -?2 billion to +?2 billion. NS&I's projected net contribution in 2012-13 is -?750 million, which is in line with its previous target range of -?3 billion to +?1 billion, set at Autumn Statement 2012. 96 Budget 2013 Table A.1: Financing arithmetic for 2012-13 and 2013-14 ? billion 2012-13 105.1 Central government net cash requirement 2013-14 113.9 Adjustment for Northern Rock Asset Management (NRAM) and Bradford & Bingley plc (B&B)1 -2.7 -2.9 Gilt redemptions 52.9 51.5 Financing for the Official Reserves 6.0 6.0 Buy-backs2 0.0 0.0 -17.2 -5.6 144.1 162.9 Planned short-term financing adjustment 3 Gross financing requirement less National Savings and Investments -0.8 0.0 144.9 162.9 a) Treasury bills4 -14.4 11.9 b) Gilts 164.8 151.0 Short 50.8 42.6 Medium 34.7 30.0 Long 37.5 32.6 Index-linked 35.9 35.8 6.0 10.0 0.0 0.0 5.6 0.0 150.5 162.9 Net financing requirement Financed by: 1. Debt issuance by the Debt Management Office (DMO) of which Conventional: Mini-tenders 2. Other planned changes in net short-term debt 5 Change in the Ways and Means Advance 3. Changes in net short-term cash position 6 Total financing Short-term debt levels at end of financial year Treasury bill stock7 56.1 68.0 Ways and Means Advance 0.4 0.4 DMO net cash position 6.1 0.5 Figures may not sum due to rounding. 1 See explanation in paragraph A.3 2 Purchases of 'rump' gilts, with a small nominal outstanding, in which Gilt-edged Market Makers (GEMMs) are not required to make two-way markets. The Government will not sell further amounts of such gilts to the market but the DMO is prepared, when asked by a GEMM, to make a price to purchase such gilts. To accommodate changes to the stated year's financing requirement resulting from: (i) publication of the previous year's CGNCR outturn; (ii) an 3 increase in the DMO's cash position; and/or (iii) carryover of unanticipated changes to the cash position from the previous year. The stock change shown for 2012-13 is a planning assumption and measures the change in the level of the Treasury bill stock in issue between endMarch 2012 and that currently forecast for end-March 2013. The stock of bills for this purpose comprises both those issued at weekly tenders and those issued separately to individual cash management counterparties. The stock change shown for 2013-14 is that currently required to take the 4 stock of Treasury bills to ?68.0 billion by end-March 2014. Total planned changes to short-term debt are the sum of: (i) the planned short-term financing adjustment; (ii) net Treasury bill sales; and (iii) changes 5 to the level of the Ways and Means Advance. The change in the short-term cash position for 2012-13 (and the level of the net short term cash position at the end of the financial year) reflects changes to the public finance forecasts, any changes to financing from NS&I and Treasury bills (including those sold directly to counterparties separately from weekly tenders). It will also reflect any differences between the gilt sales outturn and plans. In addition, the change will include any impact on financing arising from other activities carried out within government (e.g. issuance of tax instruments, transfers between central government and other sectors, and foreign exchange transactions). The zero change for the short-term cash position in 2013-14 assumes that the DMO's planning assumption for the end-year Treasury bill stock is met. A negative (positive) number here indicates an increase in (reduction in) the financing requirement for the following financial year. 7 The DMO has operational flexibility to vary the end-financial year stock subject to its operational requirements. 6 Budget 2013 97 B OBR's Economic and fiscal outlook: selected tables B.1 The Office for Budget Responsibility (OBR) has published its March 2013 Economic and fiscal outlook alongside Budget 2013. This annex reproduces the OBR's key projections for the economy and public finances. Further detail and explanation can be found in the OBR's report. Budget 2013 99 Table B.1: Detailed summary of OBR central economic forecast Percentage change on a year earlier, unless otherwise stated Outturn 2011 2012 2013 Forecast 2014 2015 2016 2017 UK economy Gross domestic product (GDP) GDP Level (2011=100) Nominal GDP Output Gap (per cent of potential output) 0.9 100.0 3.4 - 2.7 0.2 100.2 1.5 - 2.7 0.6 100.8 2.7 - 3.6 1.8 102.6 3.8 - 3.7 2.3 105.0 4.2 - 3.4 2.7 107.8 4.4 - 2.9 2.8 110.8 4.6 - 2.3 Expenditure components of GDP Domestic demand Household consumption? General government consumption Fixed investment Business General government? Private dwellings? Change in inventories3 Exports of goods and services Imports of goods and services -0.6 -1.0 -0.1 -2.9 3.1 -26.2 2.3 0.3 4.6 0.5 1.2 1.0 2.6 1.4 4.9 2.7 -5.4 -0.2 -0.3 2.0 0.5 0.5 0.4 2.2 1.9 2.6 2.0 -0.2 1.5 1.0 1.6 1.2 -0.7 6.7 6.1 5.0 8.9 0.0 4.4 3.8 2.2 1.7 -0.4 8.1 8.6 1.8 10.0 0.0 5.1 4.4 2.5 2.4 -1.0 7.7 8.6 -1.5 10.0 0.0 5.3 4.8 2.7 2.8 -1.8 7.8 8.6 -1.2 9.7 0.0 5.3 4.9 -1.3 -3.6 -2.7 -2.2 -1.9 -1.6 -1.4 4.5 5.2 2.5 2.8 3.2 1.3 2.8 3.2 2.1 2.4 2.8 2.0 2.1 3.2 1.8 2.0 3.6 1.8 2.0 3.9 1.7 Labour market Employment (millions) Wages and salaries Average earnings4 ILO unemployment (% rate) Claimant count (millions) 29.2 2.7 2.3 8.1 1.53 29.5 2.8 2.1 7.9 1.59 29.8 2.4 1.4 7.9 1.58 29.9 3.1 2.7 8.0 1.63 30.1 4.3 3.6 7.9 1.59 30.3 4.8 4.0 7.4 1.48 30.5 4.8 4.0 6.9 1.38 Household sector Real household disposable income Saving ratio (level, per cent) House prices -1.0 6.6 -1.0 1.6 7.0 1.6 0.2 6.6 1.3 0.4 5.8 1.6 1.3 5.6 3.3 1.8 5.4 4.0 2.3 5.0 4.0 3.9 1.5 5.7 5.9 3.1 -0.5 2.5 1.9 3.4 -0.5 3.7 3.4 4.1 1.0 5.6 5.2 4.4 1.3 6.0 5.6 4.6 1.7 6.2 5.7 4.6 1.9 6.3 5.8 Balance of payments current account Per cent of GDP Inflation CPI RPI GDP deflator at market prices World economy World GDP at purchasing power parity Euro Area GDP World trade in goods and services UK export markets5 1 Includes transfer costs of non-produced assets. 3 Contribution to GDP growth, percentage points. 4 Wages and salaries divided by employees. 5 100 Includes households and non-profit institutions serving households. 2 Other countries' imports of goods and services weighted according to the importance of those countries in the UK's total exports. Budget 2013 Table B.2: Determinants of the OBR central fiscal forecast Percentage change on previous year, unless otherwise stated Outturn Forecast 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 GDP and its components Real GDP Nominal GDP (? billion)1 Nominal GDP1 Nominal GDP (centred end-March) Wages and salaries2 Non-oil PNFC profits2,3 Non-oil PNFC net taxable income2,3 Consumer spending2,3 0.7 1526 3.1 2.1 2.4 6.4 9.4 3.5 0.2 1546 1.3 2.0 3.0 3.0 11.0 3.7 0.8 1595 3.2 3.7 2.4 1.8 -1.2 3.4 2.0 1658 4.0 4.1 3.3 5.8 1.7 3.5 2.4 1728 4.2 4.3 4.5 6.3 4.2 3.8 2.7 1806 4.5 4.6 4.8 6.8 5.2 4.5 2.8 1889 4.6 4.6 4.8 7.4 6.1 4.9 Prices and earnings GDP deflator RPI (September) CPI (September) Whole economy earnings growth 'Triple-lock' guarantee (September) 2.1 5.6 5.2 2.7 5.2 1.3 2.6 2.2 1.7 2.5 2.3 3.3 2.9 1.8 2.9 1.9 2.8 2.3 2.9 2.6 1.8 3.2 2.1 3.8 3.6 1.7 3.6 2.0 4.0 4.0 1.7 3.9 2.0 4.0 4.0 1.57 29.2 9.5 1.57 29.6 10.7 1.60 29.8 10.5 1.62 29.9 10.5 1.56 30.1 10.5 1.46 30.4 10.5 1.35 30.6 10.5 2903 -5.0 3.2 -0.9 915 4.9 -2.8 -9.7 3080 2.0 -1.6 2.2 938 -0.1 2.8 -18.9 3405 1.4 5.4 0.9 1083 -0.1 -1.6 12.0 3540 2.3 4.5 1.9 1139 2.6 0.1 -1.9 3690 2.8 3.6 3.6 1208 3.6 2.8 -2.4 3856 3.8 6.1 4.0 1279 3.8 4.4 -2.6 4032 4.7 7.3 4.0 1355 3.4 5.0 -2.7 111 69.2 60.6 51.9 16.1 112 70.6 59.1 44.5 13.8 113 73.4 68.6 44.4 14.1 106 68.8 68.0 44.3 14.0 101 65.2 63.9 44.1 13.9 97 62.5 60.9 44.0 13.9 93 60.1 58.3 43.9 13.8 1.0 2.2 1.16 0.7 1.8 1.23 0.6 2.4 1.16 0.7 2.7 1.16 0.9 3.3 1.16 1.4 3.6 1.15 2.0 3.9 1.15 Key fiscal determinants Claimant count (millions)4 Employment (millions) VAT gap (per cent) Financial and property sectors Equity prices (FTSE All-share index) HMRC financial sector profits1,3,5 Financial sector net taxable income1,3 Residential property prices6 Residential property transactions ('000's) Commercial property prices7 Commercial property transactions7 Volume of stampable share transactions Oil and gas Oil prices ($ per barrel)3 Oil prices (? per barrel)3 Gas prices (p/therm) Oil production (million tonnes)3,8 Gas production (billion therms)3,8 Interest rates and exchange rates Market short-term interest rates (%)9 Market gilt rates (%)10 Euro/Sterling exchange rate 1 Not seasonally adjusted. 2 Nominal. 3 Calendar year. 4 UK seasonally-adjusted claimant count. 5 HMRC Gross Case 1 trading profits. 6 Outturn data from Department for Communities and Local Government (CLG) property prices index. 7 Outturn data from HMRC information on stamp duty land tax. 8 Department of Energy and Climate Change (DECC) forecasts available at www.gov.uk/oil-and-gas-uk-field-data. 9 3-month sterling interbank rate (LIBOR). 10 Weighted average interest rate on conventional gilts. Budget 2013 101 Table B.3: Current Receipts: OBR forecast ? billion Outturn Forecast 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Income tax (gross of tax credits)1 of which: Pay as you earn Self assessment Tax credits (negative income tax) National insurance contributions Value added tax Corporation tax2 of which: Onshore Offshore Corporation tax credits3 Petroleum revenue tax Fuel duties Business rates Council tax VAT refunds Capital gains tax Inheritance tax Stamp duty land tax Stamp taxes on shares Tobacco duties Spirits duties Wine duties Beer and cider duties Air passenger duty Insurance premium tax Climate change levy Other HMRC taxes4 Vehicle excise duties Bank levy Licence fee receipts Environmental levies Swiss capital tax EU ETS auction receipts Other taxes National Accounts taxes 152.7 132.0 20.3 -4.7 101.6 98.1 43.1 33.8 9.2 -0.9 2.0 26.8 24.9 26.0 14.0 4.3 2.9 6.1 2.8 9.9 2.9 3.4 3.8 2.6 3.0 0.7 5.9 5.9 1.8 3.1 0.5 0.0 0.0 6.2 549.5 150.5 130.7 20.6 -3.1 103.8 100.7 40.3 35.5 4.8 -1.0 1.7 26.6 25.7 26.3 14.0 3.9 3.1 6.9 2.3 9.6 2.9 3.5 3.7 2.8 3.0 0.7 5.9 5.9 1.6 3.1 2.0 0.0 0.3 6.7 553.7 154.7 133.7 20.3 -2.8 106.7 103.3 39.3 34.6 4.7 -1.0 2.1 26.1 26.7 27.4 14.6 5.1 3.3 7.7 2.9 9.8 2.9 3.6 3.5 2.9 3.1 1.5 6.3 5.9 2.7 3.1 2.3 3.2 0.7 6.8 574.3 165.5 137.7 27.4 -2.4 108.6 107.2 38.1 33.7 4.4 -0.9 1.7 26.3 28.1 28.3 14.6 6.5 3.5 8.4 2.7 10.2 3.1 3.9 3.6 3.0 3.1 2.0 6.6 5.7 2.9 3.2 2.8 0.0 0.7 7.0 594.0 174.4 147.8 26.4 -1.3 113.9 111.2 36.6 33.5 3.1 -0.8 1.6 27.1 29.6 29.1 14.7 7.2 3.6 9.3 2.7 10.3 3.3 4.2 3.6 3.3 3.2 2.5 7.0 5.6 2.9 3.2 3.1 0.0 0.8 7.1 619.1 186.7 158.0 28.2 -0.5 125.5 115.2 38.2 34.9 3.3 -0.8 1.5 28.3 30.5 30.0 14.5 7.9 3.9 10.5 2.8 10.5 3.4 4.6 3.6 3.5 3.2 2.5 7.2 5.6 2.9 3.2 3.5 0.0 0.8 7.2 655.8 198.9 168.6 29.9 -0.3 132.0 119.3 39.5 36.5 3.0 -0.9 1.3 29.3 31.2 31.0 14.2 8.7 4.1 11.7 2.9 10.8 3.6 5.0 3.7 3.8 3.3 2.5 7.4 5.5 2.9 3.3 4.0 0.0 0.9 7.1 686.9 Less own resources contribution to EU budget Interest and dividends Gross operating surplus Other receipts Current receipts -5.2 5.7 23.6 -1.0 572.6 -5.4 14.8 24.2 -0.6 586.8 -5.3 18.9 25.3 -0.9 612.4 -5.1 18.5 26.7 -1.0 633.1 -5.3 17.1 27.8 -1.0 657.6 -5.6 16.3 28.8 -1.1 694.1 -5.9 13.4 29.7 -1.1 723.0 11.3 6.5 6.8 6.1 4.7 4.8 4.3 Memo: UK oil and gas revenues5 1 Includes PAYE and self assessment and also includes tax on savings income and other minor components. 2 National Accounts measure, gross of enhanced and payable tax credits. 3 Includes enhanced company tax credits. 4 Consists of landfill tax, aggregates levy, betting and gaming duties and customs duties and levies. 5 Consists of offshore corporation tax and petroleum revenue tax. Note: Table is on accruals basis in line with National Accounts definitions. Table 2.8 in the OBR supplementary tables presents receipts on a cash basis. 102 Budget 2013 Table B.4: Total Managed Expenditure: OBR forecast ? billion Outturn Forecast 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Public sector current expenditure (PSCE) PSCE in RDEL1 PSCE in Annually Managed Expenditure of which: Social security benefits Tax credits Net public service pension payments of which: CG unfunded pension schemes LG police and fire pension schemes National lottery current grants BBC domestic services current expenditure Fees associated with financial interventions Other PSCE items in departmental AME Expenditure transfers to EU institutions Locally-financed current expenditure Central government gross debt interest Depreciation Current VAT refunds Single use military expenditure Environmental levies Other National Accounts adjustments Total public sector current expenditure Public sector gross investment (PSGI) PSGI in CDEL 1 PSGI in Annually Managed Expenditure of which: National lottery capital grants Other PSGI items in departmental AME Locally-financed capital expenditure Public corporations capital expenditure Other National Accounts adjustments Total public sector gross investment Less depreciation Public sector net investment Total managed expenditure 1 322.6 321.2 319.5 337.7 320.8 352.1 317.2 362.8 314.2 380.1 307.4 396.3 299.1 413.9 174.9 27.2 8.0 182.8 28.6 10.5 180.4 29.0 11.1 184.4 29.8 12.4 189.1 31.3 13.6 193.1 33.2 14.9 197.6 34.4 16.2 6.7 1.4 1.1 3.8 -2.0 1.1 5.9 21.6 47.9 16.0 11.7 5.5 0.5 -2.2 643.8 8.9 1.6 1.1 3.4 -0.6 2.0 7.4 23.8 46.5 16.9 11.6 4.7 1.3 -2.4 657.2 9.5 1.6 1.2 3.5 -0.3 1.4 6.5 36.1 49.5 17.7 12.3 4.7 1.7 -2.6 672.9 10.7 1.6 1.3 4.0 -0.2 1.2 5.7 38.0 51.8 18.4 12.3 4.2 2.1 -2.6 680.0 11.9 1.8 1.5 3.7 0.0 1.1 6.1 39.5 57.8 19.2 12.4 4.7 2.6 -2.5 694.2 12.9 1.9 1.6 3.8 0.0 1.1 5.9 41.0 64.4 19.9 12.2 4.7 3.1 -2.5 703.7 14.1 2.0 1.7 3.9 0.0 1.2 6.0 43.1 71.3 20.6 11.8 4.7 3.8 -2.4 713.0 34.8 15.0 3.3 12.8 33.7 13.5 36.9 13.5 36.1 14.4 36.5 14.7 36.7 15.4 0.4 -7.0 16.5 6.7 -1.6 49.8 0.4 0.8 7.1 6.2 -1.7 16.1 0.5 0.8 6.4 5.9 -0.1 47.2 0.6 0.9 6.3 5.9 -0.2 50.4 0.6 0.8 6.8 6.0 0.2 50.4 0.7 0.7 7.0 6.2 0.2 51.3 0.7 1.3 6.7 6.4 0.2 52.1 -21.1 28.7 693.6 -22.1 -6.0 673.3 -23.0 24.2 720.0 -23.8 26.6 730.4 -24.6 25.8 744.7 -25.4 25.8 754.9 -26.3 25.8 765.1 Implied DEL numbers for 2015-16, 2016-17 and 2017-18. Calculated as the difference between PSCE and PSCE in AME in the case of PSCE in RDEL, and between PSGI and PSGI in AME in the case of PSGI in CDEL. Budget 2013 103 Table B.5: OBR forecast of the fiscal aggregates Per cent of GDP Outturn Forecast 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Receipts and expenditure Public sector current receipts (a) Total managed expenditure (b) of which: Public sector current expenditure (c) Public sector net investment (d) Depreciation (e) 37.5 45.5 38.0 43.6 38.4 45.2 38.2 44.0 38.1 43.1 38.4 41.8 38.3 40.5 42.2 1.9 1.4 42.5 -0.4 1.4 42.2 1.5 1.4 41.0 1.6 1.4 40.2 1.5 1.4 39.0 1.4 1.4 37.8 1.4 1.4 7.9 -6.0 6.0 -5.1 -3.2 5.6 -6.0 3.6 -3.5 -1.5 6.8 -5.2 4.3 -4.8 -2.3 5.9 -4.3 3.3 -3.8 -1.2 5.0 -3.5 2.7 -2.6 -0.3 3.4 -1.9 1.3 -0.6 1.4 2.2 -0.9 0.6 0.9 2.5 Fiscal mandate and supplementary target Cyclically-adjusted surplus on current budget -4.2 Public sector net debt1 71.8 -4.0 75.9 -2.8 79.2 -1.7 82.6 -1.2 85.1 0.1 85.6 0.8 84.8 8.3 8.1 6.8 6.8 7.1 7.0 6.8 6.6 5.8 5.6 4.6 4.4 3.3 3.1 7.8 5.9 86.0 5.6 3.6 90.7 6.8 4.4 94.9 6.0 3.4 98.6 5.2 2.8 100.8 3.5 1.5 100.8 2.3 0.7 99.4 Deficit Public sector net borrowing (b-a) Surplus on current budget (a-c-e) Cyclically-adjusted net borrowing Primary balance Cyclically-adjusted primary balance Financing Central government net cash requirement Public sector net cash requirement Stability and Growth Pact Treaty deficit2 Cyclically-adjusted Treaty deficit2 Treaty debt ratio3 ? billion Surplus on current budget Net investment Public sector net borrowing Central government net cash requirement Public sector net debt -92 29 121 127 1104 -93 -6 86 105 1189 -84 24 108 114 1286 -71 27 97 113 1398 -61 26 87 100 1502 -35 26 61 83 1580 -16 26 42 61 1637 121 121 120 108 96 67 43 7.9 7.8 7.5 6.5 5.5 3.7 2.3 6.0 5.9 5.1 4.0 3.2 1.7 0.7 -2.7 -2.9 -3.7 -3.6 -3.3 -2.7 -2.1 Underlying PSNB PSNB ex. Royal Mail and APF (? billion) PSNB ex. Royal Mail and APF (per cent of GDP) Cyclically-adjusted PSNB ex. Royal Mail and APF (per cent of GDP) Memo: Output gap (per cent of GDP) 1 General government net borrowing on a Maastricht basis. 3 104 Debt at end March; GDP centred on end March. 2 General government gross debt on a Maastricht basis. Budget 2013 Table B.6: Changes to the OBR fiscal forecast ? billion Outturn Forecast 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Surplus on current budget June 2010 forecast December 2012 forecast Change March 2013 forecast -88 -95 2 -92 -65 -89 -3 -93 -40 -74 -9 -84 -17 -62 -8 -71 0 -51 -11 -61 - -26 -9 -35 - -8 -8 -16 Net investment June 2010 forecast December 2012 forecast Change March 2013 forecast 27 27 2 29 24 -9 3 -6 20 25 -1 24 21 26 1 27 21 23 3 26 - 23 3 26 - 23 3 26 Net borrowing June 2010 forecast December 2012 forecast Change March 2013 forecast 116 121 0 121 89 80 6 86 60 99 8 108 37 88 9 97 20 73 14 87 - 49 12 61 - 31 11 42 Per cent of GDP Net borrowing June 2010 forecast December 2012 forecast Change March 2013 forecast 7.5 7.9 0.0 7.9 5.5 5.1 0.4 5.6 3.5 6.1 0.6 6.8 2.1 5.2 0.7 5.9 1.1 4.2 0.9 5.0 - 2.6 0.7 3.4 - 1.6 0.6 2.2 Cyclically-adjusted surplus on current budget June 2010 forecast -3.2 December 2012 forecast -4.3 Change 0.1 March 2013 forecast -4.2 -1.9 -3.6 -0.5 -4.0 -0.7 -2.2 -0.6 -2.8 0.3 -1.4 -0.4 -1.7 0.8 -0.8 -0.4 -1.2 - 0.4 -0.3 0.1 - 0.9 -0.2 0.8 5.0 6.0 0.0 6.0 3.4 3.0 0.6 3.6 1.8 3.8 0.6 4.3 0.8 2.9 0.4 3.3 0.3 2.0 0.6 2.7 - 0.9 0.5 1.3 - 0.3 0.3 0.6 67.2 66.4 5.5 71.8 69.8 74.7 1.2 75.9 70.3 76.8 2.3 79.2 69.4 79.0 3.7 82.6 67.4 79.9 5.1 85.1 - 79.2 6.4 85.6 - 77.3 7.5 84.8 Cyclically-adjusted net borrowing June 2010 forecast December 2012 forecast Change March 2013 forecast Net debt1 June 2010 forecast December 2012 forecast Change March 2013 forecast 1 Debt at end March; GDP centred on end March. Budget 2013 105 List of abbreviations AA AEA AFIP AIA AME APD ATI ATL AUT Annual Allowance Annual Exempt Amount Armed Forces Independence Payments Annual Investment Allowance Annually Managed Expenditure Air passenger duty Aerospace Technology Institute Above the Line Authorised Unit Trusts BIS Department for Business, Innovation and Skills CASC CAT CBI CCL CCS CCT CFC CGT CGNCR CITR CPI CPF CTF Community Amateur Sports Club Competition Appeal Tribunal Confederation of British Industry Climate change levy Carbon capture and storage Company car tax Controlled foreign company Capital gains tax Central government net cash requirement Community Investment Tax Relief Consumer Prices Index Carbon price floor Child Trust Fund DB DCLG DEL DFID DLA DWP Defined benefit Department for Communities and Local Government Departmental Expenditure Limit Department for International Development Disability Living Allowance Department for Work and Pensions EMI ESC Enterprise Management Incentives Employer Supported Childcare FBC FCA FFS FPC FLS FSA FSTIB FYA Fuel benefit charge Financial Conduct Authority Fair fuel stabiliser Financial Policy Committee Funding for Lending Scheme Financial Services Authority Financial Services Trade and Investment Board First Year Allowances Budget 2013 107 GAAR G20 GDP GVA HGV HMF HMIC HMRC HSE HVO Heavy goods vehicle Heritage Maintenance Fund Her Majesty's Inspectorate of Constabulary Her Majesty's Revenue & Customs Health and Safety Executive High value opportunities ICB IT IHT IMF IPS IUK Independent Commission on Banking Information technology Inheritance tax International Monetary Fund Industrial and Provident Societies Infrastructure UK LEP LIBOR LLP LTA Local Enterprise Partnership London Inter-Bank Offered Rate Limited liability partnership Life Time Allowance MPC Monetary Policy Committee NICs National Insurance contributions OBR ODA OECD OFT OEIC ONS OTS Office for Budget Responsibility Official Development Assistance Organisation for Economic Co-operation and Development Office of Fair Trading Open ended investment company Office for National Statistics Office of Tax Simplification PAYE PF2 PIP ppl PRA PSNB Pay As You Earn Private Finance Two Personal Independence Payments Pence per litre Prudential Regulation Authority Public sector net borrowing QROPS Qualifying recognised overseas pensions schemes R&D RDEL REITs RFSCs RPC RPI 108 General Anti-Abuse Rule A group of 20 finance ministers and central bank governors representing 19 countries plus the European Union Gross Domestic Product Gross Value Added Research and development Resource Departmental Expenditure Limits Real Estate Investment Trusts Road fund scale charges Reduced Pollution Certificates Retail Prices Index Budget 2013 SBRI SDLT SEIS SGP SMEs SUME Small Business Research Initiative Stamp Duty Land Tax Seed Enterprise Investment Scheme Stability and Growth Pact Small and medium-sized enterprises Single Use Military Equipment TME TPR Total Managed Expenditure The Pensions Regulator UKTI ULEVs UK Trade and Investment Ultra low emission vehicles VAT VBC VCT Value Added Tax Van benefit charge Venture Capital Trust Budget 2013 109 LIST OF TABLES Executive Summary: Summary of Budget policy decisions 1.1 Contributions to real GDP growth from 2010Q1 to 2012Q3 1.2 Summary of the OBR's central economic forecast 1.3 Impact of higher interest rates on debt interest payments 1.4 Total consolidation plans over this Parliament 1.5 Overview of the OBR's central fiscal forecast 1.6 Illustration of income tax and National Insurance contributions paid per year, by income level in nominal terms 2.1 Budget 2013 policy decisions 2.2 Measures announced at Autumn Statement 2012 or earlier which take effect from April 2013 or later 2.3 Total Managed Expenditure 2.4 Departmental Expenditure Limits 2.5 Estimated underspends and Budget Exchange carried forward since Budget 2012 2.6 Financial transactions: impact on central government net cash requirement A.1 B.1 Determinants of the OBR central fiscal forecast B.3 Current Receipts: OBR forecast B.4 Total Managed Expenditure: OBR forecast B.5 OBR forecast of the fiscal aggregates B.6 Budget 2013 Detailed summary of OBR central economic forecast B.2 110 Financing arithmetic for 2012-13 and 2013-14 Changes to the OBR fiscal forecast LIST OF CHARTS Executive Summary Chart 1: Government spending 2013-14 Executive Summary Chart 2: Government receipts 2013-14 1.1 Outturn compared with the OBR's November 2011 forecast 1.2 Employment levels through recessions and recoveries 1.3 Private sector debt in the UK 1.4 GVA excluding energy and financial services in the largest EU economies 1.5 International comparison of employment since the crisis 1.6 Average quoted interest rates on mortgages 1.7 Indicative senior unsecured bond spreads 1.8 General government cyclically-adjusted deficit in 2007 1.9 10-year government bond yields 1.10 Current spending on public services in real terms 1.11 Cumulative changes to Resource AME and implied Resource DEL 1.12 Cyclically-adjusted net borrowing until the end of this Parliament 1.13 Consolidation in the cyclically-adjusted current budget 1.14 Public sector net debt 1.15 Average annual infrastructure investment in the UK, public and private 1.16 Results of KPMG Annual Survey of Tax Competitiveness 1.17 Main corporation tax rates in the G20 (2015 based on announced plans) 1.18 International comparisons of projected growth of import demand 2010-17 and current UK share of import market 1.19 Cumulative cash benefit for a typical basic rate taxpayer from personal allowance changes since 2010-11 1.20 Real terms fuel duty rates (pence per litre) 1.21 Population, income and income tax share of individuals in 2012-13 Budget 2013 111 Office for Budget Responsibility Economic and fiscal outlook March 2013 Cm 8573 Office for Budget Responsibility: Economic and fiscal outlook Presented to Parliament by the Economic Secretary to the Treasury by Command of Her Majesty March 2013 Cm 8573 ?38.75 (C) Crown copyright 2013 You may re-use this information (excluding logos) free of charge in any format or medium, under the terms of the Open Government Licence. 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Contents Foreword...................................................................................... 1 Chapter 1 Executive summary Overview ................................................................................ 5 Economic developments since our previous forecast .................. 7 The economic outlook ............................................................. 8 The fiscal outlook .................................................................. 11 Performance against the fiscal targets..................................... 16 Chapter 2 Developments since the December 2012 forecast Introduction .......................................................................... 19 Economic developments ........................................................ 19 Fiscal data developments....................................................... 24 Developments in outside forecasts.......................................... 24 Chapter 3 Economic outlook Introduction .......................................................................... 29 Potential output and the output gap........................................ 29 The pace of the recovery........................................................ 36 Monetary policy..................................................................... 46 Credit conditions ................................................................... 47 The composition of GDP........................................................ 51 Inflation and the GDP deflator ............................................... 69 The labour market................................................................. 73 Comparison with external forecasts ........................................ 79 Chapter 4 Fiscal outlook Introduction .......................................................................... 85 Economic determinants of the fiscal forecast ........................... 86 Policy announcements, risks and classifications ....................... 92 Public sector receipts ........................................................... 100 Public sector expenditure ..................................................... 115 Loans and other financial transactions.................................. 146 The key fiscal aggregates..................................................... 154 Comparisons with external forecasts..................................... 166 Chapter 5 Performance against the Government's fiscal targets Introduction ........................................................................ 171 The fiscal mandate and the supplementary target ................. 171 The implications of our central forecast................................. 172 Recognising uncertainty ....................................................... 174 Annex A Budget 2013 policy measures.................................................... 185 Foreword The Office for Budget Responsibility (OBR) was established in 2010 to provide independent and authoritative analysis of the UK's public finances. In this Economic and fiscal outlook (EFO) we set out forecasts for the period to 2017-18. We also make an updated assessment of whether the Government is on course to meet the medium-term fiscal objectives that it has set itself. The forecasts presented in this document represent the collective view of the three independent members of the OBR's Budget Responsibility Committee (BRC). We take full responsibility for the judgements that underpin them and for the conclusions we have reached. We have, of course, been hugely supported in this by the full-time staff of the OBR. We are enormously grateful for the hard work, expertise and professionalism that they have brought to the task. Given the highly disaggregated nature of the fiscal forecasts we produce, we have also drawn heavily on the help and expertise of officials across government, including in HM Revenue and Customs (HMRC), the Department for Work and Pensions (DWP), HM Treasury, the Department for Communities and Local Government, the Department for Business, Innovation and Skills, the Department of Energy and Climate Change, the Office for National Statistics, the UK Debt Management Office, the Home Office and the various public sector pension schemes. We are very grateful for their time and patience. We have also had useful exchanges with staff at the Bank of England and the National Institute for Economic and Social Research, regarding their recent forecasts, for which again we are very grateful. The forecast process for this EFO has been as follows: In January, the Treasury requested that we finalise the Budget forecast on a 'pre-measures' basis (i.e. before incorporating the effect of new policy announcements) around two weeks ahead of the Budget in order to provide the Chancellor with a stable base for his final policy decisions. We began the forecast process with the preparation by OBR staff of a revised economic forecast, drawing on economic data released since the last published forecast in December 2012 and with our preliminary judgements on the outlook for the economy. 1 Economic and fiscal outlook Foreword Using the economic determinants (such as growth, inflation and unemployment) from this forecast, we then commissioned new forecasts from the relevant government departments for the various tax and spending streams that determine the state of the public finances. We then discussed these in detail with the officials producing them, which allowed us to investigate proposed changes in forecasting methodology and to assess the significance of recent tax and spending outturns. In many cases, the BRC requested changes to methodology and/or the interpretation of recent data. We sent our first economic forecast to the Chancellor on 31 January and our first fiscal forecast, including a provisional judgement on progress towards meeting the fiscal mandate, on 8 February. We provided the Chancellor with these early forecasts and provisional judgement on compliance with the fiscal mandate in order to inform his policy choices for the Budget. As the forecasting process continued, we identified the key judgements that we would have to make in order to generate our full economic forecast. Where we thought it would be helpful, we commissioned analysis from the relevant experts in the Treasury and consulted outside forecasters to help inform our views. The BRC then agreed the key judgements, allowing the production by OBR staff of a second full economic forecast. This provided the basis for a further round of fiscal forecasts. Discussion of these forecasts with HMRC, DWP and the other departments gave us the opportunity to follow up the various requests for further analysis, methodological changes and alternative judgements that we made during the previous round. We provided the second round economic and fiscal forecast to the Chancellor on 22 February, and we met with him and Treasury officials to discuss it on 28 February. Meanwhile, we also began to scrutinise the costing of tax and spending measures that were being considered for announcement at the Budget. The OBR requested a number of changes to the draft costings prepared by HMRC and DWP. We have certified the final published costings for new Budget policies as reasonable and central estimates. In the Treasury's Budget 2013 policy costings document we highlight the uncertainties around a number of the costings. We then produced a third economy and fiscal forecast which allowed us to take on latest data and to ensure that our judgements on the fiscal forecast had been incorporated. In line with the agreement in January this was our final pre-measures forecast, and we made no further material changes after this point except to incorporate the direct and indirect effects of new policy measures. We finalised this forecast and sent it to the Chancellor on 7 Economic and fiscal outlook 2 Foreword March. The forecast set out in this EFO therefore represents our central view of the economic and fiscal outlook as of 7 March. During the week before publication we produced our final forecast, incorporating the effects of the final package of new policy measures. To this end we were provided with final details of all major policy decisions with a potential impact on the economy forecast on 12 March. We provided the Treasury with our final post-measures economic and fiscal forecast on 16 March. Our final fiscal forecast included the direct fiscal effects of the full set of Budget policy decisions, the final version of which was provided to us on 15 March. At the Treasury's written request, and in line with pre-release access arrangements for data releases from the ONS, we provided the Chancellor with a full draft of the EFO on 15 March. This allowed the Treasury to prepare the Chancellor's statement and documentation. We provided a full and final copy 24 hours in advance of publication. During the forecasting period, the BRC has held around 60 scrutiny and challenge meetings with officials from departments, in addition to numerous further meetings at staff level. We have been provided with all the information and analysis that we requested. We have come under no pressure from Ministers, advisers or officials to change any of our conclusions as the forecast has progressed. A full log of our substantive contact with Ministers, their offices and special advisers can be found on our website. We would be pleased to receive feedback on any aspect of our analysis or the presentation of the analysis. This can be sent to OBRfeedback@obr.gsi.gov.uk. Robert Chote Steve Nickell Graham Parker The Budget Responsibility Committee 3 Economic and fiscal outlook 1 Executive summary Overview 1.1 The economy grew slightly more strongly than we expected in our last forecast during 2012 as a whole, but it also shrank a little more than we expected in the final quarter - mainly due to disrupted production in the North Sea. With the economy entering 2013 with somewhat less momentum than we expected in December, a weaker outlook for consumer spending, business investment and exports has prompted us to revise down our near-term growth forecasts to 0.6 per cent this year and 1.8 per cent in 2014. 1.2 Our growth forecasts are unchanged thereafter, rising steadily to 2.8 per cent by 2017. The pace of recovery is constrained by slow growth in productivity and real incomes, continued problems in the financial system, the fiscal consolidation and the outlook for the global economy. We expect real GDP to be 0.6 per cent lower in 2017-18 than we thought in December, with nominal GDP 2.6 per cent lower as we have also revised down our forecast for whole economy inflation. 1.3 Chart 1.1 shows that public sector net borrowing (PSNB) - the gap between what the Government spends and raises in revenue - fell by a quarter between 200910 and 2011-12, thanks primarily to the tax increases and public spending cuts announced by this and the previous government. But, after adjusting for special factors, the decline in cash borrowing now appears to have stalled. We expect PSNB to be broadly flat this year and next, resuming its fall in 2014-15. 1.4 The headline measure of PSNB is forecast to come in at ?86 billion this year, well down from its post-war peak of ?159 billion in 2009-10. But excluding the Government's decisions to bring the Royal Mail's historic pension fund assets into the public sector, and to transfer the cash balances in the Bank of England's Asset Purchase Facility (APF) to the Exchequer, we forecast underlying deficits very close to ?120 billion in 2011-12, 2012-13 and 2013-14. 1.5 We have raised our forecast for the underlying deficit this year by ?1 billion since December. Tax receipts are around ?5.1 billion lower (after adjusting for statistical reclassifications), mostly due to unexpectedly weak income tax and North Sea revenues. But the Government has chosen to offset most of the impact on the deficit by bearing down on spending by central government departments. We now expect departments to underspend the plans it set out last March by almost ?11 billion this year, ?3.4 billion more than we forecast in December. Our forecast for other spending is also ?0.7 billion lower than in December. 5 Economic and fiscal outlook Executive summary Chart 1.1: Public sector net borrowing excluding the Royal Mail and Asset Purchase Facility transfers 180 160 (11.2%) (9.5%) 140 (Per cent of GDP) (7.9%) (7.8%) (7.5%) ? billion 120 (6.5%) (5.5%) 100 80 (3.7%) 60 (2.3%) 40 20 0 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Source: OBR 1.6 The underlying deficit is higher in cash terms throughout the forecast, with an upward revision of ?11.8 billion by 2017-18. This reflects the weaker outlook for the economy and tax receipts. Relative to the size of the economy, receipts remain broadly flat through the forecast, as in December. Public spending falls by only 0.3 per cent of GDP between 2011-12 and 2013-14, compared to 0.8 per cent in December - downward revisions to nominal GDP push up given cash spending as a share of GDP. Thereafter public spending and the underlying deficit both fall at roughly the same rate as we expected in December. 1.7 The tax and spending measures in the Treasury's Budget policy decisions table have a relatively modest impact on the deficit, increasing or reducing it by no more than ?3 billion (0.2 per cent of GDP) in any one year. The 'giveaways' and 'takeaways' net to zero when aggregated over the forecast. We have made no significant adjustments to our economic forecast to reflect these measures. The Treasury's table does not include the impact of its action to reduce spending by central government departments in 2012-13. 1.8 The Government's 'fiscal mandate' requires it to balance the cyclically-adjusted current budget (CACB) - the amount the Government borrows to finance noninvestment spending, adjusted for the state of the economy - five years ahead. Our central forecast shows the CACB in surplus by 0.8 per cent of GDP in 201718, implying that the Government is more likely than not to meet the mandate. Thanks to the Budget measures, the CACB is also just in surplus in 2016-17. Economic and fiscal outlook 6 Executive summary 1.9 Public sector net debt (PSND) is forecast to peak at 85.6 per cent of GDP in 2016-17, rather than 79.9 per cent a year earlier as in our December forecast. This means that the Government is once again not on course to achieve its 'supplementary target' of reducing PSND as a share of GDP in 2015-16. The cash value of PSND has been pushed higher by our upward revisions to PSNB and by assumptions about gilt issuance. Our downward revision to nominal GDP also means that a given cash debt now corresponds to a larger share of GDP. 1.10 There is huge uncertainty around all public finance projections, especially over this time horizon. We stress test the Government's chances of achieving its targets using sensitivity and scenario analysis. A key risk is that potential output turns out to be lower at the end of the forecast than we currently assume. More of the deficit would then be structural and would remain after the economy recovers. Economic developments since our previous forecast 1.11 The latest data suggest that the UK economy shrank by 0.3 per cent in the final quarter of 2012. This was slightly larger than the 0.1 per cent fall we forecast in December, reflecting disrupted North Sea oil production. Output rose by 0.2 per cent in 2012 as a whole, against our December forecast of a 0.1 per cent fall. Surveys suggest little pick-up in underlying activity in recent months. 1.12 The labour market continues to surprise on the upside, despite the continued weakness of GDP growth. Employment rose to 29.7 million in the three months to December, against our December forecast that it would remain at 29.6 million. This increase was driven by a rise in full-time employees. Total hours worked per week rose by a further 2 million in the fourth quarter of 2012, to 947 million, compared to our forecast of a marginal fall of 1.4 million. The unemployment rate remains at 7.8 per cent, against our forecast of a slight increase to 7.9 per cent in the three months to December. 1.13 Earnings growth has been weaker than expected. Growth in average weekly earnings in the private sector in the fourth quarter of 2012 fell to 1.3 per cent, compared to 2.0 per cent in the third quarter and our December forecast for the fourth quarter of 2.0 per cent. 1.14 Our December forecast of 1.2 per cent GDP growth for 2013 was marginally above the average of outside forecasts at the time. Subsequently, the average forecast has fallen to 0.9 per cent. This partly reflects weaker-than-expected fourth quarter GDP, which suggests slightly less momentum going into 2013 than many forecasters envisaged at the time of our December forecast. 7 Economic and fiscal outlook Executive summary The economic outlook 1.15 We expect the economy to grow by 0.6 per cent this year and 1.8 per cent in 2014, down from 1.2 and 2.0 per cent respectively in our December forecast. These revisions reflect smaller contributions from net trade and consumption, as relatively weak UK export markets reduce the scope for export growth and sluggish disposable income growth weighs on household consumption. We also expect a smaller contribution from business investment, as upward revisions to the starting level lead us to expect less growth looking forward. 1.16 Business and consumer surveys, and other cyclical indicators, suggest that spare capacity in the economy was flat or shrank in the final quarter of 2012. This would imply that the weakness in output over this period was structural and that trend total factor productivity (TFP) had contracted. As in December we believe wider indicators are hard to square with severe renewed structural weakness. So we assume that the output gap was -2.7 per cent of potential in the fourth quarter, consistent with flat rather than negative trend TFP growth over 2012. 1.17 We have not changed our view on the outlook for potential growth since December. We expect it to pick up steadily, but still to remain below its long-term rate by the end of our forecast. This is consistent with the view that the financial system will remain impaired for some time to come and that the persistently negative output gap will itself weigh down on potential GDP. 1.18 There are some grounds for optimism as regards financial markets, with relative calm in the euro area and the Funding for Lending (FLS) scheme helping to improve bank funding conditions. But there is little evidence that this is yet increasing lending to the real economy. The situation in the euro area also remains a major risk to our forecast, with the underlying situation still fragile and the completion of long-term structural and institutional reforms a long way off. 1.19 Our view on medium-term growth prospects is unchanged from December. We expect the economy to grow by 2.3 per cent in 2015, 2.7 per cent in 2016 and 2.8 per cent in 2017. With GDP growing less quickly than potential GDP in the near term, the output gap widens to -3.8 per cent by the end of 2013. 1.20 Growth is not expected to return to above-trend rates until 2015, as credit conditions begin to normalise and real wages and productivity start to recover, supporting the growth of consumption. Even then, the output gap is assumed to narrow only at a relatively gradual rate thereafter, reflecting slow growth in productivity and real incomes, continued problems in financial markets, the fiscal consolidation, and the weak outlook for the global economy. Economic and fiscal outlook 8 Executive summary Table 1.1: Economic forecast overview Percentage change on a year earlier, unless otherwise stated Outturn Forecast1 2011 2012 2013 2014 2015 2016 2017 Output at constant market prices Gross domestic product (GDP) GDP Level (2011 =100) Output gap (per cent of potential output) Expenditure components of GDP at constant market prices Household consumption2 Business investment General government consumption General government investment Net trade3 Inflation CPI Labour market Employment (millions) Average earnings4 ILO unemployment (% rate) Claimant count (millions) Output at constant market prices Gross domestic product (GDP) GDP Level (2011=100)5 Output gap (per cent of potential output) Expenditure components of GDP at constant market prices Household consumption2 Business investment General government consumption General government investment Net trade3 Inflation CPI Labour market Employment (millions) Average earnings4 ILO unemployment (% rate) Claimant count (thousands) 0.9 100.0 -2.7 0.2 100.2 -2.7 0.6 100.8 -3.6 1.8 102.6 -3.7 2.3 105.0 -3.4 2.7 107.8 -2.9 2.8 110.8 -2.3 -1.0 3.1 -0.1 -26.2 1.2 1.0 4.9 2.6 2.7 -0.8 0.5 1.9 0.4 2.6 0.1 1.2 6.1 -0.7 5.0 0.1 1.7 8.6 -0.4 1.8 0.1 2.4 8.6 -1.0 -1.5 0.1 2.8 8.6 -1.8 -1.2 0.1 4.5 2.8 2.8 2.4 2.1 2.0 2.0 30.3 29.9 30.1 29.8 29.5 4.0 2.7 3.6 1.4 2.1 7.4 7.9 8.0 7.9 7.9 1.48 1.59 1.59 1.58 1.63 Changes since December forecast 30.5 4.0 6.9 1.38 29.2 2.3 8.1 1.53 0.0 0.0 0.0 0.3 0.3 0.3 -0.6 -0.3 -0.1 -0.3 -0.6 -0.3 0.0 -0.6 -0.3 0.0 -0.6 -0.3 0.0 -0.6 -0.4 -0.1 0.2 -0.3 -5.9 0.0 0.4 1.1 0.2 11.9 -0.1 -0.4 -3.0 1.1 5.1 -0.1 -0.3 -2.1 0.7 0.1 0.0 -0.1 -1.6 0.8 4.8 0.0 -0.1 -1.5 1.1 1.1 0.0 -0.1 -0.9 1.3 -1.9 0.0 0.0 0.0 0.3 0.2 0.1 0.0 0.0 0.0 0.1 0.0 0 0.0 -0.7 0.0 -4 0.2 -0.8 -0.3 -78 0.1 0.0 -0.2 -63 0.1 -0.1 -0.1 -41 0.1 0.0 -0.2 -49 0.1 0.0 -0.2 -53 1 The forecast is consistent with the second estimate of GDP data for the fourth quarter of 2012, released by the Office for National Statistics on 27th February 2013. 2 Includes households and non-profit institutions serving households. 3 Contribution to GDP growth, percentage points. 4 Wages and salaries divided by employees. 5 Per cent change since December. 9 Economic and fiscal outlook Executive summary 1.21 Over time we expect the recovery to be supported by contributions from private consumption, business investment and net trade: a weaker outlook for disposable income has led us to expect a smaller contribution from consumption to GDP growth than in December. Consumption growth is expected to slow this year, remain subdued in 2014, and then pick up from 2015 as disposable income growth recovers; business investment is forecast to make a relatively significant contribution to the recovery in growth in the medium term. But we have again revised down our forecast for business investment growth, as data revisions have increased the starting level and thus limited the scope for further growth; there is a small positive contribution from net trade over the forecast period, though weak recent export performance means that this contribution is slightly smaller in the near-term than we forecast in December; and government consumption reduces GDP growth from 2014, but less so than in December, reflecting further data revisions suggesting that real government consumption is holding up relative to nominal spending. 1.22 The labour market performed more strongly in the fourth quarter than we expected in December, with surveys pointing to continued employment growth into 2013. As a result we have revised up our employment forecast and lowered our unemployment forecast. We now expect unemployment to peak at 8.0 per cent of the labour force in 2014 before falling back to 6.9 per cent in 2017. 1.23 Total market sector employment is expected to rise by around 2.6 million between the start of 2011 and the start of 2018, more than offsetting a total reduction in general government employment of around 1.2 million. 1.24 Higher employment and lower GDP growth mean that productivity growth is forecast to be weaker than in December. As a result we have also made a slight downward revision to our forecast for nominal wage growth since December. Our forecast for real wage growth is also weaker than in December. We now expect real wage growth to be negative in 2013 and only marginally positive in 2014 before picking up in 2015 and reaching 2 per cent in 2016. 1.25 We expect CPI inflation to be higher in 2013 than we forecast in December, due to recent outturn data and higher oil prices. We also assume that sterling's recent depreciation will put upward pressure on CPI inflation over the next few years by pushing up import prices. Overall, we expect CPI inflation to rise towards the middle of this year and then fall gradually over 2014 and 2015. Economic and fiscal outlook 10 Executive summary 1.26 We have also lowered our forecast for the GDP deflator, due to recent data and a reassessment of the rate of growth in the price of government consumption. The level of nominal GDP in 2017-18 is 2.6 per cent lower than in our December forecast. Of this, 0.6 per cent is attributable to a lower level of real GDP, with the remainder reflecting a lower GDP deflator. Around two-thirds of the reduction in real GDP is assumed to be cyclical rather than structural and persistent. 1.27 There is considerable uncertainty around any economic forecast. Chart 1.2 presents our central growth forecast with a fan showing the probability of different outcomes based on the pattern of past official forecasting errors. The solid black line shows our median forecast, with successive pairs of lighter shaded areas around it representing 20 per cent probability bands. It suggests there is a roughly 30 per cent chance that the economy will shrink in 2013. Chart 1.2: GDP fan chart Percentage change on a year earlier 6 4 2 0 -2 -4 -6 2002 2004 2006 2008 2010 2012 2014 2016 March central forecast Source: ONS, OBR The fiscal outlook 1.28 Public sector net borrowing (PSNB) is estimated to have fallen by about a quarter from its post-war peak of ?158.9 billion (11.2 per cent of GDP) in 2009-10 to ?121.0 billion (7.9 per cent of GDP) in 2011-12. We forecast that it will come in at ?86.5 billion (5.6 per cent of GDP) this year, but this figure is flattered by Government policy decisions that have a temporary impact on the deficit. 1.29 Excluding the decisions to transfer the Royal Mail's historic pension assets to the public sector, and the surpluses in the Bank of England's Asset Purchase Facility 11 Economic and fiscal outlook Executive summary (APF) to the Exchequer, the underlying PSNB is expected to be little changed this year or next from the figure recorded in 2011-12. Specifically, we forecast an underlying deficit of ?120.9 billion (7.8 per cent of GDP) in 2012-13, and ?119.8 billion (7.5 per cent of GDP) in 2013-14. 1.30 Given the uncertainty surrounding all public finance forecasts - and the typical size of revisions to the outturn data - the small falls in PSNB in 2012-13 and 2013-14 are fiscally and statistically insignificant. Over the past 20 years the average in-year error for the official PSNB forecasts made at Budget time has been 0.3 per cent of GDP or about ?5 billion in today's terms. 1.31 The underlying deficit is then expected to fall more sharply again from 2014-15, dropping from 6.5 per cent of GDP in that year to 2.3 per cent of GDP in 201718. We expect public spending to fall from 45.2 per cent of GDP next year to 40.5 per cent in 2017-18, despite an increase in debt interest spending of 0.7 per cent of GDP over the same period. Public sector receipts are expected to be broadly flat, falling from 38.4 per cent of GDP next year to 38.3 per cent in 2017-18. Table 1.2: Fiscal forecast overview Per cent of GDP Forecast Outturn 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Public sector net borrowing 7.9 Cyclically-adjusted net borrowing 6.0 Surplus on current budget -6.0 Fiscal mandate and supplementary target Cyclically-adjusted surplus on current -4.2 budget 71.8 Public sector net debt1 5.6 3.6 -6.0 6.8 4.3 -5.2 5.9 3.3 -4.3 5.0 2.7 -3.5 3.4 1.3 -1.9 2.2 0.6 -0.9 -4.0 -2.8 -1.7 -1.2 0.1 0.8 84.8 Public sector net borrowing Cyclically-adjusted net borrowing Surplus on current budget Cyclically-adjusted surplus on current budget 0.0 0.0 0.1 75.9 79.2 82.6 85.1 85.6 Changes since December forecast 0.4 0.6 0.7 0.9 0.7 0.6 0.6 0.4 0.6 0.5 -0.3 -0.6 -0.6 -0.7 -0.5 0.1 -0.5 -0.6 -0.4 -0.4 -0.3 -0.2 Public sector net debt1 Underlying public sector net borrowing PSNB excluding Royal Mail and APF transfers 5.5 1.2 2.3 3.7 5.1 6.4 7.5 7.9 7.8 7.5 6.5 5.5 3.7 2.3 1 0.6 0.3 -0.4 Debt at end March; GDP centred on end March. 1.32 Table 1.3 shows that our forecast for underlying PSNB in 2012-13 is ?1.0 billion higher than the estimate we made in December. Adjusting for statistical reclassifications, tax receipts this year are around ?5.1 billion weaker than in December, primarily reflecting unexpectedly weak income tax and North Sea Economic and fiscal outlook 12 Executive summary receipts over the last couple of months. But the impact on the deficit has been largely offset by the Government taking action to reduce central government departmental expenditure in 2012-13, including by pushing some spending into 2013-14. We anticipate that central government departmental expenditure will be ?11 billion lower this year than the Treasury planned last March and ?3.4 billion lower than we anticipated in December. Our forecast implies very low expenditure in the remainder of 2012-13, compared to previous years. But the outturn data may take some time to reflect the recent decisions and their impact may be reflected in revisions to the data for previous months. Table 1.3: Change in public sector net borrowing ? billion Forecast Outturn 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Public sector net borrowing excluding Royal Mail and APF transfers December forecast March forecast Change of which: Receipts forecast1 Expenditure forecast1 Measures in the Treasury's policy decision table Changes to departmental underspends2 121.4 121.0 -0.4 119.9 120.9 1.0 112 120 8.3 99 108 9.9 81 96 14.3 56 67 11.4 31 43 11.8 -3.1 2.7 5.1 -0.7 8.9 -0.3 8.6 -0.9 11.9 -0.5 13.5 -0.4 14.1 -1.0 0.0 0.0 -1.3 1.6 2.8 -1.7 -1.3 0.0 -3.4 1.0 0.5 0.0 0.0 0.0 1 Excluding fiscally neutral switches including the reclassification of SLS transfers and changes in the proportion of tax credits treated as negative tax 2 Including as a result of action taken by the Government to reduce and/or delay expenditure 1.33 Compared to our December forecast, underlying PSNB excluding the Royal Mail and APF transfers is considerably higher each year from 2013-14, with the difference reaching ?12 billion in 2017-18. Table 1.3 shows that this is driven by the following factors: forecasting changes increase borrowing by ?13 billion in 2017-18. This is primarily driven by lower expected receipts, due to our weaker economic forecast. In particular our forecast for income tax and NICs is ?6 billion lower by 2017-18 due to a lower forecast for labour income growth and due to the weakness of these receipts seen in recent months. A number of forecasting changes have left medium-term expenditure broadly unchanged from December; and 13 Economic and fiscal outlook Executive summary policy measures on the Treasury's Budget policy decisions table are neutral over the forecast horizon, with a small fiscal tightening of ?1.3 billion in 2017-18. 1.34 The current budget balance, which excludes borrowing to finance net investment spending, is forecast to move from a deficit of ?93 billion or 6.0 per cent of GDP this year to a deficit of ?16 billion or 0.9 per cent of GDP in 2017-18. Compared to our December forecast, the deterioration in the current budget is slightly less than the deterioration in PSNB, reflecting changes to investment spending. 1.35 The cyclically-adjusted current budget (CACB) moves from a deficit of 4.0 per cent of GDP in 2012-13 to a surplus of 0.8 per cent of GDP in 2017-18. The CACB in 2017-18 has deteriorated by 0.2 per cent of GDP compared to our December forecast. This is smaller than the 0.4 per cent of GDP deterioration in the unadjusted current budget balance, as most of the downward revision to the GDP forecast is deemed to be cyclical rather than structural. 1.36 All fiscal forecasts are subject to significant uncertainty. Chart 1.3 shows our median forecast for PSNB with successive pairs of shaded areas around it representing 20 per cent probability bands. As in Chart 1.2 above, the bands show the probability of different outcomes if the pattern of past official forecasting errors were to be a reasonable guide to future forecasting errors. Chart 1.3: PSNB fan chart 12 10 Per cent of GDP 8 6 4 2 0 -2 -4 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Source: ONS, OBR Economic and fiscal outlook March 2013 EFO central forecast 14 Executive summary 1.37 Public sector net debt (PSND) rises as a share of GDP each year up to and including 2016-17, peaking at 85.6 per cent of GDP, before falling to 84.8 per cent of GDP in 2017-18. PSND in 2017-18 is now expected to be around 7.5 per cent of GDP higher than we forecast in December. Table 1.4 breaks down this change as follows: the level of nominal GDP over the past year has been lower than we forecast in December, and we expect lower nominal GDP growth in the future. By reducing the denominator we use when calculating PSND as a share of GDP, this increases PSND by 2.2 per cent of GDP in 2017-18; our forecast for PSND in cash terms is also higher than in December, by 5.3 per cent of GDP in 2017-18. This is a consequence of: higher net borrowing (excluding APF transfers) over the forecast period which leads to a rise in PSND of ?56 billion by 2017-18; a judgement that the Debt Management Office is likely to issue gilts at a lower premium relative to their nominal value than we assumed in December increases the forecast by ?28 billion by 2017-18; and other changes increase PSND by ?15 billion in 2017-18. Budget measures increase net debt by ?5 billion and the stock of Bradford & Bingley and Northern Rock (Asset Management) liabilities winds down more slowly in later years. These public sector bodies have now been included in 2011-12 outturns for the first time. Table 1.4: Change in public sector net debt Per cent of GDP Forecast Outturn 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 December forecast March forecast Change of which: Change in nominal GDP1 Change in cash level of net debt December forecast March forecast Change in cash level of net debt of which: Changes in net borrowing (ex. APF) Auction price effects Asset purchase facility Financial transactions and other 1 66.4 71.8 5.5 74.7 75.9 1.2 76.8 79.2 2.3 79.0 82.6 3.7 79.9 85.1 5.1 79.2 85.6 6.4 77.3 84.8 7.5 0.4 5.1 1.0 0.2 1.3 1.0 1.5 2.2 ? billion 1362 1270 1398 1286 36 17 1.8 3.4 2.0 4.4 2.2 5.3 1025 1104 78 1186 1189 3 1442 1502 60 1498 1580 82 1534 1637 103 0 0 0 79 1 2 0 1 19 12 0 6 33 17 0 10 44 23 2 13 56 28 4 15 9 5 0 3 Non-seasonally-adjusted GDP centred end-March. 15 Economic and fiscal outlook Executive summary Performance against the fiscal targets 1.38 In the June 2010 Budget the Coalition Government set itself a medium-term fiscal mandate and a supplementary target, namely: to balance the cyclically-adjusted current budget (CACB) by the end of a rolling, five-year period, which is now 2017-18; and to see public sector net debt (PSND) falling as a share of GDP in 2015-16. 1.39 Our latest forecasts suggest that the Government has a greater than 50 per cent chance of meeting the fiscal mandate. In December we forecast that the CACB would be in surplus by 0.9 per cent of GDP in 2017-18. In the absence of the policy measures in the Budget, the expected surplus would have fallen to 0.5 per cent of GDP. The measures - which include a switch from current to capital spending that improves the current balance without affecting borrowing overall - take the expected surplus back up to 0.8 per cent of GDP. 1.40 The Budget policy measures also mean that we expect the CACB to be in surplus by 0.1 per cent of GDP in the previous mandate year, 2016-17. In the absence of the measures we would have forecast a deficit of 0.2 per cent of GDP, compared to the surplus of 0.4 per cent of GDP that we forecast in December. 1.41 PSND is forecast to rise to a peak of 85.6 per cent of GDP in 2016-17, rather than 79.9 per cent a year earlier as in December. Consequently, as in December, we do not believe that the Government is on course to hit the supplementary target - we expect PSND to rise by 2.4 per cent of GDP in the target year, up from an increase of 1 per cent of GDP in December. 1.42 In the absence of the Royal Mail and APF transfers, and the ONS decision last year to reclassify Bradford & Bingley and Northern Rock (Asset Management) as central government bodies, we would still have expected the Government to meet the mandate, but with 0.1 per cent of GDP less margin for error. We would also have expected the rise in PSND in 2015-16 to be 3.2 per cent of GDP rather than 2.4 per cent of GDP, thus breaching the supplementary target by a slightly wider margin. 1.43 There is considerable uncertainty around our central forecast, as there is around all fiscal forecasts. This reflects uncertainty both about the outlook for the economy and about the performance of revenues and spending for any given state of the economy. Given these uncertainties we probe the robustness of our central judgement in three ways: first, by looking at past forecast errors. If our central forecasts are as accurate as official forecasts were in the past, then there is a roughly 70 per Economic and fiscal outlook 16 Executive summary cent probability that the CACB will be in balance or surplus in 2017-18 (as the mandate requires) and a roughly 50 per cent chance a year earlier; second, by looking at its sensitivity to varying key features of the economic forecast. The biggest risk to the achievement of the mandate is that we again need to revise down our estimates of future potential output, reducing the size of the output gap in the target year. If potential output was 1 per cent lower than in our central forecast in 2017-18, and the output gap therefore -1.1 per cent of potential rather than -2.1 per cent, then the Government would no longer be on course to balance the CACB in 201718. We would also expect the Government to miss the mandate if gilt yields increased by 150-200 basis points relative to our central forecast, assuming that this was not offset by higher interest and dividend receipts; and third, by looking at alternative economic scenarios. We examine the potential impact of a further 15 per cent depreciation of sterling, noting the that the impact on GDP could be positive or negative depending on the consequences for exports and inflation. In either event, given the particular parameters we choose, the Government would still be on course to meet the mandate, but to breach the supplementary target. 17 Economic and fiscal outlook 2 Developments since the December 2012 forecast Introduction 2.1 This chapter summarises: the main economic and fiscal data developments since our last forecast in December 2012 (from paragraph 2.2); and recent external forecasts for the UK economy (from paragraph 2.13). Economic developments Revisions to previous GDP data 2.2 Since our December forecast, the ONS has published the Quarterly National Accounts for the third quarter of 2012 and the Preliminary and Second Estimates of GDP for the final quarter. Revisions in these releases suggest that GDP grew by 0.9 per cent between the first quarter of 2011 and the third quarter of 2012, up from 0.5 per cent in the data available in December, as shown in Table 2.1. This growth rate remains extremely weak by the standards of past economic recoveries. Table 2.1: Contributions to real GDP growth from 2011Q1 to 2012Q31 December data Latest data Difference2 Percentage points Private Government Government Private consumption consumption investment investment 0.6 0.6 -0.4 0.5 0.7 0.6 -0.1 0.3 0.1 -0.1 0.3 -0.2 1 Components may not sum to total due to rounding and the statistical discrepancy. 2 Net GDP growth, Stocks per cent trade -0.8 0.1 0.5 -1.1 0.8 0.9 -0.2 0.7 0.4 Difference in unrounded numbers, rounded to one decimal place. 2.3 The composition of GDP has also been revised. Stock-building and government investment are now thought to have contributed more to growth over this period than at the time of our December forecast, while net trade and private investment have contributed less. The contributions of private and government consumption 19 Economic and fiscal outlook Developments since the December 2012 forecast are broadly unchanged. The stock-building revision is particularly big, but this is usually an area of uncertainty in early estimates and may well be revised again. GDP growth since the December 2012 forecast 2.4 The latest data suggest that the UK economy shrank by 0.3 per cent in the final quarter of 2012. This was a slightly bigger fall than the 0.1 per cent we forecast in December. In sectoral terms the difference can be explained by disruption to North Sea oil production. The GDP figure for the fourth quarter, together with revisions to earlier quarters, means that output rose by 0.2 per cent in 2012 as a whole, against our December forecast that it would shrink by 0.1 per cent. 2.5 The composition of GDP growth in the fourth quarter is shown in Table 2.2, broken down by categories of spending. Weaker than expected growth can be more than accounted for by lower stock-building. Private and government consumption both made small positive contributions to growth, against our expectation of negative contributions. The other components of demand were broadly in line with our forecast, though in the case of net trade this was because both exports and imports were weaker than we forecast by similar amounts. Table 2.2: Contributions to real GDP growth in 2012Q41 Percentage points Total Private Government Net trade consumption consumption investment 3 December forecast -0.1 -0.2 -0.1 -0.1 Latest data 0.1 0.2 0.0 -0.1 2 Difference 0.1 0.3 0.0 0.0 1 Difference in unrounded numbers, rounded to one decimal place. 3 0.3 -0.4 -0.7 GDP growth, per cent -0.1 -0.3 -0.1 Components may not sum to total due to rounding and the statistical discrepancy. 2 Stocks The split of investment into private and government is not yet available for the fourth quarter. Business surveys 2.6 1 Most survey evidence suggests either unchanged or a slight pick-up in underlying activity in recent months. The composite CIPS Purchasing Managers' Index rose to a four-month high in January. Although the composite index fell back slightly in February it remained at a level consistent with a small increase in GDP. 1 However, the CIPS Index has had a mixed relationship with official GDP statistics over the past year. This was most obvious in the first quarter of 2012, when there was a strong pick-up in the CIPS Index to a level consistent with a return to growth, whereas the current vintage of official data shows that GDP fell. Only the January CIPS data was available at the time of finalising our economy forecast for data releases. Economic and fiscal outlook 20 Developments since the December 2012 forecast 2.7 Other survey evidence also points to at best a small improvement in underlying activity in the first quarter of 2013. The February Bank of England Agents' Summary reports that investment intentions and exports of goods have edged higher, but demand for consumer goods and services remain subdued. The GfK Consumer Confidence measure suggests that consumer sentiment has risen slightly since December, but remains weak. However, the Confederation of British Industry (CBI)'s Quarterly Services Sector Survey reported a fall in business volumes in the three months to February, though volumes are expected to increase in the following three months. Labour market 2.8 The labour market continues to surprise on the upside, relative to the continued weakness of GDP growth. Employment rose to 29.7 million in the three months to December, against our December forecast that it would remain unchanged at 29.6 million (Chart 2.1). This increase was driven by a rise in full-time employees. Total hours worked per week rose by a further 1.8 million in the fourth quarter of 2012, to 947 million, compared to our forecast of a small fall of 1.4 million. The unemployment rate remains at 7.8 per cent, against our forecast of a slight increase to 7.9 per cent in the three months to December. Chart 2.1: LFS employment and December forecast 29.9 29.7 Millions 29.5 29.3 December forecast 29.1 28.9 28.7 Q1 2010 Source: ONS, OBR Q2 Q3 Q4 Q1 2011 Q2 LFS employment 21 Q3 Q4 Q1 2012 Q2 Q3 Q4 December forecast Economic and fiscal outlook Developments since the December 2012 forecast 2.9 The claimant count measure of unemployment has also performed better than we expected in December. It fell to 1.54 million in January, more than 86,000 lower than the level implied by our December forecast for the first quarter of 2013 as a whole. Average earnings growth has been weaker than we expected in December. Growth in average weekly earnings (AWE) in the private sector in the fourth quarter fell to 1.3 per cent compared to 2.0 per cent in the third quarter and our forecast of 2.0 per cent in December. Inflation 2.10 Annual CPI inflation in January was 2.7 per cent, slightly above our December forecast (Chart 2.2). 2 Education, food and energy prices have contributed to the pick-up in CPI inflation since the third quarter of 2012, while fuel prices have made a small downward contribution. Chart 2.2: CPI inflation and December forecast 5.5 December forecast 5.0 4.5 Per cent 4.0 3.5 3.0 2.5 2.0 1.5 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 CPI (monthly) Apr-12 Jul-12 Oct-12 Jan-13 December forecast (quarterly) Source: ONS, OBR 2 Our current forecast takes into account CPI and RPI inflation outturns up to and including January 2013. Economic and fiscal outlook 22 Developments since the December 2012 forecast Box 2.1: Rewriting history: the trade balance after sterling depreciations National accounts data are subject to continuous revision. Over time the inclusion of new data and methodological improvements can materially change the profile of GDP growth and its composition. In this box we look at the contribution of net trade to GDP growth following the last two large depreciations of sterling: the roughly 15 per cent drop in the effective exchange rate between the third quarter of 1992 and early 1993; and the roughly 25 per cent drop between the final quarter of 2007 and early 2009. In both cases the latest data suggest that the depreciation was associated with a bigger boost to GDP from net trade over the subsequent three years than earlier data suggested. Following the 1992 depreciation, the Office for National Statistics initially estimated that export growth increased GDP by 5.2 per cent between the third quarter of 1992 and the third quarter of 1995. Subsequently this has been revised up to 5.9 per cent. Growth in imports over the same period was originally assumed to have reduced GDP by 3.6 per cent and this figure has been revised fractionally higher to 3.7 per cent. Taking both elements together, the improvement in net trade over these three years is now thought to have increased GDP by 2.2 per cent, up from an originally estimated 1.6 per cent. Exports grew much more slowly following the 2007 depreciation than they did in the early 1990s, even though the fall in sterling was significantly bigger. This mainly reflects weaker global demand, though the depreciation did less to boost the UK's share of world export markets than the previous depreciation. Imports actually fell, primarily reflecting the weakness of domestic spending in the UK. The net result was an improvement in net trade that is currently estimated to have increased GDP by 2 per cent over the three years, a slightly smaller boost than in the early 1990s despite a significantly larger depreciation. That said, as in the early 1990s, the net trade boost to GDP following the 2007 depreciation has been revised up from the original estimate. Export growth is now thought to have increased GDP by 0.8 per cent rather than reducing it by 0.3 per cent, while lower imports has increased GDP by 1.2 per cent rather than 1.4 per cent. The total contribution to GDP from net trade has thus been revised up from 1.1 per cent to 2 per cent. Table A: Contributions of net trade to GDP growth First three years after depreciation Original data Latest data Difference1 1 Percentage points Exports Imports Net trade Exports Imports Net trade 2007Q4 - 2010Q4 1992Q3-1995Q3 -0.3 1.4 1.1 5.2 -3.6 1.6 0.8 1.2 2.0 5.9 -3.7 2.2 1.1 -0.2 0.9 0.6 0.0 0.6 Difference in unrounded numbers, rounded to one decimal place. The weakness of the original estimate for export growth between 2007 and 2010 looked particularly puzzling, given the scale of the depreciation. Given the more recent behaviour of sterling and global demand, export growth since 2010 also looks puzzlingly weak in the current data and it will be interesting to see if this too is revised higher. 23 Economic and fiscal outlook Developments since the December 2012 forecast The global economy 2.11 Growth in other advanced economies has also been weaker than expected since our December forecast. Output in the euro area shrank by 0.6 per cent in the final quarter of 2012. This is the largest quarterly fall in euro area GDP since early 2009 and confirms that the euro area remains in recession. GDP growth in both the US and Japan was flat in the final quarter of 2012. There was more positive news from China, where growth has started to pick up again having slowed from the start of 2012. World trade growth has slowed further since our December forecast, with trade growing by 0.2 per cent in the third quarter, down from an average quarterly growth rate of 0.9 per cent in the first half of 2012, and below our December forecast. Fiscal data developments 2.12 The joint Office for National Statistics and HM Treasury statistical bulletin on the public sector finances provides monthly data on central government receipts and expenditure and provisional estimates for the public sector fiscal aggregates. Since our previous forecast, bulletins have been released which cover the public finances over the months from November to January. Growth in total central government receipts in these months has been lower than in our December forecast, mainly reflecting shortfalls in offshore corporation tax and income tax receipts. Central government spending growth has been slightly higher than we forecast for the year as a whole, but this reflects timing effects. These developments and their implications for our latest fiscal forecast are discussed in more detail in Chapter 4. Developments in outside forecasts 2.13 Many private sector, academic and other outside organisations forecast the UK economy, using different techniques and data. A number of publications collate and average these forecasts. 3 This section sets out some of the movements in these forecasts since our December forecast. 2.14 When interpreting the average of outside forecasts, it is important to bear in mind that different analysts forecast different variables. So the average forecast is not constrained to paint an internally consistent picture, which makes it difficult to compare it directly with our own. 3 See HM Treasury, 2013, Forecasts for the UK economy: a comparison of independent forecasts, March and February. A full list of contributors is available at the back of the Treasury publication. A number of financial reporting services also monitor these average or consensus figures. Economic and fiscal outlook 24 Developments since the December 2012 forecast GDP growth 2.15 Our forecast of 1.2 per cent GDP growth during 2013 was marginally above the average of outside forecasts at the time of our December forecast (Chart 2.3). Subsequently, the average forecast has fallen to 0.9 per cent. This will partly reflect the weaker than expected fourth quarter GDP estimate, which suggests slightly less momentum going into 2013 than many forecasters envisaged at the time of our December forecast. However, the wide range of forecasts highlights the considerable uncertainty around the expected performance of the economy in 2013, with many forecasters expecting the economy to outperform the updated forecast in this EFO of growth of 0.6 per cent in 2013. Chart 2.3: Forecasts for GDP growth in 2013 3.5 3.0 Per cent 2.5 2.0 1.5 1.0 0.5 0.0 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 Feb-13 Date of forecast GDP forecast range Average GDP forecast OBR GDP forecast Source: HM Treasury, OBR 2.16 Expectations for the composition of demand have changed slightly between November and March. The average forecast for the contribution of net trade to GDP growth in 2013 fell by 0.1 percentage points to zero. The average forecast for growth in private consumption has also fallen by 0.2 percentage points to 0.9 per cent and by 0.4 percentage points for investment growth to 1.8 per cent. Meanwhile, the average forecast for government consumption growth has risen by 0.6 percentage points to -0.4 per cent. 2.17 The average forecast for GDP growth in 2014 is unchanged at 1.7 per cent since our December forecast. Looking at the smaller sample of medium-term forecasts, GDP growth in 2015 and 2016 is now expected to be higher by 0.1 percentage points, at 2.1 and 2.2 per cent respectively. The HMT forecast comparison now 25 Economic and fiscal outlook Developments since the December 2012 forecast includes forecasts for 2017, which shows an average forecast for GDP growth of 2.2 per cent. Inflation 2.18 The average external forecast for CPI inflation for the fourth quarter of 2013 has risen by 0.4 percentage points since the November forecast comparison to 2.5 per cent (Chart 2.4). This is likely to reflect recent outturn data, with CPI inflation remaining elevated at 2.7 per cent. The average forecast for fourth quarter RPI inflation has also been revised up to 3 per cent in the March forecast comparison. Chart 2.4: Forecasts for CPI inflation in the fourth quarter of 2013 4.0 3.5 Per cent 3.0 2.5 2.0 1.5 1.0 0.5 0.0 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 Feb-13 Date of forecast CPI forecast range Average CPI forecast OBR CPI forecast Source: HM Treasury, OBR Labour market 2.19 The average forecast for claimant count unemployment for the final quarter of 2013 has been falling since our previous forecast. It now stands at 1.59 million, which is 60,000 lower than in the November forecast comparison (Chart 2.5). The average forecast for employment growth in 2013 has risen from 0.4 per cent in November to 0.6 per cent in March. Economic and fiscal outlook 26 Developments since the December 2012 forecast Chart 2.5: Forecasts for the claimant count in the fourth quarter of 2013 2.6 2.4 2.2 Millions 2.0 1.8 1.6 1.4 1.2 1.0 0.8 Feb-12 May-12 Aug-12 Nov-12 Feb-13 Date of forecast Claimant count (CC) forecast range Average CC forecast OBR CC forecast Source: HM Treasury, OBR Public finances 2.20 The OBR forecast for public sector net borrowing (PSNB) in our December forecast for 2012-13 was around ?20 billion below the average forecast in the November forecast comparison release. The average forecast has since fallen from ?100.3 billion to ?88.5 billion. This fall likely reflects the inclusion of oneoff factors, such as receipts from the sale of spectrum and transfers from the Asset Purchase Facility, into 2012-13 forecasts. The average forecast for PSNB for 2013-14 has fallen since November from ?111.9 to ?105.9 billion. The average forecast for PSNB in 2014-15 is ?96 billion. Market expectations of interest rates 2.21 Expectations of interest rates derived from financial market instruments have direct implications for our forecast, as we assume that monetary policy follows the path expected by participants in financial markets. These expectations have changed little since our December forecast. Market expectations are for Bank rate to start rising in 2015, the same as in our December forecast. By the first quarter of 2018 Bank rate is now expected to be 2.1 per cent, slightly higher than the level expected at the time of our December forecast. This difference is smaller when expectations of quantitative easing (QE) are taken into account alongside expectations of Bank rate, as Chart 2.6 demonstrates. The February forecast comparison shows market participants expecting additional QE of around ?8 billion in 2013, compared to expectations in November. 27 Economic and fiscal outlook Developments since the December 2012 forecast Chart 2.6: Market expectation for Bank rate and QE 4 3.0 2.0 1.0 Per cent 0.0 -1.0 -2.0 -3.0 -4.0 -5.0 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 2013 2014 2015 2016 2017 2018 Bank rate February Bank rate November Bank rate adjusted QE February Bank rate adjusted QE November Source: Bank of England, HM Treasury, OBR Key judgements and scenarios 2.22 Forecasters differ not just in their numerical forecasts for key variables, but also in their assessment of important economic and policy trends. Differences of opinion on such trends can help explain the dispersion of external forecasts. One current topic of debate is the future path of the exchange rate. In our central forecast, exchange rates, after the first quarter of 2013, are assumed to follow a path implied by the uncovered interest parity condition (UIP). The UIP suggests a relationship between differences in interest rates between countries and exchange rate movements and currently implies that the sterling exchange rate edges marginally lower during our forecast. Given the sharp falls in sterling during January and February and the UK's large current account deficit some commentators have questioned whether there could be a larger fall in sterling. 5 In Chapter 5 we examine the potential impact on our central economic and fiscal forecasts of a large depreciation in the effective sterling exchange rate. 4 We adjust Bank rate expectations by 100 basis points for each ?100 billion of QE that market participants expect, consistent with Bank of England analysis. For more details see Joyce, Tong, and Woods, 2011, The United Kingdom's quantitative easing policy: design, operation and impact, Bank of England Quarterly Bulletin Volume 51 No. 3. Market expectations for QE are based on the average new forecast reported in HM Treasury, 2012, Forecasts for the UK economy: a comparison of independent forecasts, February 2013 and November 2012. 5 For example, MPC member Martin Weale suggests that "unless we continue to enjoy capital gains, this points to a marked increase in United Kingdom net external debt at the current exchange rate. The likely outcome of this would be a lower real exchange rate." February 2013, The balance of payments. Economic and fiscal outlook 28 3 Economic outlook Introduction 3.1 This chapter: sets out our estimates of the amount of spare capacity in the economy and the likely growth in its productive potential (from paragraph 3.2); discusses how quickly economic activity is likely to return to potential (from paragraph 3.17), how monetary policy and credit conditions are assumed to affect this, (from paragraph 3.32) and how the composition of growth is likely to evolve (from paragraph 3.48); assesses prospects for inflation (from paragraph 3.87) and the labour market (from paragraph 3.106); and compares our central forecast to selected external forecasts (from paragraph 3.117). Potential output and the output gap 3.2 The amount of spare capacity in the economy (the 'output gap') and the growth rate of potential output are key judgements in our forecast. Together, they determine the scope for actual growth as activity returns to a level consistent with maintaining stable inflation in the long term. The size of the output gap also determines how much of the budget deficit at any given time is cyclical and how much is structural. In other words, how much will disappear automatically, as the recovery boosts revenues and reduces spending, and how much will be left when economic activity has returned to its full potential. The narrower the output gap, the larger the proportion of the deficit that is structural, and the less margin the Government will have against its fiscal mandate, which is set in structural terms. 3.3 In this section we first consider how far below potential the economy is currently operating. We then consider how quickly potential output has grown in the recent past and the speed at which it is likely to grow in the future. 29 Economic and fiscal outlook Economic outlook Latest estimates of the output gap 3.4 The first step in the forecast process is to assess how the current level of activity in the economy compares with the potential level consistent with stable inflation in the long term. We cannot measure the supply potential of the economy directly, but various techniques can be used to estimate it indirectly. 3.5 We use cyclical indicators to help us judge the amount of spare capacity in the economy, as well as looking at estimates derived from other methodological approaches. To estimate the output gap from cyclical indicators, we use two approaches: 'aggregate composite' estimates, which weight together business survey indicators; and 'principal components analysis', which combine survey and non-survey based indicators.1 The latest cyclical indicator estimates point towards a flat or a narrowing output gap in the final quarter of 2012 since the third quarter, suggesting a fall in potential output (Chart 3.1). Chart 3.1: Estimates of the output gap based on cyclical indicators 3 2 1 Pe r ce nt 0 -1 -2 -3 -4 -5 -6 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2007 2008 2009 2010 2011 2012 "Aggregate composite" estimates "Principal components analysis" estimates Source: OBR 3.6 As in our December Economic and fiscal outlook (EFO) we have used our assessment of trend labour input and the capital stock in a production function framework to analyse what these estimates of the output gap, and therefore 1 More details are set out in OBR, 2011, Briefing Paper No.2: Estimating the output gap, April; and Pybus, T, 2011, Working Paper No.1: Estimating the UK's historical output gap, November. Economic and fiscal outlook 30 Economic outlook potential output, imply for trend total factor productivity (TFP) - the efficiency with which different inputs could be combined to produce a unit of output. Further information on the production function framework can be found in Box 3.1 in our December 2012 EFO. 3.7 As shown on Chart 3.2, using this production function the cyclical indicators imply a sharp fall in trend TFP through 2012, which would imply that the economy has become noticeably less efficient in its ability to combine inputs to produce a unit of output. Given likely movements in the capital stock, this also implies a fall in trend labour productivity. A sustained fall in trend TFP and trend labour productivity seemed plausible during 2008-09, given the severity of the financial crisis at that time, its impact on output from the financial sector, and the consequences for capital allocation in the rest of the economy. In recent quarters, however, the financial system has not been under anything like the same strain (although it remains impaired). As a result, we believe that it is unlikely that trend TFP would have fallen sharply over this period. Chart 3.2: Implied trend TFP from cyclical indicators approach 101.5 101.0 Index 2007 Q1 = 100 . 100.5 100.0 99.5 99.0 98.5 98.0 97.5 97.0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2007 2008 2009 2010 2011 2012 Source: OBR 3.8 Trend TFP Trend TFP (adjusted) Consequently, and in line with the approach we took in December, we have adjusted the output gap estimate derived from the cyclical indicators approach so that it is consistent with flat rather than falling trend TFP from the first quarter of 2012. Using the production function approach, this suggests an output gap of 2.7 per cent in the first quarter, -3.2 per cent in the second, -2.4 per cent in the third and -2.7 per cent in the final quarter. Overall the output gap is estimated to have been -2.7 per cent in 2012. 31 Economic and fiscal outlook Economic outlook 3.9 Estimates of potential output and the output gap are particularly uncertain at present because of the ongoing 'productivity puzzle'. Output per hour and output per worker were 12 per cent and 13 per cent below their pre crisis levels in the fourth quarter of 2012, respectively, measured as non-oil GVA.2 In December we set out various possible explanations for very weak productivity seen in the UK economy since the 2008-09 recession, some of which imply a permanent hit to productivity and potential and some of which imply a temporary hit. Recent research in this area includes the following: A recent ONS paper3 attempts to find evidence to explain the productivity puzzle using firm-level data. The authors find the dispersion of productivity across firms in 2008 and 2009 has increased, with high productivity firms becoming more productive and low productivity firms less so, and in some cases experiencing negative productivity. This gives some support to the view that there has been an increase in the degree of misallocation of capital in the economy. The widening distribution suggests that some firms continue to operate despite low or even negative returns, potentially hindering capital flow to firms with higher returns. A Bank of England working paper4 from January this year looks at the long and short-term effects of financial crises on labour productivity, capital and output. The findings support the view that credit rationing and impaired financial markets can negatively affect productivity. Banking crises on average are found to reduce the short-run growth rate of labour productivity by between 0.6 and 0.7 percentage points per year and permanently reduce the level of productivity by around 1 per cent for each year of the crisis. A paper by Goodridge et.al.,5 published in February, investigates whether the exclusion of investment in intangibles from GDP might explain the slowdown in measured productivity. The authors argue that real output growth was probably underestimated in 2009-2011, but overstated in most of the 2000s, as a result of this omission. They believe this measurement error explains only a small part of the puzzle from the start of 2011. 2 We estimate the pre-crisis trend as the average growth rate, per quarter, from the first quarter of 2003 to the first quarter of 2008. 3 ONS, 2013, Micro-data perspective on the UK productivity conundrum, January. 4 Oulton and Sebastia-Barriel, 2013, Long and short-term effects of the financial crisis on labour productivity, capital and output, Bank of England Working Paper No. 470, January. 5 Goodridge et.al., 2013, Can Intangible Investment Explain the UK Productivity Puzzle?, February. Economic and fiscal outlook 32 Economic outlook 3.10 In estimating potential output we continue to assume that a significant part of the shortfall in productivity is structural. Compared to our December forecast, the level of potential output is around 0.4 per cent lower from the final quarter of 2012. This reflects the fact that the output gap appears to have been narrower in the fourth quarter than we expected in December, as well as revisions to the trend employment rate and capital input. The impact is partly offset by an upward revision to the level of real non-oil GVA.6 3.11 Any sensible forecaster will recognise that there is considerable uncertainty around any central estimate of the output gap. Charts 3.3 and 3.4 compare our central output gap forecasts for 2012 and 2013 to those produced by other forecasters, including those set out in the Treasury's March Comparison of Independent Forecasts and estimates produced by NIESR, the European Commission and OECD. The average estimate is -2.9 per cent in 2012, slightly wider than our central estimate, and -3.1 per cent in 2013, somewhat narrower than our central estimate. In Chapter 5 we test the sensitivity of our judgements regarding the Government's performance against its fiscal targets to different estimates of the size of the output gap. 3.12 Of the -2.7 per cent output gap we estimate for the fourth quarter of 2012, we attribute 2.3 percentage points to the employment rate lying below its potential level (consistent with a variety of indicators pointing to slack in the labour market) and 1.5 percentage points to output-per-hour lying below potential (i.e. cyclical weakness in productivity). These are offset by 1.2 percentage points from average hours lying above their trend level, perhaps reflecting the impact of unexpectedly weak income growth and negative wealth shocks for many households temporarily increasing labour market participation. 6 If we used the same principal components approach as in the March 2012 EFO our estimate of the output gap in 2012 would now be 2.0 per cent. Other things being equal, this would imply lower potential output and a higher structural deficit. But, at the same time as adjusting the principal components approach to assume flat trend TFP in December 2012, we assumed a weaker profile for potential GDP growth over the medium term. The two judgements taken together mean that potential output is forecast to be 0.2 per cent lower than would otherwise be the case at the end of the forecast horizon. This increases the size of the structural deficit and makes the Government's fiscal mandate marginally harder to achieve. 33 Economic and fiscal outlook Economic outlook Chart 3.3: Estimates of the output gap in 2012 0 -1 -0.8 Per cent -2 -3 -4 -4.2 -5 -6 -6.0 -3.6 -4.0 -3.1 -3.0 -3.3 -3.2 -2.7 -2.5 -2.2 -2.0 -2.0 -2.0 -1.5 -1.8 -1.6 Average -2.9 per cent -5.6 EIU Fathom Consulting Schroders IM Nomura Scotiabank Barclays Commerzbank OECD BCC OBR Santander CBI EC Goldman Sachs Lombard Street NIESR IMF Capital Economics Oxford Economics -7 Source: HM Treasury, 2013, Forecasts for the UK economy: a comparison of independent forecasts, March, plus additions or updates where known. Goldman Sachs estimate refers to the fiscal year 2011-12. Chart 3.4: Estimates of the output gap in 2013 -1 Per cent -2.5 -4 -4.5 -4.4 -5.5 -3.5 -3.4 -3.8 -3.6 -3.2 -2.7 -2.1 -2.0 -2.4 -2.3 -2.2 -2.2 -1.7 -1.3 -0.9 Average -3.1 per cent -6.0 -7 -7.3 Fathom Consulting Nomura EIU Scotiabank Schroders IM Barclays Commerzbank OECD Santander BCC EC CBI Goldman Sachs OBR Lombard Street IMF NIESR Capital Economics Oxford Economics -8.5 Source: HM Treasury, 2013, Forecasts for the UK economy: a comparison of independent forecasts, March, plus additions or updates where known. Goldman Sachs estimate refers to fiscal year 2012-13. Economic and fiscal outlook 34 Economic outlook The growth of potential output 3.13 We assume a similar medium-term path for potential output growth as in our December forecast. Potential output growth remains below its long-run rate at the end of the forecast horizon, consistent with financial and credit markets taking time to normalise and downward pressure on potential GDP while the output gap remains negative. As discussed in the credit conditions section, financial markets have strengthened since December and bank funding conditions have continued to improve, helped by the period of relative calm in the euro area and the impact of the Funding for Lending Scheme (FLS). But there is limited evidence that this is yet feeding through to increased lending to the real economy. 3.14 Taken together, revisions to non-oil GVA, investment and trend labour input as well as our revision to trend TFP growth in the fourth quarter of 2012 have prompted a small downward revision to potential output growth in 2012 and 2013.7 Potential output is now forecast to have grown by 0.4 per cent in 2012 and is assumed to recover gradually to 2.2 per cent growth in 2016. 3.15 Our projections for population growth are based on average inward net migration of 140,000 per annum, in line with the long-term assumption underpinning the ONS's low migration variant population projections. We continue to assume that the long-term non-accelerating inflation rate of unemployment (NAIRU) is 5.4 per cent.8 3.16 Chart 3.5 compares our forecast for the level of potential output with other forecasters. Our forecast for potential output in 2016 is higher than that of the OECD and European Commission, similar to that of the IMF but lower than that of Oxford Economics. Our estimate is within a wide range of outside estimates. 7 We have also updated our methodology for estimating the trend activity and employment rate in the economy since December. We now use a simple Hodrick-Prescott (HP) filter to estimate the trend level up to the latest data point. We forecast the trend rate going forward using the cohort model. For further information on the cohort model see our June 2010 Pre-Budget forecast page 77. 8 This is in line with the unemployment rate at the beginning of 2008. 35 Economic and fiscal outlook Economic outlook Actual output index 2012=100 . Chart 3.5: Potential output comparison with other forecasters1 116 114 112 110 108 106 104 102 100 2012 Range forecasts 2013 OBR 2014 OECD 2015 EC 2016 Oxford Economics IMF 1 The range of forecasts is based on those set out in the February comparison of independent forecasts only, as this is the latest edition that contains forecasts beyond 2014. Source: OBR; OECD, November 2012 Economic Outlook up to 2014 and June 2012 Economic Outlook for 2015 2016; European Commission, 2013, Winter European Economic Forecast, February; Oxford Economics, March 2013; IMF, 2012, World Economic Outlook, October; HM Treasury, 2013, Forecasts for the UK economy: A comparison of independent forecasts, February. Range of city forecasters includes Barclays, Capital Economics, Commerzbank, Goldman Sachs, Nomura and Schroders, GDP growth and output gap forecasts. Table 3.1: Potential output growth forecast (annual growth rate, per cent) Potential Potential productivity1 average hours 2012 2013 2014 2015 2016 2017 1 2 3 -0.1 1.0 1.6 1.8 1.9 2.0 -0.2 -0.2 -0.2 -0.2 -0.2 -0.2 Potential employment rate2 0.1 0.0 -0.1 -0.1 -0.1 -0.1 Potential population2 Potential output3 0.7 0.7 0.5 0.5 0.5 0.5 0.4 1.5 1.9 2.1 2.2 2.2 Output per hour. Corresponding to those aged 16 and over. Components may not sum to total due to rounding The pace of the recovery 3.17 In this section we set out the expected path of GDP growth over the forecast period. We first consider the short-term outlook using information from recent economic data and forward-looking surveys. We then consider the rate at which GDP will grow over the medium term as spare capacity is taken up and economic activity approaches the potential level identified in the previous section. Economic and fiscal outlook 36 Economic outlook The short-term outlook 3.18 GDP is currently estimated to have fallen by 0.3 per cent in the fourth quarter of 2012, slightly more than the 0.1 per cent we forecast in December. The difference can be explained by unexpected weakness in the oil and gas sector, which we have assumed to be a one-off effect. 3.19 It has been difficult to judge the underlying momentum of GDP growth during 2012, due to one-off factors affecting the second, third and fourth quarters (Chart 3.6). Our best estimate is that the Olympics boosted GDP growth by around 0.3 percentage points in the third quarter, before reducing it by the same amount in the fourth quarter. This would imply that the underlying trend in GDP in the fourth quarter was broadly flat. Chart 3.6: Underlying and headline growth in GDP Percentage change on quarter earlier . 1.2 Forecast 1.0 0.8 0.6 0.4 0.2 0.0 -0.2 -0.4 -0.6 Q2 2011 Q3 Q4 Q1 Underlying Q2 2012 Q3 Holiday Q4 Q1 Olympics Q2 2013 Q3 Q4 GDP Source: ONS, OBR 3.20 Based on the economy's momentum at the turn of the year, and the latest survey data, we expect growth in the first quarter of 2013 to be 0.1 per cent.9 This implies a slightly less than 50 per cent chance of a 'triple-dip' recession, with particular uncertainty around the extraction and construction sectors. 9 The January construction output and index of production outturn data was not available at the time of finalising our economy forecast. 37 Economic and fiscal outlook Economic outlook 3.21 We expect growth to pick up more strongly in the second half of 2013, though by slightly less than in our December forecast (Table 3.2). This reflects weaker net trade and earnings growth in the data since December. Taking into account revisions already made to previous data, we now expect GDP growth of 0.6 per cent in 2013, compared to 1.2 per cent in our December forecast. Table 3.2: The quarterly GDP profile Percentage change on previous quarter March forecast? December forecast? Change Q1 0.4 0.5 0.0 2011 Q2 Q3 0.1 0.6 0.1 0.5 0.1 0.0 Q4 -0.3 -0.4 0.1 Q1 -0.1 -0.3 0.2 2012 Q2 Q3 -0.4 1.0 -0.4 1.0 0.0 0.0 Q4 -0.3 -0.1 -0.1 Q1 0.1 0.3 -0.2 2013 Q2 Q3 0.2 0.3 0.4 0.5 -0.2 -0.2 Q4 0.4 0.5 -0.1 ? Forecast from first quarter of 2013. ? Forecast from fourth quarter of 2012. 3.22 As we set out in our October 2012 Forecast Evaluation Report, mechanically applying the 'multipliers' we have used in previous forecasts to the consolidation measures put in place by the previous and current governments would have been sufficient to reduce the level of GDP in 2011-12 by around 1.4 per cent, reflecting both their direct impact on GDP via government consumption and investment and their indirect effect on the private sector's contribution. The same approach would imply that the consolidation measures could have reduced GDP in 2012-13 by around 1.9 per cent. That said, estimates of the size of multipliers and the timescale over which they take effect are both highly uncertain. 3.23 This calculation is based on Institute for Fiscal Studies (IFS) estimates of the size of the fiscal consolidation produced at the time of the March 2012 forecast. It therefore excludes the effect of the substantial underspending by central and local government departments in 2012-13 that has arisen over the course of the year and the modest tax measures in the Autumn Statement. The direct effect of the underspends on government consumption and investment is impossible to identify at this stage, as the eventual impact is uncertain and it would take some time to feed through fully to the National Accounts. But mechanically applying the same multipliers would imply that these underspends might have reduced GDP by around a further 0.5 per cent in 2012-13. 3.24 This should be seen as an upper bound of the possible impact for this choice of multipliers - some of the areas where the underspends occurred, for example payments to international institutions, might not have a significant effect on recorded economic activity, either directly or indirectly. Nevertheless, it is possible that the multiplier effect of these additional underspends could explain at least part of the weakness of GDP in 2012-13 relative to our March 2012 forecast, although the unexpectedly poor performance of exports is more than sufficient on its own to explain the shortfall. Economic and fiscal outlook 38 Economic outlook The medium-term outlook 3.25 Our forecasts for medium-term growth are shaped by our estimate of the amount of spare capacity in the economy, and the speed with which it seems likely to be absorbed. The judgements surrounding the effect of monetary policy and credit conditions, which underpin this growth forecast, are set out in the next section. 3.26 Quarterly growth in GDP is expected to remain well below trend rates over the short term, with the output gap widening to around -3.8 per cent of potential by the end of 2013 (Chart 3.7). This deterioration reflects a drag from both net trade and consumption, as relatively weak UK export markets reduce the scope for export growth and sluggish disposable income weighs on household consumption. Growth is not expected to return to above-trend rates until 2015, as credit conditions begin to normalise and real wages and productivity start to recover, supporting the growth of consumption. However, the output gap is assumed to narrow at a relatively gradual rate over the medium term, reflecting the constraints on economic growth over this period: the slow growth of productivity and real incomes, continued problems in financial markets, the fiscal consolidation and the weak outlook for the global economy. Chart 3.7: The output gap 0 Forecast Per cent -1 -2 -3 -4 -5 2010 2011 2012 2013 2014 December forecast 2015 2016 2017 2018 March forecast Output gap estimates on a quarterly basis, based on the latest National Accounts data and expressed as actual output less trend output as a percentage of trend output (non-oil basis). Source: OBR 3.27 The weaker short-term outlook for consumption and exports means that growth in 2013 and 2014 is expected to be lower than we forecast in December, while our forecast for growth from 2015 onwards is broadly unchanged. Taken together with the latest data, these downward revisions leave the level of real GDP in 2017 0.6 per cent lower than in our December forecast. 39 Economic and fiscal outlook Economic outlook Chart 3.8: Projections of actual and potential output 135 -1.9% output gap Actual output index 2003Q1 = 100. 130 125 120 115 110 105 100 95 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Output (non-oil GVA) Potential output Source: ONS, OBR 3.28 Our central growth forecast is shown in Chart 3.9. The distribution surrounding it shows the probability of different outcomes if you expected our forecasts to be as accurate as official forecasts have been in the past. The solid black line shows our median forecast, with the successive pairs of lighter shaded areas around it representing 20 per cent probability bands. 3.29 The probability bands are based on the distribution of official forecast errors since 1987. They do not represent a subjective measure of the distribution of risks around the central forecast. It suffices to say that although we believe that the chances of growth being above or below our central forecast are broadly equal, the risk of a disorderly outcome in the euro area means that a much weaker outcome is more likely than a much stronger one. Economic and fiscal outlook 40 Economic outlook Chart 3.9: GDP fan chart Percentage change on a year earlier 6 4 2 0 -2 -4 -6 2002 2004 2006 2008 2010 2012 2014 2016 March central forecast Source: ONS, OBR 41 Economic and fiscal outlook Economic outlook Box 3.1: The economic effects of policy measures This box considers the possible effects on the economy of policy measures announced in Budget 2013. More details of each measure are set out in the Treasury's Budget document and our assessment of the fiscal implications can be found in Chapter 4. The Government has announced a number of policy measures that are expected to have a broadly neutral fiscal impact in aggregate between 2012-13 and 2017-18, with 'giveaways' almost exactly offsetting 'takeaways' over this period. Correspondingly, we also assume that they will have a broadly neutral effect on the economy, with no impact on the level of GDP at the end of the forecast horizon. There is a small negative GDP effect from lower current departmental spending in 2013-14 and 2014-15. This is offset from 2013-14 by a number of other measures, including an increase in the personal allowance to ?10,000 and the introduction of an employer NICs allowance in 2014-15. Taken together these measures reduce GDP growth by less than 0.1 per cent in 2013 and increase GDP growth by less than 0.1 per cent in 2014. These estimates are based on the same multipliers that the interim OBR used in June 2010. Given the relatively small size of these measures, using larger multipliers would have little effect on our estimate of the overall GDP effect. There are a number of other measures which could affect economic activity in the medium term. The reduction in the main rate of corporation tax from 2015-16 has a small positive effect on business investment in our forecast, while the decision to abolish the contracted-out NICs rebate slightly reduces disposable income and household consumption. The Government has also decided to increase capital spending and reduce current departmental spending from 2015-16. Given the long time horizon and the fact that the overall net effect of these changes is relatively small, we have not adjusted our overall GDP forecast. We have adjusted our inflation forecast to take account of measures that directly impact the price level. These include the decisions to cancel the September 2013 fuel duty increase and to reduce beer duty by 2 per cent in 2013-14 and raise it by RPI rather than RPI plus 2 per cent in 2014-15. These measures are estimated to reduce annual CPI inflation by around 0.1 percentage points at the end of 2013 and in the first half of 2014 relative to the continuation of pre-announced changes. This is a permanent effect on the price level but a temporary effect on inflation. The Government's decision to increase the personal allowance and the decision to abolish the contracting-out NICs rebate could marginally impact the labour supply decision of individuals. The higher personal allowance makes it marginally more attractive to work, while the abolishing of contracting out makes it marginally less so. The policy decision to introduce an employers' NICs allowance could marginally boost labour demand. Given the small size of these potential effects we have not made any explicit adjustments to our forecast. Economic and fiscal outlook 42 Economic outlook The Government has announced various measures aimed at improving the supply of UK housing and supporting property transactions. These include an extension and expansion of the Government's Help to Buy scheme, the Right to Buy scheme and the Build to Rent Fund, and the introduction of a Mortgage Equity Guarantee aimed at high loan-to-value mortgages. The expansion of the existing schemes is likely to have a relatively small additional impact on transactions and residential investment. The details and timing of the guarantee scheme have yet to be finalised and it is therefore too early to quantify the likely impact. Overall, however, these measures, alongside the Funding for Lending Scheme, should support the significant growth in property transactions and residential investment that we forecast over the next two years. 3.30 Chart 3.10 plots our central GDP forecast for the next three years against the average of outside forecasts and the Bank of England's February Inflation Report forecast.10 For the purposes of comparison we have used the Bank of England's modal forecast - that is, the most likely outcome implied by their forecast distribution. The negative 'skew' in the February Inflation Report forecast distribution means that the mean forecast is somewhat lower, implying a level of GDP around 0.5 per cent below the modal forecast by 2015. 3.31 Our forecast for the level of GDP over the next few years is slightly weaker than the Bank's modal forecast. This reflects weaker expected growth in 2013, as well as the fact that the Bank's 'backcast' points to stronger growth over the recent past than the latest ONS data. Our forecast is broadly in line with the latest outside average, although slightly stronger in the medium term. 3.32 It should be emphasised that the differences between these point forecasts are dwarfed by the uncertainties around them - as demonstrated by the fan charts in this EFO and the Bank of England's Inflation Report. Outside forecasts for cumulative GDP growth between 2012 and 2016 vary significantly, with our latest forecast toward the middle of a very wide range (Chart 3.11).11 10 HMT, 2013, Forecasts for the UK economy: a comparison of independent forecasts, February and March; Bank of England, 2013, Inflation Report, February. 11 Based on numbers set out in the February Comparison only, as this is the latest edition that contains forecasts beyond 2014. 43 Economic and fiscal outlook Economic outlook Chart 3.10: Forecasts of the level of GDP 114 112 Index 2009= 100 110 108 106 104 102 100 2009 2010 2011 OBR 2012 2013 Outside average 2014 2015 2016 2017 Bank of England Source: ONS; OBR; Bank of England, 2013, Inflation Report, February; HM Treasury, 2013, Forecasts for the UK economy: a comparison of independent forecasts, February and March. Average 8 6 4 2 EI i ti U gr ou an p ki ng C & EBR M a Sc rke hr ts od e C E x p rs om e ri a m er n zb IH C an Be am S G N k ac br on id lo b IES Ec ge E al In R on s c om ono ig h m t ic Fo etr r e i cs ca sti ng IT O B Ba E M R r C clay Cl ap u s ita Ca b lE pi O t c xf or ono al d m G E co i cs ol n dm o m an ics Sa Li ve ch rp s oo IM lM F ac ro IN Re G se ar ch G lo ba lB C om ur a 0 RB S 1 10 N Cumulative percentage change, 2012-2016 . Chart 3.11: Forecasts of cumulative growth between 2012 and 20161 The range of forecasts is based on those set out in the February comparison of independent forecasts only, as this is the latest edition that contains forecasts beyond 2014. Source: OBR; HM Treasury, Forecasts for the UK economy: a comparison of independent forecasts, February. Economic and fiscal outlook 44 Economic outlook Box 3.2: Is it plausible to assume a negative output gap after five years? In normal times it would be unusual to forecast that the economy would be operating with significant spare capacity at the end of a five year forecast horizon. Typically forecasts assume that monetary policy and other equilibrating factors will ensure that economic activity returns to a sustainable level in the medium term. But in light of the depth of the recent downturn, and the weakness of the subsequent recovery, most major forecasters assume that some negative output gap will persist at the end of their forecast horizon, even though most also assume a significant sustained reduction in potential output relative to pre-crisis trends. Our forecast in this EFO implies that potential output would be 14.6 per cent below an extrapolation of its pre-crisis trend in 2017, with actual output a further 2.3 per cent below that. How plausible is this combination of a big reduction in potential output and a persistently negative output gap, relative to the alternatives? And what impact would those alternatives have on the Government's chances of meeting the fiscal mandate? 1 Some economistsa argue that the current output gap is significantly wider than in our central forecast, judging that there was little or no hit to potential output following the financial crisis. Unless you assume a very strong economic recovery, or a significant and sustained slowdown in potential output growth in future years, this would imply an even larger negative output gap after five years than in our forecast. This would be even more at odds with the usual assumed effect of monetary policy and other equilibrating factors. We find the argument that the output gap is much larger today than in our central forecast hard to square with the recent strength of private sector employment growth, the persistence of above-target inflation and most surveys of capacity utilisation. 2 One way to avoid having a negative output gap at the end of the medium-term horizon would be to assume an even bigger hit to potential as a result of the financial crisis, and thus a significantly smaller output gap today. Given the relative strength of the labour market, this would imply an even bigger hit to the level of potential productivity - deepening the 'productivity puzzle' that most economists are already struggling to solve.b 3 One way to be more pessimistic about the supply potential of the economy, without having to explain why the financial crisis has done so much to reduce it, would be to assume that the trend growth rate of potential output was significantly overestimated even before the crisis.c Forecasters who derive their estimates of potential output from statistical filters of actual GDP data - or from production functions that use filters to identify the trend path of the different factors of production - will tend to move in this direction over time as the continued weakness of actual GDP 45 Economic and fiscal outlook Economic outlook mechanically drags down the assumed path of potential output both before and after the downturn. As we can see from the estimates of bodies like the International Monetary Fund and the Organisation for Economic Co-operation and Development (OECD), this implies an increasingly large positive output gap immediately prior to the crisis in 2007. (For example, the latest OECD Economic Outlook estimates that output was 4.4 per cent above potential in 2007, compared to 0.2 per cent in its June 2008 Outlook.) We find a large positive output gap in the period running up to the crisis hard to square with low rates of inflation and other cyclical indicators at that time. 4 The final way to close the output gap over the five year horizon would be to assume a much stronger recovery in actual GDP. As shown in Chart 3.10 most outside forecasters are expecting relatively weak growth in coming years. Even if we were to combine our estimate of trend output with the strongest forecast for actual output growth from Chart 3.11, we would still have a negative output gap by the end of the forecast horizon. All these alternatives have different implications for the Government's chances of meeting its fiscal mandate i.e. balancing the structural current budget after five years. The first alternative would make it easier to meet the mandate, as a wider output gap implies that more of the current deficit is cyclical rather than structural. The second and third alternativesd imply a larger structural deficit and a tougher task meeting the mandate, as they imply a narrower output gap today than in our forecast. The fourth alternative - a stronger recovery - would boost receipts and lower spending, reduce the headline deficit and lower the path for public sector net debt. But this would not increase the chances of meeting the mandate if the improvement was purely cyclical. a See for example: Capital Economics, 2012, Is the output gap a crack or a chasm, October and Martin and Rowthorn, 2012, Is the British economy supply constrained II? A renewed critique of productivity pessimism, UK-IRC May. b See for example: Nomura, 2013, The moribund metastable equilibrium, January. c See for example: OECD, 2012, Economic Outlook, November. d Assuming that the hit to supply following the crisis is not smaller than in our central forecast. Monetary policy 3.33 An important anchoring assumption in our forecast is that the Bank of England will endeavour to bring inflation to target by the end of its forecast horizon. Coupled with a view that domestic price pressures - as represented by the output gap - are important drivers of inflation in the medium term, this implies that monetary policy would generally reduce the size of any negative or positive output gap over time by stimulating or softening aggregate demand respectively. Economic and fiscal outlook 46 Economic outlook 3.34 That said, there are limits to the speed at which the economy is likely to return to potential. As set out above, we expect constrained real income growth, ongoing dislocation in financial markets, the fiscal consolidation and weak global growth to limit the rate of growth over the medium term. As a consequence, we expect the output gap to narrow at a relatively gradual rate, leaving a negative output gap at the end of the forecast period. We expect inflation to fall back to target over the forecast period, with downward pressure on prices from the negative output gap offset to some extent by upward pressure from above trend growth rates and falling unemployment in the later years of the forecast. 3.35 Chart 2.6 shows that, relative to December, policy rates are now expected to be 30 basis points higher by the end of the forecast period, with Bank rate not expected to rise until 2015. This has implications for our fiscal forecast, which we discuss in Chapter 4. 3.36 In July 2012 the Bank of England and HM Treasury launched the Funding for Lending Scheme (FLS), which provides banks with relatively cheap funding from the Bank of England, for up to four years. The next section discusses recent evidence on the effect of the FLS. Credit conditions 3.37 The improvement in financial market sentiment that began in mid-2012 has continued. The European Central Bank's (ECB) reasserted commitment to the euro area has reassured investors by reducing the risk of a euro exit. Most indicators of stress have subsided substantially. Debt costs for peripheral euro area sovereigns have fallen, banks have begun to repay the emergency funds provided by the ECB in 2011-12, and the euro has appreciated markedly against a basket of currencies. Financial market conditions have also continued to improve outside the euro area, with equity prices generally rising and credit spreads narrowing. 3.38 However, real economy growth prospects have deteriorated in many developed economies since our last forecast. For euro area countries this could lead to renewed concern over the sustainability of sovereign finances. Indeed, the risk remains that renewed weakness in any one part of the system - real economy, banks or sovereigns - will destabilise the rest, as in early 2012. Some key institutional reforms which aim to reduce systemic vulnerability are in train. For example, some progress has been made in establishing a single euro area banking supervisor. This is an important step in reducing negative feedbacks between bank and sovereign balance sheets. But these are unlikely to be complete until at least 2014, even assuming they obtain the necessary backing from euro members. 47 Economic and fiscal outlook Economic outlook 3.39 Financial market sentiment in the UK has also improved further. Measures of wholesale market stress, such as short-term counterparty risk (as measured by the LIBOR-OIS differential), have fallen to near pre-crisis levels. Other measures of the funding spreads paid by banks, in both retail and wholesale markets, have also continued to fall. This may be due to lower market perceptions of bank credit risk; but also partly to the limited supply of UK bank debt relative to investor demand, reduced by bank deleveraging plans, the FLS and easing of regulatory liquidity requirements. There has now been a sustained fall in banks' funding costs since June 2012 and we expect further improvement in the short to medium term (Chart 3.12). Chart 3.12: Indicative marginal funding cost (MFC) of UK banks1 7 Forecast 6 Per cent 5 4 3 2 1 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Bank rate Short-term funding spread Medium-term funding spread MFC March 2013 MFC March 2012 MFC December 2012 1 The short-term funding spread is proxied by 3m LIBOR-Bank rate spread; and the medium-term funding spread is proxied by 5-year CDS premia. Source: OBR, Thomson Reuters Credit supply 3.40 Our forecast for lower bank funding costs depends on both continued stability in the euro area and the success of the FLS. Launched by the Bank of England and the Government in July 2012, this scheme provides funding to banks and building societies for an extended period at below current market rates. It is designed to encourage banks and building societies to expand lending to households and private non-financial corporates, with both the price and quantity of funding provided linked to their lending performance. 3.41 To the extent that FLS costs are lower than those prevailing in private markets, they should directly reduce banks' borrowing costs. On this measure, given that private funding costs have fallen substantially, the FLS may now have less direct impact than was expected when it was introduced. However, the FLS may also be Economic and fiscal outlook 48 Economic outlook partly responsible for lower costs in other markets, as it reduces banks' non-FLS funding requirements and pricing. Given the difficulty of isolating FLS from nonFLS influences, we include it in our forecast as one contributing factor to a sustained, general improvement in UK bank funding conditions (Chart 3.12). 3.42 Lower bank funding costs should then lead to lower offered interest rates, which generate more loan applications, approvals, advances, lower effective rates on new loans and, eventually, lower average borrowing costs for corporates and households. Each step will take time, but there is already some evidence of an impact on the mortgage market. Offered interest rates on new household loans, particularly fixed-rate mortgages, have fallen significantly, and mortgage loan approvals and advances are beginning to rise. We expect offered rates to fall further given how far bank funding costs have fallen. This has not yet translated appreciably into greater supply of real economy credit - net flows of lending remain very weak - but we expect a greater impact as 2013 progresses, particularly on mortgage lending. 3.43 However, the extent to which lower bank costs lead to more credit will be limited by banks' own risk appetite. Access to capital remains a concern. For domestic banks profits on average remain very weak. Access to markets for new equity capital appears limited given most banks' low profitability. Regulatory changes, such as the most recent recommendation of the Financial Policy Committee that banks' capital reflect "a proper valuation of their assets" could lead to greater provisions or regulatory capital requirements. Combined with the long-run target of Basel III compliance, banks are likely to remain cautious in taking on more risky lending throughout the forecast period. 3.44 Some boost to lending should come from the activity of those relatively healthy banks that are unencumbered by poor loans or are new to the market,12 depending on competition conditions. The recent relaxation of Basel III liquidity rules could allow further relaxation in UK banks' liquidity buffers, increasing profits and generating more real economy lending. However, we expect capital to remain a constraint throughout the forecast period and the supply of bank credit to remain weak. Credit demand Households 3.45 12 Recent data show some signs of greater household demand for credit. Mortgage approvals rose moderately in the fourth quarter of 2012, as did loan advances, There is some evidence of this in the distribution of new lending in the Bank of England's latest FLS data. 49 Economic and fiscal outlook Economic outlook particularly for house purchase. We expect this trend to continue through 2013, boosted by greater mortgage availability and falling new mortgage rates. We also expect the spread between risk categories to narrow as easier bank funding conditions feed greater competition for higher loan-to-value borrowers. This should encourage more low-equity buyers into the housing market and increase property transactions. However, we do not expect a return to conditions prevailing before the recession, given tighter prudential regulation. Some potential borrowers will therefore remain limited by their ability to raise sufficient equity, as well as their own concerns over affordability. 3.46 Demand for consumer credit (credit cards and personal loans) also picked up at the end of 2012, according to the Bank of England's most recent Credit Conditions Survey. Lower bank funding costs have helped reduce personal loan rates (although to a much lesser extent than mortgage rates), encouraging a rise in personal loans in early 2013. The result has been a return to annual growth in unsecured household borrowing after more than three years of contraction. However, this is a small part of the average household's balance sheet13 and we do not expect unsecured borrowing to outpace secured borrowing consistently, given both banks' risk appetite and the relatively high cost of unsecured debt.14 Private, non-financial corporations (PNFCs) 3.47 Bank credit to corporates continues to contract across a range of sectors. This is partly due to the availability of alternatives. For large corporates, the attraction and use of wholesale debt are currently strong. The cost of non-financial corporate bonded debt is very low, helped by low interest rates and reduced bank debt issuance. In aggregate, PNFCs are substituting wholesale for bank debt and equity and we expect this to continue while monetary policy remains loose. 3.48 However, smaller companies, without access to wholesale funds, are also reducing their bank borrowing. This is part due to their own perceptions of reduced availability, and part due to banks' own risk management and the depressed economic outlook. Affordability, based on profit projections depressed by the current macroeconomic environment,15 remains a constraint. Combined with their own subdued confidence, this means small companies prefer internal 13 Around 16 per cent of household loan debt, according to ONS statistics, the rest being secured on property. 14 Unsecured debt rates, particularly on credit cards, are considerably higher than mortgage rates and have responded much less to changes in Bank rate since the crisis. 15 Although the proportion of small and medium sized enterprises (SMEs) making a profit remained fairly stable in 2012, for those making profits, median profit levels fell by more than half - see SME Finance Monitor, Q4 2012 for the Business Finance Taskforce. Economic and fiscal outlook 50 Economic outlook to external funds, which will limit their ability to expand and contribute to the recovery. Improvement in bank funding costs should gradually feed through to small and medium sized enterprises (SME) loan rates, but recovery in SME credit demand also depends on the outlook for profits and growth. The composition of GDP 3.49 Our forecast for the level of GDP is a key driver of our assessment of the outlook for the public finances. But the composition of GDP is also important. This section discusses the broad outlook for the income and expenditure measures of GDP, and our forecasts of the expenditure components in more detail. Nominal and real GDP Income 3.50 For a given profile of nominal GDP, the outlook for the public finances will vary with the relative contribution of different types of income flow. This is mainly because the Government receives more revenue from every pound of labour income than from every pound of profits. 3.51 Chart 3.13 shows the pattern of income flows associated with our forecast for nominal GDP growth. Weak nominal income growth in 2012 was attributable to a smaller contribution from net taxes and profits than in recent years, while the contribution from labour income was slightly higher, consistent with the relative strength of the labour market. We expect wages and salaries growth to slow slightly in 2013, reflecting relatively weak average earnings growth, with nominal GDP growth supported by rebounds in profits and net taxes. The contribution of labour income to nominal GDP growth is expected to strengthen gradually in subsequent years. 51 Economic and fiscal outlook Economic outlook Chart 3.13: Income counterparts to nominal GDP growth Percentage change on a year earlier 7 Forecast 6 5 4 3 2 1 0 -1 -2 -3 -4 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Compensation of employees Gross operating surplus and other income Net taxes on products and production Nominal GDP Source: ONS, OBR Expenditure 3.52 Table 3.3 shows our forecast for the contribution of different expenditure components to real GDP growth. Private consumption is expected to make a limited contribution to GDP growth in the short term, before picking up as real disposable income starts growing again. We expect a relatively large contribution from business investment, although lower than in December. Net trade is expected to make only a very small positive contribution to growth, in part reflecting relatively weak growth of UK export markets. We discuss our forecast for these expenditure components in more detail in the following sections. Economic and fiscal outlook 52 Economic outlook Table 3.3: Expenditure contributions to growth1 GDP growth, per cent Main contributions Private consumption Business investment Dwellings investment2 Government3 Change in inventories Net trade Outturn 2011 0.9 -0.6 0.3 0.0 -0.7 0.3 1.2 Percentage points, unless otherwise stated Forecast 2012 2013 2014 2015 2016 0.2 0.6 1.8 2.3 2.7 0.6 0.4 -0.2 0.6 -0.2 -0.8 0.3 0.2 0.1 0.2 -0.2 0.1 0.8 0.5 0.4 -0.1 0.0 0.1 1.1 0.8 0.4 -0.1 0.0 0.1 1.5 0.8 0.5 -0.3 0.0 0.1 1 1.8 0.9 0.5 -0.4 0.0 0.1 Components may not sum to total due to rounding and the statistical discrepancy. 2 2017 2.8 The sum of public corporations and private sector investment in new dwellings and improvements to dwellings. The sum of government consumption and general government investment. 3 Components of domestic demand Consumer spending 3.53 Consumer spending remains subdued. Private consumption increased by a cumulative 0.3 per cent in the second half of 2012, weaker than the 0.5 per cent growth implied by our December forecast. Despite this, revisions to outturns in earlier quarters mean that consumption growth in 2012 is now slightly above the 0.5 per cent implied by our December forecast, with the latest data indicating growth of 1 per cent for the full year. 3.54 Household disposable income picked up strongly over the first half of 2012, supported by the up-rating of household benefits in line with the September 2011 CPI inflation outturn of 5.2 per cent (Chart 3.14). Real disposable income is now estimated to have grown by 2.8 per cent in the year to the third quarter of 2012, although the relative weakness of consumption meant the saving ratio picked up over the year, reaching 7.7 per cent. 3.55 Consumer confidence indicators point to limited consumption growth in the near term. While the GfK Consumer Confidence balance picked up slightly in January, the indicator remains well below its long-run average. Retail sales fell back in January in both value and volume terms, pointing to little momentum in consumer spending heading into 2013. 3.56 We expect a weaker outlook for disposable income to reduce the contribution of consumption to GDP growth relative to our December forecast. Consumption growth is expected to slow this year and remain subdued in 2014, before gathering pace from 2015 as disposable income growth picks up. 53 Economic and fiscal outlook Economic outlook Chart 3.14: Contributions to real household disposable income growth 8 Percentage change on a year earlier Forecast 6 4 2 0 -2 -4 -6 -8 2007 2008 2009 2010 Pre-tax labour income Prices 2011 2012 2013 Non-labour income Total Source: ONS, OBR Economic and fiscal outlook 54 2014 2015 2016 2017 Net benefits and taxes Economic outlook Box 3.3: Household saving and balance sheets The household saving ratio - the average propensity of UK households to save out of current income - continued to rise in 2012. A significant contribution comes from an adjustment for employers' net contributions to funded pension schemes,a rather than from active household savings decisions. This adjustment is driven by corporate balance sheet management and profitability, and has been quite variable in recent years. However, with or without this adjustment, by the third quarter of 2012 the saving ratio had risen to a level comparable to 2009 (the highest since the 1990s), when the economy was contracting severely. Households may be choosing to save more for a number of reasons, including: tighter credit conditions, resulting in bigger down payments to buy a house; and fear of future negative income shocks, perhaps from fiscal consolidation or unemployment or a new tightening of credit conditions. The latest NMG Consulting surveyb shows a growing share of those respondents planning to increase their saving in 2013 doing so for a deposit, or to reduce their existing debts. Different sections of the population may also be affected in different ways: the young particularly by tighter credit conditions and greater deposit requirements for first-time home buyers. Looking forward, improvements in credit conditions could put downward pressure on the saving ratio. The Funding for Lending Scheme (FLS) could encourage lenders to compete for new borrowers by lowering deposit requirements. A further rise in inflation and fall in real incomes could also reduce the ratio as households save less in order to continue consuming essentials. But concerns over future income levels are only likely to recede slowly, as economic growth and public finances stabilise, and we do not expect a rapid return to the record-low saving ratios seen prior to the crisis. The higher saving ratio, combined with the resilience of nominal household disposable income levels (and further growth in 2012, see paragraph 3.53), has increased the flow of money into household balance sheets. Faced with the choice of purchasing new assets or paying off existing debts, households in aggregate appear to be choosing more financial assets, particularly deposits, perhaps in part due to higher collateral requirements for mortgages. The absolute level of household (loan) debt has even risen slightly, beyond its pre-recession peak. However, given resilient house prices, record low Bank rate and continued accumulation of financial assets, the effective burden of household debt has fallen steadily since the peak of the crisis (Chart A). Given other key features of our forecast (a very gradual pick up in Bank rate, continued improvement in credit conditions, weak growth in disposable income and house prices), we expect the burden of servicing household debt, on average, to remain well below the crisis and pre-crisis period - even with a moderate pick up in new borrowing. We expect slower accumulation of debt than in our March 2012 55 Economic and fiscal outlook Economic outlook forecast, given consistently weak actual borrowing data, by pre-crisis standards. But we do not expect a rapid or unstable path of debt reduction, which could induce a more significant response in the saving ratio, consumption and GDP growth. Chart A: Household leverage indicators 30 Forecast 25 Per cent 20 15 10 5 0 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 Debt leverage Income leverage Bank Rate Note: Debt leverage = gross household debt / net financial and non-financial equity; Income leverage = annual debt servicing costs / annual disposable income Source: ONS, Bank of England, OBR a Exclusion of which, from the denominator and numerator, can reduce the saving ratio by 2-4 per cent. b Bank of England, 2012, Quarterly Bulletin, Influences on household spending, 2012Q4. Business investment 3.57 Business investment data can be exceptionally volatile from quarter to quarter, and is often subject to significant revision. The latest data suggest that business investment fell by just over 1 per cent in the final quarter of 2012, having increased by just under 0.5 per cent in the third. Business investment is now estimated to have grown by 4.9 per cent in 2012 as a whole, a slightly stronger rate than we were expecting in December. 3.58 Surveys of investment intentions indicate little substantive change in the near-term outlook (Chart 3.15), namely a moderate rate of business investment growth. Over the near term we expect relatively subdued rates of investment, with overall growth in 2013 expected to be somewhat weaker than in 2012, partly reflecting the sharp recorded fall in business investment in the final quarter of last year. Economic and fiscal outlook 56 Economic outlook Chart 3.15: Investment intentions and uncertainty about demand 0.2 0.0 0.7 -0.5 1.2 -1.0 1.7 -1.5 2.2 -2.0 2.7 Standardised responses . -0.3 0.5 Standardised responses. 1.0 3.2 -2.5 2008 2009 CBI investment intentions 2010 2011 2012 CBI uncertainty about demand (Right hand axis, inverted) Source: CBI 3.59 As we have set out previously, it may be the case that the asset position of private non-financial corporations is currently overstated. In particular, the significant recent growth in deposits held overseas by UK firms may have been incorrectly attributed to non-financial companies rather than financial intermediaries.16 This does not necessarily mean that the corporate sector has been in deficit. However, it could suggest the size of corporate surplus as measured on the financial account has been over recorded.17 3.60 Our medium-term forecast for business investment is conditioned on the possibility that corporates' asset position is not as strong as suggested in the National Accounts. Upward revisions to outturns also mean there has been a greater bounce back in business investment since the end of the recession than previously thought - suggesting that less growth is required in future years to achieve a recovery in the medium-term level of business investment. 16 OBR, 2011, Economic and fiscal outlook, November, Box 3.5. 17 In 2012 the ONS established a working group examining issues related to the allocation of foreign deposits - see ONS, 2012, Reviewing and Improving ONS statistics: Measurement of UK Private NonFinancial Corporations' Overseas Deposits and Loans, September. As part of their development work for the 2013 Blue Book, the ONS have announced planned improvements to the method of allocating UK nonbank deposits and loans held with overseas banks. See ONS, 2012, Content of Blue Book 2013, November. 57 Economic and fiscal outlook Economic outlook 3.61 As a result our medium-term forecast for business investment growth is weaker than in previous forecasts. Business investment is now expected to grow at an average rate of just over 8 1/2 per cent between 2014 and 2017, lower than the average rate of just under 10 per cent assumed in our December forecast. These growth rates continue to mean that business investment rises as a share of GDP, continuing the general trend seen over the past two decades.18 Nevertheless, the cumulative recovery in business investment is expected to be weaker than that seen following the recession of the early 1990s (Chart 3.16), even though the pick-up in investment to date has been broadly in line with the 1990s. 3.62 The 1 per cent reduction in the main rate of corporation tax announced in the Budget is assumed to reduce the cost of capital faced by firms, and increases the level of business investment by around 0.5 per cent by 2017. Chart 3.16: Level of business investment 100= Level of investment at output peak . . 150 140 130 120 110 100 90 80 70 0 2 4 6 8 10 12 1990s recession 14 16 18 20 22 24 26 Quarters from peak in output 2008-09 recession 28 30 32 34 36 38 40 March 2013 forecast Source: ONS, OBR. Data for 1990s recession constructed using latest available ONS estimates for business investment growth prior to 1997, and latest available business investment levels from 1997. Residential investment 3.63 Residential investment remains volatile. The latest data suggest that residential investment fell by just under 7 per cent in the third quarter of 2012, having grown cumulatively by just over 5 per cent over the first half of the year. The weakness in the third quarter is consistent with other indicators of housing market 18 Between 1990 and 2008 the ratio of business investment to GDP at the peak and trough of each cycle has risen in successive cycles, which could be attributable to a fall in the relative price of capital goods. Our forecast implies that the real share will reach just under 11 per cent by 2017. Economic and fiscal outlook 58 Economic outlook activity: construction output, for example, fell by just over 2 per cent. Taken together, the latest data now suggest that residential investment declined by just over 2 per cent between the final quarter of 2011 and the third quarter of 2012, compared to our December forecast for growth of just over 2 per cent. 3.64 Residential property transactions picked up strongly in the fourth quarter of 2012, increasing by 4.4 per cent compared to the third quarter and largely in line with our December forecast. This is consistent with improvements in credit conditions and a slight increase in new mortgage lending over the same period. We expect credit conditions to continue to improve in 2013, manifesting as better terms and availability of secured credit to households. Easier credit will lead to continued growth in the pace of house purchases in 2013, albeit from a very low base. While we still expect strong growth in property transactions in 2013 and 2014, supported by the FLS and other Government schemes, we have reduced our forecast relative to December to a level which is more consistent with other outside forecasters. 3.65 We expect transactions to start to slow in the first half of 2014 as the FLS drawdown period ends. We expect steady growth to resume thereafter, with the level of transactions converging slowly on the long-run average rate of property turnover over the rest of the forecast period. The pace of recovery in transactions - which are currently running at just over half their peak rate in mid-2000 - will be limited by ongoing capital constraints for some buyers. Accumulation of a deposit will remain a considerable hurdle to first-time buyers, as well as existing owners with negative or insufficient equity. We expect a relaxation of loan-tovalue (LTV) limits in 2013 (the average LTV ratio for first time buyers reached 80 per cent in 2012,19 its lowest level for at least 30 years), but we do not expect a rapid return to pre-financial crisis standards. 3.66 We expect relatively subdued residential investment over the near term, with overall annual growth of 2 per cent in 2013. Residential investment is then forecast to pick up strongly from the second half of this year, consistent with a relatively robust recovery in residential property transactions. Residential investment growth rates remain relatively strong over the medium term as transactions continue to move back toward the long-run trend; despite this, the level of residential investment remains below its pre-crisis peak throughout the forecast period. 19 See Home Builders Federation report, 2013, Broken Ladder III, The Locked Out Generation, February. 59 Economic and fiscal outlook Economic outlook Stock building 3.67 In our December forecast we expected stocks to make a negative contribution to growth in 2012 of -0.6 percentage points. Data released for the fourth quarter of 2012, taken together with revisions to earlier quarters, now suggest that stocks acted as a much smaller drag on GDP growth last year, contributing -0.2 percentage points. There have been significant revisions to the quarterly profile of stocks through the course of 2012. The latest estimates now suggests that stocks contributed 0.5 percentage points to growth in the third quarter, while data available at the time of our December forecast indicated a negative contribution of 0.3 percentage points. 3.68 We expect stocks to make a small negative contribution of -0.2 percentage points to growth in 2013, as the stock-to-output ratio declines from its relatively elevated level at the end of 2012. We expect no contribution from this component over the medium term, with measures of stock adequacy moving back towards normal levels. Government 3.69 The latest ONS data indicate that real government consumption grew by 2.6 per cent in 2012, slightly above our December forecast of 2.4 per cent. However, government consumption growth was weaker than expected in cash terms. Downward revisions to outturns over the first half of the year now mean that nominal government consumption grew by 2 per cent in 2012, compared to our December forecast for growth of 3.6 per cent. 3.70 The relatively robust growth of real government consumption relative to nominal consumption is likely to reflect the way in which much of government activity is measured.20 Around two-thirds of real government activity is measured directly - for example, using the number of prescriptions, or school pupils. If these measures of activity hold up when nominal spending growth falls back, then real government consumption growth will rise relative to nominal growth. As a result the implicit price of government consumption has grown much more slowly over the past few years: since 2010, annual growth of the implied government consumption deflator has been close to zero, compared to an average annual growth rate of 3.5 per cent between 1992 and 2010 (Chart 3.17). 20 OBR, 2012, Economic and fiscal outlook, December, Box 3.6. Economic and fiscal outlook 60 Economic outlook Chart 3.17: Government consumption (average annual growth) 6 Average annual growth 5 4 3 2 1 0 1992-2010 2010-2012 -1 Real growth Deflator growth Nominal growth Source: ONS 3.71 In December we reduced our forecast for the growth of the government consumption deflator, implying a stronger contribution from real government consumption growth. However, the latest outturn data suggest that the government consumption deflator has been even weaker - and real government consumption even stronger - than we thought at the time. Data available at the time of the December forecast indicated that the government consumption deflator grew by 2.7 per cent in the year to the third quarter of 2012; recent outturns now indicate growth of 0.4 per cent over the same period. 3.72 Given this, and the way in which government activity is measured, we have made a further downward adjustment to our forecast for the growth of the government consumption deflator. For a given profile for cash spending, this revision has the effect of increasing real government consumption growth by 0.7 percentage points in 2014 and just over 1 1/2 percentage points in subsequent years. World economy 3.73 World output growth appears to have slowed to 3.1 per cent in 2012 from 3.9 per cent in 2011. Some survey evidence suggests it is beginning to pick-up again at the start of this year. For example, the JP Morgan Global Manufacturing Purchasing Managers' Index (PMI) rose to a ten-month high in January. Although the overall Composite PMI has fallen slightly since December, the average level so far during the first quarter of 2013 is above the average level during the final 61 Economic and fiscal outlook Economic outlook quarter of 2012. Our forecast for world growth in 2013 of 3.4 per cent remains broadly unchanged from our December forecast. 3.74 The euro area remains a major risk to our forecast. The improvements in euro area financial markets seen since last summer have been maintained so far this year. However, these improvements have yet to feed through to the real economy and the underlying situation remains very fragile. Euro area GDP contracted by 0.6 per cent in the final quarter of 2012, the sharpest quarterly fall since 2009. 3.75 We have revised down our forecast for euro area growth in 2013 to -0.5 per cent, reflecting the sharp fall in output at the end of 2012 and the latest survey indicators. The Markit euro area Composite PMI rose to a ten-month high in January but fell back in February and remains at a level consistent with a further fall in euro area GDP. We expect the euro area to start recovering in the second half of 2013, with growth of 1 per cent in 2014, broadly unchanged from our December forecast. The difficulties of the euro area will not be resolved quickly and our central assumption remains that they are likely to constrain growth for several years to come. 3.76 US growth was zero in the final quarter of 2012. This sharp slowdown was due to large falls in inventories, defence spending and exports. Meanwhile consumption and investment, the main components of domestic demand, both held up. We assume that this weakness is short-lived, with growth in the US economy pickingup in the first quarter of 2013. The extent of fiscal tightening in the US during 2013 continues to create uncertainty. The American Taxpayer Relief Act of January 2012 removed part of the uncertainty around at the time of our December forecast, but some remains due to negotiations over spending cuts that took effect at the start of March and attempts to agree a budget for 2013. In line with external forecasters, such as the IMF, we expect fiscal tightening worth around 1.5 per cent of GDP in 2013. Even if the risk of greater tightening is avoided in 2013, the long process of reform and consolidation of US public finances is likely to remain a source of ongoing uncertainty. 3.77 Developments in China's economy have been more positive since our December forecast. Growth in China appears to be picking-up, having slowed in the middle of last year, and leading indicators, such as the HSBC China Composite PMI, which rose to a two-year high in January, suggest this pick-up will continue into 2013. World trade 3.78 Whereas outturns for world growth this year have been broadly in line with our December forecast, world trade has been weaker than we expected. The slowdown in world trade has been broad based, with trade growth slower in Economic and fiscal outlook 62 Economic outlook nearly all regions during 2012 than in 2011. The CPB Netherlands Bureau for Economic Policy Analysis World Merchandise Index suggests that world trade growth remained weak in the final quarter of 2012. We now expect world trade to grow by 2.5 per cent in 2012 and assume that the weakness of trade relative to world output is likely to continue. As a result, the increase in world trade generated by higher global output growth during the next couple of years will be less sharp than we forecast in December. We now expect world trade to grow by 3.7 per cent in 2013 and 5.6 per cent in 2014, a revision down of 0.7 and 0.3 percentage points from December. In their January World Economic Outlook Update the IMF made similar downward revisions to its world trade forecasts. 3.79 Growth in UK export markets is expected to be slower than growth in world trade (see Chart 3.18). This is because slower-growing economies, such as the euro area, make up a larger share of UK exports. We now expect growth of 1.9 per cent in 2012, 3.4 per cent in 2013 and 5.2 per cent in 2014, which is lower than in our December forecast. These downward revisions reflect weaker import growth in the euro area and the US, two key UK export markets, than we were expecting in December. Chart 3.18: World trade and UK export market weighted trade growth 7 Percentage change 6 5 4 3 2 1 2011 Source: ONS, OECD, OBR 2012 2013 2014 World trade 2015 2016 2017 UK export markets Exports 3.80 UK exports have slowed significantly over the past year. The latest data indicate that volumes fell 0.3 per cent in 2012, weaker than the 0.1 per cent growth we expected in December and weaker than in 2011, when volumes grew 4.6 per 63 Economic and fiscal outlook Economic outlook cent. Recent data suggest that exports remained weak going into 2013, with volumes falling by 1.5 per cent in the final quarter of 2012. 3.81 At least part of the weakness in exports reflects the deterioration in UK export markets. The latest data indicate that UK export market growth slowed to just under 2 per cent in 2012 from just under 6 per cent in 2011, as output in the euro area declined and world trade volumes slowed. However, weak export performance cannot be attributed solely to slower export market growth. While export volumes declined in 2012, export markets continued to grow, albeit at a relatively slow rate. This implies a fall in exporters' market share. Box 3.4 discusses recent movements in UK exporters' market share in more detail. 3.82 The downward revision to our forecast for UK export markets means that we now expect weaker export growth than in December. We have revised down our forecast for export growth in 2013 from 3.1 per cent to 1.5 per cent, reflecting both the relative weakness of UK exports at the end of 2012 and slower UK export market growth through 2013. Weaker export markets growth also reduces export growth in 2014 by around 0.1 per cent relative to our December forecast. 3.83 Our forecast for exports continues to imply a loss of export market share, continuing the general trend seen over the past decade (Chart 3.19). The decline in share is expected to be less steep than over the recent past, as some of the factors behind the sharp deterioration in exports - such as the relatively weak performance of the financial sector - might not be expected to exert the same drag in future years. This, taken together with relatively subdued export price growth, points to a more modest decline in export share than recent trends. Economic and fiscal outlook 64 Economic outlook Chart 3.19: UK exports market share 100 Forecast Index 1998Q1=100 . 95 90 85 80 75 70 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 Source: ONS, OECD, OBR. UK export share defined as exports divided by UK export markets, where exports series have been adjusted to account for the effect of VAT Missing Trader Intra Community (MTIC) fraud. 65 Economic and fiscal outlook Economic outlook Box 3.4: UK export markets Rising exports added 4.3 per cent to GDP between the trough of the recession in the second quarter of 2009 and the final quarter of 2011. But, since the end of 2011, exports have fallen and reduced GDP by 0.8 per cent rather than rising and increasing it by 1.2 per cent as we forecast in March 2012. This disappointing performance in part reflects weaker-than-expected growth in UK export markets and some rise in sterling. However, part of the weakness remains unexplained. In assessing recent trends it is useful to distinguish between goods and services exports. Between 1997 and 2007, UK exporters lost market share in G7 import markets for goods exports (Table A). Since the sterling depreciation between 2007 and 2009 the UK market share of goods exports has been broadly unchanged. For services, the UK market share expanded rapidly between 2002 and 2007 with strong growth in financial services exports. Since 2007, the UK market share for services exports remained broadly steady before falling sharply from the start of 2012. The value of UK financial services exports has fallen by a tenth in the four quarters to the third quarter of 2012 on a year earlier (Chart B).a Table A: Average quarterly growth in the ratio of UK exports to rest of the G7 imports Goods Services Total 1997Q1-2001Q4 -0.8 0.0 -0.6 2002Q1-2007Q3 -0.8 1.4 -0.1 2007Q4-2011Q4 0.2 -0.1 0.1 2012Q1-2012Q3 -0.2 -2.3 -0.9 It is not clear why UK exports of financial services have fallen so sharply in the past year or whether this trend will continue. Over the last few years there have been large revisions to the export data (see Box 2.1 in Chapter 2), so this fall could be revised away in subsequent data vintages. There may also be problems with measuring financial service activity.b However, US financial exports have also fallen by 7 per cent in the four quarters to the third quarter of 2012 on a year earlier. A recent report highlights that global crossborder capital flows remain well down on their pre-recession level and have fallen back since 2010.c The Bank of England argues that the fall in UK financial services exports could reflect changes in both the demand for and supply of UK financial services.d In particular, demand for the types of financial products that the UK specialises in may have fallen, while banks may be trying to make changes to the riskiness of their balance sheets by reducing their overseas and domestic business.e Economic and fiscal outlook 66 Economic outlook Chart B: US and UK financial services exports 130 Index 2007 Q4= 100. 120 110 100 90 80 70 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 2007 2008 2009 2010 2011 2012 UK financial services exports US financial services exports Source: ONS, Bureau of Economic Analysis, OBR a The ONS do not currently publish volume data for different types of services exports. The latest data available for the types of services exports by value is the third quarter of 2012. b Martin Weale, 2009, Growth prospects and financial services, January. c McKinsey Global Institute, 2013, Financial globalization: Retreat or reset, March. d Bank of England, 2013, Inflation Report, February. e Bank of England, 2012, Financial Stability Report, November. Imports 3.84 Our forecast for imports is determined by the outlook for import-weighted domestic demand, set out in Chart 3.20. The downward revision to domestic demand growth in 2013 and 2014 means that we now expect slightly weaker import growth over the near term, although the effect on net trade is more than offset by weaker export growth. Within domestic demand, both consumption and investment have relatively high import intensity and the recovery in these components supports the pick up in import growth from 2015. The weakness of government activity has relatively little offsetting effect on import growth, reflecting the relatively low import intensity of this component of demand. 67 Economic and fiscal outlook Economic outlook Chart 3.20: Contributions to import-weighted domestic demand growth and UK import growth 10 Percentage change on a year earlier Forecast 5 0 -5 -10 -15 2007 2008 2009 2010 Private consumption Stocks 2011 2012 2013 Government consumption Exports 2014 2015 2016 2017 Investment Imports Source: ONS, OBR Net trade 3.85 We expect net trade to make a weaker contribution to near-term growth than we forecast in December. Net trade is now expected to contribute 0.1 percentage points to growth in 2013, revised down from the 0.3 percentage points we expected in our December forecast. This partly reflects the effect of data released since December. Net trade is now estimated to have added slightly less to growth over the final two quarters 2012 than we expected in December. Net trade is also expected to contribute slightly less to growth through this year, as weaker export market growth is only partially offset by the effect of slower domestic demand growth on imports. The contribution from net trade to growth is expected to remain at around 0.1 percentage points in subsequent years of the forecast. Balance of payments 3.86 The current account deficit widened sharply over the first half of 2012, reflecting both a widening of the trade deficit and a significant deterioration in the investment income balance in the second quarter.21 Despite a subsequent 21 For more discussion of recent movements in the current account balance see Martin Weale, 2013, The Balance of Payments, February. Economic and fiscal outlook 68 Economic outlook improvement in the trade and investment balances, the current account deficit remained relatively large in the third quarter, at just over 3 per cent of GDP. 3.87 The gradual improvement in net exports means that we expect the current account deficit to narrow slowly over the forecast period, reaching around 1.4 per cent of GDP by 2017. We expect the investment income balance to recover from its relatively weak position in 2012, although we do not expect it to return to its pre-crisis share of GDP. Chart 3.21: Current account balance as a share of GDP 3 Forecast 2 1 Per cent 0 -1 -2 -3 -4 -5 2000 2002 2004 Transfers and other 2006 2008 Trade balance 2010 2012 Net investment income 2014 2016 Current balance Source: ONS, OBR Inflation and the GDP deflator 3.88 In assessing the outlook for the economy and the public finances, we are interested in a number of measures of inflation, including the Consumer Prices Index (CPI) and the Retail Prices Index (RPI) measures. The basic approach to the measurement of inflation using these indices is the same, although there are a number of differences due to coverage, the representative population covered by the indices and the methods used to construct them.22 22 For more details on the differences between the RPI and CPI see Miller, R, 2011, OBR Working Paper No. 2: The long-run difference between RPI and CPI inflation, November. 69 Economic and fiscal outlook Economic outlook 3.89 The RPI and CPI measures of inflation are important because they have different effects on our fiscal forecast. The Government uses CPI for the indexation of most tax rates, allowances and thresholds and for the uprating of benefits and public sector pensions. The RPI is used for calculating interest payments on index-linked gilts, student loan payments and the revalorisation of excise duties. 3.90 In November 2012, the ONS announced that a new additional measure of consumer price inflation (CPIH), including owner occupiers' housing costs, will be published.23 We have not produced a forecast of CPIH inflation in this EFO, as this variable is not required for our fiscal forecast. CPI inflation 3.91 CPI inflation has been slightly higher than in our December forecast, at 2.7 per cent both over the final quarter of 2012 and in January 2013.24 Retail gas and electricity price rises and increases in university tuition fees made a significant contribution to CPI inflation at the end of 2012. Food prices have also contributed more, in part due to bread, cereal and vegetable prices.25 3.92 Looking ahead, we have raised our forecast for CPI inflation in 2013 due to recent outturn data and higher oil prices. We also assume that there will be upward pressure on CPI inflation over the next few years due to higher import prices as a result of sterling's recent depreciation. We expect retail food price inflation to be relatively elevated in 2013 as we continue to assume that rises in food commodity prices in 2012 feed through into higher retail food prices. Overall, we expect CPI inflation to rise towards the middle of this year and then fall gradually over 2014 and 2015. 3.93 Our forecast assumes that world oil prices will move in line with the prices implied by futures markets. For our forecast we take an average over the ten working days ending 25 February 2013. These are higher than in our December forecast. 3.94 Rises in retail electricity and gas prices by the major UK energy suppliers at the end of 2012 and beginning of 2013 have now been implemented, with the last occurring on 18 January. Some UK energy suppliers have pointed to increased distribution, network and environmental policy costs as well as wholesale costs. 23 ONS, 2013, Introducing the New CPIH Measure of Consumer Price Inflation, March. 24 Our forecast takes into account inflation outturns up to and including January 2013. 25 ONS Statistical Bulletin, Consumer Price Indices, November 2012 to January 2013. Economic and fiscal outlook 70 Economic outlook 3.95 We expect these environmental policy and network costs to persist in coming years, contributing to rises in domestic gas and electricity prices. Policy costs could account for an average increase of around 2 per cent per annum in retail electricity prices and around 0.5 per cent per annum increases in household gas prices in the years to 2020.26 Network costs could add a further 2 per cent per annum to domestic energy prices over the next few years.27 While wholesale energy costs are inherently uncertain, there may also be some further upward pressure from increased wholesale prices in winter 2013 based on the forward prices at the time of producing this forecast. 3.96 Overall we assume rises in domestic energy prices of around 7 per cent in winter 2013. We also assume that there is a rise of around 3 per cent towards the end of 2014. This implies that the contribution to CPI inflation from retail energy prices is around 0.3 and 0.1 percentage points in winter 2013 and winter 2014 respectively. However there are uncertainties around these estimates, depending on the pricing strategies used by suppliers and the extent to which these nonwholesale costs may already be factored into current retail prices. 3.97 In the medium term we expect CPI inflation to fall back to target, remaining close to 2 per cent from 2016 onwards (Chart 3.22). We expect downward pressure on prices from the negative output gap over the forecast period to be offset, to some extent, by upward pressure from above trend growth rates and falling unemployment in the later years. 3.98 Policy announcements by the Government have also been incorporated into our inflation forecast. Cancelling the rise in fuel duty in September 2013 will reduce annual CPI inflation by around 0.1 percentage points at the end of 2013 and in the first half of 2014.28 Reducing beer duty by 2 per cent in 2013-14 and raising it by RPI rather than RPI plus 2 per cent in 2014-15 has an additional small downward effect on CPI inflation relative to the continuation of pre-announced changes. 26 This has been calculated based on figures in Table E1 and E2 in DECC, 2011, Estimated impacts of energy and climate change policies on energy prices and bills, November. 27 This is based on increases in agreed allowed revenue taking into account forecasted decreases in demand. For percentage changes in allowed revenues see: Ofgem, 2012, RIIO-T1: Final Proposals for SP Transmission Ltd and Scottish Hydro Electric Transmission Ltd, April; Ofgem, 2012, RIIO-T1: Final Proposals for National Grid Electricity Transmission and National Grid Gas, December. Ofgem, 2009 Final proposals for Electricity Distribution Price Control Review, December. 28 This impact is relative to a baseline including pre-announced changes to fuel duty. 71 Economic and fiscal outlook Economic outlook Chart 3.22: CPI inflation forecast 5.0 Forecast Percentage change on a year earlier 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 Source: ONS, OBR RPI inflation 3.99 The ONS has considered methodological changes to the RPI based on the use of different formulae to aggregate prices at the lowest level.29 Since our December forecast, the National Statistician has concluded that the RPI formula will remain unchanged - even though it does not meet international standards - and that a new inflation index will be published from March 2013, called RPIJ.30 We have not produced a forecast of RPIJ inflation in our EFO, as this variable is not used in our fiscal forecast. The announcement has not affected our RPI forecast. 3.100 RPI inflation is expected to follow a similar path to CPI inflation, but this measure also includes mortgage interest payments (MIPs) and housing depreciation. 3.101 House price inflation was higher than expected in the final quarter of 2012. We assume that house prices move in line with the median outside forecast of ONS house prices.31 This suggests a weaker annual rate of ONS house price inflation 29 OBR, 2012, Economic and fiscal outlook, December, Box 3.7. 30 This will use a geometric formulation (Jevons). For more details see: National Statistician's Consumer Prices Advisory Committee Outcome from the National Statistician's consultation on the Retail Prices Index, October - November 2012; ONS, 2013, Introducing the New RPIJ Measure of Consumer Price Inflation, March. 31 See HM Treasury, 2013, Forecasts for the UK economy: a comparison of independent forecasts, February. Economic and fiscal outlook 72 Economic outlook in the fourth quarter of 2013 and 2014 compared to our December forecast. In the medium term, we expect house price inflation to rise broadly in line with the long-term average rate of earnings growth. 3.102 Lower bank funding spreads lead to a gradual fall in average mortgage rates in the first few years of our forecast. Rising Bank rate then feeds into higher mortgage rates and put upward pressure on the RPI in the medium term. Our forecast for the contribution of MIPs to RPI inflation is higher in the medium term than in December, largely as a result of higher expectations for Bank rate. The GDP deflator 3.103 GDP deflator growth is the broadest measure of inflation in the domestic economy. It measures the changes in the overall level of prices for goods and services that make up GDP, including price movements in consumption, government spending, investment and trade. 3.104 The GDP deflator was lower through 2012 than we thought in December, reflecting ONS revisions. Going forward, our forecast for growth in the consumption deflator is higher than previously expected, in line with the upward revisions to our forecast for CPI inflation. 3.105 Recent outturn data suggest that the government consumption deflator has been even weaker - and real government consumption has been even stronger - than we thought at the time of our December forecast. Given this, and the way in which government activity is measured, we have made a further downward adjustment to our forecast for the growth of the government consumption deflator (see paragraphs 3.68 to 3.71 for more details). 3.106 The level of nominal GDP is lower than we forecast in December throughout the forecast period. This reflects both a weaker forecast for real GDP growth and a downward adjustment to the GDP deflator. Taken together these adjustments leave the level of nominal GDP in 2017-18 around 2.6 per cent lower than in our December forecast. Of this, around 0.6 of a percentage point is attributable to a lower level of real GDP, with the remainder reflecting a lower GDP deflator. The labour market Employment, unemployment and inactivity 3.107 As set out in Chapter 2, the labour market performed more strongly in the fourth quarter than we expected in December. Employment rose to 29.7 million in the final quarter of 2012, compared to our forecast of 29.6 million, while the unemployment rate remained at 7.8 per cent rather than rising to 7.9 per cent. 73 Economic and fiscal outlook Economic outlook The rise in employment was driven by people working full time, while the number of people working part time fell. This is in contrast with the trend we have seen in most previous quarters where the rise in employment has been driven by parttime workers as shown in Chart 3.23. 3.108 People employed in government supported training and employment programmes fell marginally in the fourth quarter after rising in the four preceding quarters. Of the total increase in employment in 2012, compared to 2011, around 14 per cent reflects increased participation in those programmes. Chart 3.23: Cumulative change in employment of people working full time and part time since 2008 800 600 400 Thousands 200 0 -200 -400 -600 -800 -1,000 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2008 2009 2010 2011 2012 Full time Part time Total Source: ONS 3.109 The activity rate continued to rise in the final quarter of 2012. At 63.6 per cent, it is now only fractionally below its pre-crisis peak of 63.7 per cent. Activity has increased among older workers,32 compensating for a fall in activity among younger people. This is consistent with later retirement age of women and greater participation in full-time education. 3.110 We have revised up our employment forecast in line with continued strength of employment in the fourth quarter and survey indicators suggesting increased 32 See for example: Cribb et.al. 2013, Incentives, shocks or signals: Labour supply effects of increasing the female state pension age in the UK, IFS working paper, March. Economic and fiscal outlook 74 Economic outlook employment at the start of 2013. We now expect unemployment to peak at 8.0 per cent in 2014 before falling back to 6.9 per cent in 2017. 3.111 Consistent with our unemployment profile, we now expect the claimant count to remain relatively flat in the next few years, peaking at 1.63 million in 2014 before falling back to 1.38 million in 2017 (Chart 3.24). Chart 3.24: Unemployment levels 3,500 Forecast 3,000 Thousands 2,500 2,000 1,500 1,000 500 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 Source: ONS Claimant count ILO unemployment 3.112 Total market sector employment is expected to rise by around 2.6 million between the start of 2011 and the start of 2018, more than offsetting the total reduction in general government employment of around 1.2 million. Excluding the reclassification of almost 200,000 employees from the public to the private sector in 2012, market sector employment is forecast to rise by 2.4 million and public sector employment to fall by 1 million (Box 3.5). 75 Economic and fiscal outlook Economic outlook Box 3.5: General government employment Our projection for general government employment (GGE) is built up from projections of total government paybill and paybill per head. We use these projections to estimate the total decline in GGE from the start of the 2010 Spending Review period to the end of the forecast and then make a stylised assumption that employment falls at a constant rate from the latest outturn data. Our latest projections incorporate updated expenditure projections and new data on average earnings and workforce reductions so far in 2012-13: In December we forecast a 1.1 million fall in general government employment from the start of 2011 to the start of 2018. Excluding a classification change introduced in the second quarter of 2012, which moved around 196,000 employees from the public to the private sector, the fall was around 930,000. Data on public sector average earnings growth since December was marginally stronger than we expected, resulting in a small upward revision to our paybill per head growth assumption in 2012-13 to 2.0 per cent from 1.9 per cent. For the rest of the forecast the assumptions are unchanged since December. Our latest forecast assumes that there will be around 2 per cent less departmental spending available for paybill at the start of 2018 compared to our December forecast. Combining this assumption with our paybill per head growth assumptions implies a total reduction in GGE of around 1.2 million from the start of 2011 to the start of 2018 or around 1 million excluding the reclassification.a In December, the ONSb revised up its estimate of central government employment after improving the method it uses to estimate the level of employment in Academy schools in England. The size of the revision increases from around 20,000 more employees at the start of 2011 to around 100,000 more in the second quarter of 2012. As shown on Chart C this is consistent with a more gradual decline in employment and less frontloading than previous data suggested. All this implies an average fall in GGE of around 36,000 per quarter over the reminder of the period, compared to an average fall to date of around 34,000 per quarter from the first quarter of 2011 to the third quarter of 2012, excluding the classification change. Economic and fiscal outlook 76 Economic outlook Chart C: Forecast for GGE - December 2012 compared to March 2013 adjusted for reclassification 5,800 Forecast 5,600 Thousands 5,400 5,200 5,000 4,800 4,600 4,400 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: ONS, OBR December 2012 EFO March 2013 EFO In our December EFO we mentioned that growth in paybill per head, measured using ONS data on wages and salaries divided by number of employees, had been considerably stronger than growth in public sector average weekly earnings (AWE) in recent years. Some commentators suggested that higher paybill per head - rather than frontloading - explained the sharp reduction in GGE to date and suggested that the total reduction going forward would be larger. The data revision mentioned above, as well as downward revisions to wages and salaries since December, has narrowed this gap. Looking at the last three fiscal years (2009-10 to 2011-12), aggregate growth in the two measures is now roughly the same although the rates vary in individual years. There are various reasons for the growth rates to differ. For example, some elements of redundancy payments, expenses and wages and salaries in kind (such as discounted meals and provision of recreation facilities) are included in wages and salaries but not in AWE. a More details on the paybill per head forecast and the general government employment projections by year in the latest forecast can be found in the supplementary tables accompanying this EFO, available on our website. b ONS, 2012, Change in method for estimating employment in education in England, December. 77 Economic and fiscal outlook Economic outlook 3.113 The strong performance of the labour market in recent quarters provides little evidence of a significant structural deterioration since our December forecast. We have not therefore adjusted our estimate of the long-term non-accelerating inflation rate of unemployment (NAIRU). Long-term unemployment, as a share of total unemployment, fell marginally in the final quarter of 2012. The youth unemployment rate, for those aged 16 to 24, was broadly flat. Excluding those in full-time education, the rate fell by 0.3 percentage points in the fourth quarter. Earnings 3.114 Average earnings growth continued to fall in the fourth quarter with average weekly earnings (AWE) in the private sector growing by only 1.3 per cent compared to 2.0 per cent in the third quarter and our forecast of 2.0 per cent in December. 3.115 Key determinants of the prospects for average earnings growth include the growth rate of productivity, the extent of labour market slack, and the degree of real wage resistance to changes in price inflation. We have made a slight downward revision to our forecast for nominal wage growth since December. This reflects both the weak outturns in the fourth quarter for nominal wages and productivity and a weaker forecast for productivity growth going forward, consistent with a stronger employment but a weaker output growth forecast. Whole economy wages are expected to grow by 1.4 per cent this year and around 2.7 per cent in 2014, rising gradually to 4.0 per cent in 2016. 3.116 With an upward revision to price inflation and a downward revision to wage growth, our forecast for real wage growth is weaker than in December. We now expect real wage growth to be negative in 2013 and only marginally positive in 2014, before picking up in 2015 and reaching 2 per cent in 2016. 3.117 Despite a downward revision to average earnings our forecast for wages and salaries - a key determinant for tax receipts from labour income - is only around 1 per cent lower by 2017 than we expected in December with an upward revision to employment partly offsetting the fall in earnings. Economic and fiscal outlook 78 Economic outlook Comparison with external forecasts 3.118 In this section, we compare our latest projections with those of key outside forecasters. Estimates of the current degree of spare capacity and the potential growth rate of the economy, where available, differ widely as discussed in Box 3.2. 3.119 In its January World Economic Outlook Update, the IMF forecast GDP growth of 1 per cent in 2013, around 0.4 percentage points stronger than our central forecast. The IMF published its forecast before the estimate of GDP growth in the final quarter of 2012, which may partly explain the difference. Further out, the IMF's update assumed growth of 1.9 per cent in 2014, slightly stronger than our central forecast. The IMF's January update did not include new medium-term forecasts. However, the IMF's October World Economic Outlook forecast growth to average around 2.6 per cent between 2014 and 2017, in line with the average growth rate implied by our latest forecast. 3.120 The OECD published an updated forecast as part of its November Economic Outlook. Their short-term forecast for GDP growth is slightly stronger than our central forecast: the OECD expect growth of 0.9 per cent in 2013, although this forecast was published prior to the estimate of GDP for the final quarter of 2012. The OECD forecast growth of 1.6 per cent in 2014 - slightly below our central forecast - and there are some differences in the expected composition of growth, with the OECD expecting a larger contribution from consumption and net trade, but a weaker contribution from investment and government consumption. 3.121 The European Commission published its latest forecast in February. They expect growth of 0.9 per cent this year and 1.9 per cent in 2014, a little stronger than our central forecast in both years. The Commission expect a stronger contribution from trade, with net exports contributing 0.2 percentage points to growth in 2013 and 0.6 percentage points in 2014 - this compares to our forecast for a contribution of 0.1 percentage point in each year. They also expect a stronger contribution from consumer spending, with consumption growth expected to average 1.3 per cent between 2012 and 2014, compared to an average growth rate of 0.8 per cent in our central forecast. The effect of stronger contributions from consumption and net trade on GDP growth is partially offset by a weaker forecast for government consumption and investment than our central case. 3.122 In its February Economic Review, the National Institute for Economic and Social Research (NIESR) forecast GDP growth of 0.7 per cent in 2013, slightly above our central forecast. However, they forecast slightly weaker growth over the medium term with growth averaging around 2.1 per cent between 2013 and 2017, compared to an average growth rate of 2.4 implied by our latest forecast. Much of the difference between the forecasts is attributable to a weaker medium-term 79 Economic and fiscal outlook Economic outlook outlook for investment and government consumption, partly offset by a stronger contribution from net trade. NIESR also expect lower average inflation than our central forecast. This may be attributable to a larger output gap forecast, but we cannot be sure as they do not publish the profile for this variable. 3.123 Comparison with the Monetary Policy Committee's economic forecast is not straightforward because the Bank of England only publishes point estimates for two variables, CPI inflation and GDP growth. The Bank of England's modal forecast for GDP is slightly stronger in 2013 and 2014 than our central forecast, although they assume slightly weaker growth in 2015. The MPC's modal forecast for CPI inflation is higher in both 2013 and 2014 than our central forecast. 3.124 Oxford Economics' forecast, published in March 2013, assumes higher GDP growth than our central forecast in all years. They also expect weaker CPI inflation than we do, which may partly reflect the larger output gap implied by their forecast. Economic and fiscal outlook 80 Economic outlook Table 3.4: Comparison of external forecasts 2011 OBR (March 2013) GDP growth CPI inflation Output gap IMF (October 2012) GDP growth1 CPI inflation Output gap OECD (November 2012) GDP growth CPI inflation Output gap EC (February 2013) GDP growth CPI inflation Output gap NIESR (February 2013) GDP growth CPI inflation Output gap Bank of England (February 2013) GDP growth (mode)2 CPI inflation (mode)2 Oxford Economics (March 2013) GDP growth CPI inflation Output gap 2012 2013 Per cent 2014 2015 2016 2017 0.9 4.5 -2.7 0.2 2.8 -2.7 0.6 2.8 -3.6 1.8 2.4 -3.7 2.3 2.1 -3.4 2.7 2.0 -2.9 2.8 2.0 -2.3 0.9 4.5 -2.6 -0.2 2.7 -4.2 1.0 1.9 -4.4 1.9 1.7 -3.6 2.6 1.8 -2.7 2.6 1.8 -2.1 2.7 1.9 -1.4 0.9 4.5 -1.4 -0.1 2.6 -2.2 0.9 1.9 -2.3 1.6 1.8 -2.0 0.9 4.5 -2.7 0.0 2.8 -3.3 0.9 2.6 -3.2 1.9 2.3 -2.5 0.9 4.5 0.0 2.8 -4 0.7 2.4 -4 1/2 1.5 2.3 2.1 2.2 2.3 1.8 2.3 1.9 0.3 2.8 0.9 3.0 1.8 2.7 2.0 2.2 0.2 2.8 -5.6 0.9 2.6 -6.0 2.0 1.6 -5.5 2.5 1.5 -5.0 2.8 1.5 -4.2 2.9 1.7 -3.5 0.9 4.5 -3.6 1 GDP growth up to 2014 is from the IMF January 2013 World Economic Outlook Update 2 Mode forecast based on market interest rates and the Bank of England's 'backcast' for GDP growth. 81 Economic and fiscal outlook Economic outlook Table 3.5: Detailed summary of forecast Percentage change on a year earlier, unless otherwise stated Forecast Outturn 2011 2012 2013 2014 2015 2016 2017 UK economy Gross domestic product (GDP) GDP Level (2011=100) Nominal GDP Output Gap (per cent of potential output) Expenditure components of GDP Domestic demand Household consumption? General government consumption Fixed investment Business General government? Private dwellings? Change in inventories3 Exports of goods and services Imports of goods and services Balance of payments current account Per cent of GDP Inflation CPI RPI GDP deflator at market prices Labour market Employment (millions) Wages and salaries Average earnings4 ILO unemployment (% rate) Claimant count (millions) Household sector Real household disposable income Saving ratio (level, per cent) House prices World economy World GDP at purchasing power parity Euro Area GDP World trade in goods and services UK export markets5 0.9 100.0 3.4 - 2.7 0.2 100.2 1.5 - 2.7 0.6 100.8 2.7 - 3.6 1.8 102.6 3.8 - 3.7 2.3 105.0 4.2 - 3.4 2.7 107.8 4.4 - 2.9 2.8 110.8 4.6 - 2.3 -0.6 -1.0 -0.1 -2.9 3.1 -26.2 2.3 0.3 4.6 0.5 1.2 1.0 2.6 1.4 4.9 2.7 -5.4 -0.2 -0.3 2.0 0.5 0.5 0.4 2.2 1.9 2.6 2.0 -0.2 1.5 1.0 1.6 1.2 -0.7 6.7 6.1 5.0 8.9 0.0 4.4 3.8 2.2 1.7 -0.4 8.1 8.6 1.8 10.0 0.0 5.1 4.4 2.5 2.4 -1.0 7.7 8.6 -1.5 10.0 0.0 5.3 4.8 2.7 2.8 -1.8 7.8 8.6 -1.2 9.7 0.0 5.3 4.9 -1.3 -3.6 -2.7 -2.2 -1.9 -1.6 -1.4 4.5 5.2 2.5 2.8 3.2 1.3 2.8 3.2 2.1 2.4 2.8 2.0 2.1 3.2 1.8 2.0 3.6 1.8 2.0 3.9 1.7 29.2 2.7 2.3 8.1 1.53 29.5 2.8 2.1 7.9 1.59 29.8 2.4 1.4 7.9 1.58 29.9 3.1 2.7 8.0 1.63 30.1 4.3 3.6 7.9 1.59 30.3 4.8 4.0 7.4 1.48 30.5 4.8 4.0 6.9 1.38 -1.0 6.6 -1.0 1.6 7.0 1.6 0.2 6.6 1.3 0.4 5.8 1.6 1.3 5.6 3.3 1.8 5.4 4.0 2.3 5.0 4.0 3.9 1.5 5.7 5.9 3.1 -0.5 2.5 1.9 3.4 -0.5 3.7 3.4 4.1 1.0 5.6 5.2 4.4 1.3 6.0 5.6 4.6 1.7 6.2 5.7 4.6 1.9 6.3 5.8 ? Includes households and non-profit institutions serving households 2 Includes transfer costs of non-produced assets 3 Contribution to GDP growth, percentage points 4 Wages and salaries divided by employees 5 Other countries' imports of goods and services weighted according to the importance of those countries in the UK's total exports Economic and fiscal outlook 82 Economic outlook Table 3.6: Detailed summary of changes to forecast Percentage change on a year earlier, unless otherwise stated Forecast Outturn 2011 2012 2013 2014 2015 2016 2017 UK economy Gross domestic product (GDP) GDP Level (2011=100)1 Nominal GDP Output Gap (per cent of potential output) Expenditure components of GDP Domestic demand Household consumption2 General government consumption Fixed investment Business General government3 Private dwellings3 Change in inventories4 Exports of goods and services Imports of goods and services Balance of payments current account Per cent of GDP Inflation CPI RPI GDP deflator at market prices Labour market Employment (millions) Wages and salaries Average earnings5 ILO unemployment (% rate) Claimant count (thousands) Household sector Real household disposable income Saving ratio (level, per cent) House prices World economy World GDP at purchasing power parity Euro Area GDP World trade in goods and services UK export markets6 1 0.0 0.0 -0.2 0.0 0.3 0.3 -0.7 0.3 -0.6 -0.3 -0.6 -0.1 -0.3 -0.6 -0.3 -0.3 0.0 -0.6 -0.2 -0.3 0.0 -0.6 -0.3 -0.3 0.0 -0.6 -0.3 -0.4 -0.2 -0.1 -0.3 -0.5 0.2 -5.9 2.0 0.0 0.1 0.0 0.7 0.4 0.2 0.4 1.1 11.9 -7.8 0.4 -0.4 0.0 -0.4 -0.4 1.1 0.0 -3.0 5.1 3.1 -0.4 -1.6 -1.1 -0.2 -0.3 0.7 -1.4 -2.1 0.1 -0.6 0.0 -0.1 -0.1 0.0 -0.1 0.8 -0.4 -1.6 4.8 0.0 0.0 -0.1 -0.1 0.0 -0.1 1.1 -1.0 -1.5 1.1 0.0 0.0 -0.1 -0.1 0.0 -0.1 1.3 -0.9 -0.9 -1.9 0.0 0.0 -0.1 -0.1 0.6 0.4 -0.1 0.0 0.1 0.0 0.0 0.0 0.0 -0.2 0.0 0.0 -1.0 0.3 0.2 0.0 0.2 0.2 -0.1 0.1 0.0 -0.2 0.0 0.2 -0.3 0.0 0.2 -0.3 0.0 0.1 0.1 0.0 0 0.0 -0.5 -0.7 0.0 -4 0.2 -0.3 -0.8 -0.3 -78 0.1 -0.1 0.0 -0.2 -63 0.1 -0.2 -0.1 -0.1 -41 0.1 0.0 0.0 -0.2 -49 0.1 0.0 0.0 -0.2 -53 0.5 0.6 0.0 -0.5 -0.1 0.2 -0.2 0.4 0.6 -0.4 0.3 -0.9 -0.3 0.1 -0.5 -0.2 0.0 0.0 0.0 0.0 0.0 0.0 0.0 -0.1 0.0 -0.1 -0.1 -0.5 -0.7 -0.1 -0.4 -0.7 -0.8 -0.1 -0.1 -0.3 -0.4 -0.1 0.0 -0.3 -0.2 0.0 0.0 -0.3 -0.3 0.0 0.0 -0.2 -0.3 Per cent change since December 2 Includes households and non-profit institutions serving households 3 Includes transfer costs of non-produced assets, which were excluded in previous forecasts 4 Contribution to GDP growth, percentage points 5 Wages and salaries divided by employees 6 Other countries' imports of goods and services weighted according to the importance of those countries in the UK's total exports 83 Economic and fiscal outlook 4 Fiscal outlook Introduction 4.1 This chapter: sets out the key economic and market determinants that drive the fiscal forecast (paragraphs 4.3 to 4.23); explains the effects of new policies announced in this Budget, and since the Autumn Statement in December, and reclassifications on the fiscal forecast (paragraphs 4.24 to 4.45); describes the outlook for public sector receipts, including a tax-by-tax analysis explaining how the forecasts have changed since December (paragraphs 4.46 to 4.95); describes the outlook for public sector expenditure, focusing on departmental expenditure limits and the components of annually managed expenditure (paragraphs 4.96 to 4.167); describes the outlook for government lending to the private sector and other financial transactions (paragraphs 4.168 to 4.187); sets out the outlook for the key fiscal aggregates: public sector net borrowing, the current budget, the cyclically-adjusted current budget and public sector net debt (paragraphs 4.188 to 4.201); and provides a comparison with external forecasts (paragraphs 4.202 to 4.207). 4.2 Further breakdowns of receipts and expenditure and other details of our fiscal forecast are provided in the supplementary tables available on our website. The medium-term forecasts for the public finances in this chapter consist of an in-year estimate for 2012-13, which makes use of provisional ONS outturn data for April 85 Economic and fiscal outlook Fiscal outlook to January, and then forecasts to 2017-18.1 As in previous Economic and fiscal outlooks, this fiscal forecast: represents our central view of the path of the public finances. We believe that the outturns are as likely to be above the forecast as below it. We illustrate the uncertainties that are inherent in any fiscal forecast by using fan charts, sensitivity analysis and alternative economic scenarios; is based on announced Government policy on the indexation of rates, thresholds and allowances for taxes and benefits, and incorporates the impact of certified costings for all new policy measures announced by the Chancellor in the Budget; and focuses on fiscal aggregates that exclude the temporary effects of interventions in the financial sector.2 The Government's fiscal mandate and supplementary target are defined in terms of these measures. We also present measures of underlying public sector net borrowing, which exclude some significant one-off or temporary transactions. Economic determinants of the fiscal forecast 4.3 Our forecasts for the public sector finances are based on the economic forecasts presented in Chapter 3. Forecasts of tax receipts are particularly dependent on the path and composition of economic activity. And while much of public sector expenditure is set out in multi-year plans, large elements (such as social security and debt interest payments) are linked to developments in the economy. Table 4.1 sets out some of the key economic determinants of the fiscal forecast and Table 4.2 shows how these have changed since our forecast in December. 1 Outturn data is consistent with the Public Sector Finances January 2013 Statistical Bulletin published by the Office for National Statistics and HM Treasury. We have also used HMRC administrative data on central government receipts in February and early March to inform our forecast. 2 Office for National Statistics, 2010, Public sector finances excluding financial sector interventions. Economic and fiscal outlook 86 Fiscal outlook Table 4.1: Determinants of the fiscal forecast Percentage change on previous year unless otherwise specified Forecast Outturn 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 GDP and its components Real GDP Nominal GDP (? billion)1 Nominal GDP1 Nominal GDP (centred end-March) Wages and salaries2 Non-oil PNFC profits2,3 Non-oil PNFC net taxable income2,3 Consumer spending2,3 Prices and earnings GDP deflator RPI (September) CPI (September) Whole economy earnings growth 'Triple-lock' guarantee (September) Key fiscal determinants Claimant count (millions)4 Employment (millions) VAT gap (per cent) Financial and property sectors Equity prices (FTSE All-share index) HMRC financial sector profits1,3,5 Financial sector net taxable income1,3 Residential property prices6 Residential property transactions ('000's) Commercial property prices7 Commercial property transactions7 Volume of stampable share transactions Oil and gas Oil prices ($ per barrel)3 Oil prices (? per barrel)3 Gas prices (p/therm) Oil production (million tonnes)3,8 Gas production (billion therms)3,8 Interest rates and exchange rates Market short-term interest rates (%)9 Market gilt rates (%)10 Euro/Sterling exchange rate 0.7 1526 3.1 2.1 2.4 6.4 9.4 3.5 0.2 1546 1.3 2.0 3.0 3.0 11.0 3.7 0.8 1595 3.2 3.7 2.4 1.8 -1.2 3.4 2.0 1658 4.0 4.1 3.3 5.8 1.7 3.5 2.4 1728 4.2 4.3 4.5 6.3 4.2 3.8 2.7 1806 4.5 4.6 4.8 6.8 5.2 4.5 2.8 1889 4.6 4.6 4.8 7.4 6.1 4.9 2.1 5.6 5.2 2.7 5.2 1.3 2.6 2.2 1.7 2.5 2.3 3.3 2.9 1.8 2.9 1.9 2.8 2.3 2.9 2.6 1.8 3.2 2.1 3.8 3.6 1.7 3.6 2.0 4.0 4.0 1.7 3.9 2.0 4.0 4.0 1.57 29.2 9.5 1.57 29.6 10.7 1.60 29.8 10.5 1.62 29.9 10.5 1.56 30.1 10.5 1.46 30.4 10.5 1.35 30.6 10.5 2903 -5.0 3.2 -0.9 915 4.9 -2.8 -9.7 3080 2.0 -1.6 2.2 938 -0.1 2.8 -18.9 3405 1.4 5.4 0.9 1083 -0.1 -1.6 12.0 3540 2.3 4.5 1.9 1139 2.6 0.1 -1.9 3690 2.8 3.6 3.6 1208 3.6 2.8 -2.4 3856 3.8 6.1 4.0 1279 3.8 4.4 -2.6 4032 4.7 7.3 4.0 1355 3.4 5.0 -2.7 111 69.2 60.6 51.9 16.1 112 70.6 59.1 44.5 13.8 113 73.4 68.6 44.4 14.1 106 68.8 68.0 44.3 14.0 101 65.2 63.9 44.1 13.9 97 62.5 60.9 44.0 13.9 93 60.1 58.3 43.9 13.8 1.0 2.2 1.16 0.7 1.8 1.23 0.6 2.4 1.16 0.7 2.7 1.16 0.9 3.3 1.16 1.4 3.6 1.15 2.0 3.9 1.15 1 Not seasonally adjusted Nominal 3 Calendar year 4 UK seasonally-adjusted claimant count 5 HMRC Gross Case 1 trading profits 6 Outturn data from Department for Communities and Local Government (CLG) property prices index 2 7 Outturn data from HMRC information on stamp duty land tax Department of Energy and Climate Change (DECC) forecasts available at www.gov.uk/oil-and-gas-uk-field-data 9 3-month sterling interbank rate (LIBOR) 10 Weighted average interest rate on conventional gilts 8 87 Economic and fiscal outlook Fiscal outlook Table 4.2: Changes to determinants since the December forecast Percentage point change unless otherwise specified Forecast Outturn 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 GDP and its components Real GDP Nominal GDP (? billion)1 Nominal GDP1 Nominal GDP (centred end-March) Wages and salaries2 Non-oil PNFC profits2,3 Non-oil PNFC net taxable income2,3 Consumer spending2,3 Prices and earnings GDP deflator RPI (September) CPI (September) Whole economy earnings growth 'Triple-lock' guarantee (September) Key fiscal determinants Claimant count (millions)4 Employment (millions) VAT gap (per cent) Financial and property sectors Equity prices (FTSE All-share index) HMRC financial sector profits1,3,5 Financial sector net taxable income1,3 Residential property prices6 Residential property transactions ('000's) Commercial property prices7 Commercial property transactions7 Volume of stampable share transactions Oil and gas Oil prices ($ per barrel)3 Oil prices (? per barrel)3 Gas prices (p/therm) Oil production (million tonnes)3,8 Gas production (billion therms)3,8 Interest rates and exchange rates Market short-term interest rates9 Market gilt rates10 Euro/Sterling exchange rate 0.2 -3 -0.2 -0.4 0.0 -1.3 0.0 -0.3 0.1 -18 -1.0 -0.8 -0.7 1.0 7.4 0.0 -0.7 -26 -0.5 -0.4 -0.1 -3.3 -5.9 -0.4 -0.1 -30 -0.2 -0.2 -0.2 -2.1 -4.8 -0.2 0.0 -35 -0.2 -0.3 -0.1 -1.5 -1.5 -0.1 0.0 -42 -0.3 -0.3 0.0 -1.9 -1.9 0.0 0.0 -50 -0.3 -0.3 0.0 -0.2 0.6 0.0 -0.2 0.0 0.0 0.0 0.0 -1.3 0.0 0.0 -1.0 0.0 0.3 0.2 0.3 -0.5 0.3 -0.1 0.1 0.1 -0.1 0.0 -0.3 0.1 0.1 -0.1 -0.1 -0.3 0.2 0.0 0.0 0.0 -0.3 0.2 0.0 0.0 0.0 0.00 0.0 -0.2 -0.02 0.1 0.2 -0.08 0.2 -0.1 -0.05 0.1 -0.1 -0.04 0.1 -0.1 -0.05 0.1 -0.1 -0.05 0.1 -0.1 0.0 0.0 0.0 0.0 1.1 0.5 0.0 0.5 101 0.0 0.7 0.4 -7 2.1 4.9 -9.0 304 -1.1 -1.2 0.3 -33 -1.1 2.8 10.6 309 -0.2 -1.1 -1.0 -86 -0.5 -1.1 -1.9 313 0.3 0.1 -0.2 -103 0.0 0.0 -2.4 318 -0.3 0.1 0.0 -109 -0.1 0.0 -2.6 321 -0.3 1.6 0.0 -101 -0.1 -0.2 -2.7 0.0 0.0 0.0 0.0 0.0 0.0 -0.1 1.3 -1.1 -0.4 7.0 6.5 12.7 -0.7 -0.1 4.7 5.1 14.8 -0.4 0.0 3.2 4.1 13.1 -0.3 0.0 2.1 3.4 12.0 -0.1 0.1 1.1 2.7 11.0 0.1 0.1 0.0 0.0 0.00 0.0 0.1 -0.02 -0.1 0.1 -0.09 0.0 0.1 -0.09 0.0 0.4 -0.10 0.2 0.5 -0.10 0.3 0.5 -0.10 1 Not seasonally adjusted Nominal 3 Calendar year 4 UK seasonally-adjusted claimant count 5 HMRC Gross Case 1 trading profits 6 Outturn data from Department for Communities and Local Government (CLG) property prices index 2 7 Outturn data from HMRC information on stamp duty land tax Department of Energy and Climate Change (DECC) forecasts available at www.gov.uk/oil-and-gas-uk-field-data 9 3-month sterling interbank rate (LIBOR) 10 Weighted average interest rate on conventional gilts 8 Economic and fiscal outlook 88 Fiscal outlook GDP and the output gap 4.4 Most economic forecasts focus on the outlook for real GDP, but it is the outlook for nominal GDP that matters most when forecasting the public finances. Nominal GDP growth is lower than in our December forecast in each year of the forecast. As explained in Chapter 3, the downward revision reflects both lower real GDP growth and a lower GDP deflator. 4.5 The 'structural', or cyclically-adjusted, component of net borrowing and the current budget balance is determined by the size of the output gap. A negative output gap implies that the economy is operating below capacity and we would therefore expect tax revenues to increase and spending to shrink automatically as the economy returns to its potential level. Our latest estimate of the output gap is wider than we thought in December in each year of the forecast. We assume that the output gap was -2.7 per cent of GDP in the final quarter of 2012. It widens to -3.7 per cent in 2014 before narrowing to -2.3 per cent in 2017. Income and expenditure 4.6 The composition of GDP growth is also very important for the fiscal forecast. For example: labour income is generally taxed at higher effective rates than company profits; indirect tax receipts, such as VAT, are driven by movements in household consumption; and, stronger business investment will increase capital allowances, reducing corporation tax receipts in the short-term. 4.7 The most important element of labour income is wages and salaries, which are determined by employment and earnings. Reflecting recent data, we now expect earnings growth to be lower than in December, which is only partially offset by higher employment. Overall, this means growth in wages and salaries is marginally lower in most years than in the December forecast. Total wages and salaries have been revised down by around ?9.5 billion in 2017-18. 4.8 Nominal consumer spending is the main driver of receipts from VAT and other indirect taxes. Growth is expected to be slightly weaker than we assumed in December over the next two years. Consumer spending is now expected to grow at an average rate of 4.1 per cent between 2012 and 2017. 4.9 Company profits are an important determinant of corporation tax receipts. Nonoil, non-financial company profits growth was slightly higher in 2012 than we expected in December, but we continue to forecast subdued growth next year. We then expect growth to pick up from 2014, although at a much weaker pace than we assumed in December, reflecting the downward revision to our business investment forecast. Non-oil, non-financial company profits are expected to be around ?28 billion lower in 2017 than we in assumed in December. Our 89 Economic and fiscal outlook Fiscal outlook financial sector profits growth forecast has also been revised down, in line with our overall GDP forecast. Financial sector profits continue to grow more slowly than non-financial profits, constrained by regulatory and structural reforms in the later years of the forecast. 4.10 Net taxable income is calculated by adjusting our company profits forecast for estimates of other corporate income and deductions relating to losses, allowances and reliefs. For non-financial companies, slower net taxable income growth than in December across most of the forecast reflects the downward revisions to our profits forecast. Income growth from next year is lower than profit growth as firms offset profits with losses made in previous years and increasingly make use of capital allowances to offset taxable liabilities. In contrast, financial company income increases faster than profits, reflecting a rise in interest income as interest rates start to rise. Inflation 4.11 The CPI measure of inflation is used to index most tax rates, allowances and thresholds and to uprate benefits and public sector pensions. Our forecast for CPI inflation is slightly higher over the next few years than we assumed in December. This reflects the effect of recent outturn data, higher oil prices and higher import prices, the latter being largely a consequence of the recent depreciation of sterling. 4.12 RPI inflation determines the interest paid on index-linked gilts and is used to revalorise excise duties. RPI inflation is expected to follow a similar path to CPI inflation over the forecast period but higher expected interest rates in the later years of the forecast have resulted in upward revisions. 4.13 From 2014-15 the GDP deflator is lower than we assumed in December, which reflects a downward revision to the government consumption component. 4.14 The basic state pension is uprated in April each year in line with the 'triple-lock' guarantee and rises by the highest of average earnings growth, CPI inflation in the previous September and 2.5 per cent. As a result, pension payments will be uprated by 2.5 per cent in 2013-14. On our current forecast, uprating will be in line with CPI in 2014-15 and by average earnings growth in each year thereafter. Equity markets 4.15 Equity prices are a significant determinant of capital gains tax, inheritance tax and stamp duty receipts. Equity prices are assumed to rise from their current level in line with nominal GDP. The current level is determined by the average of the Economic and fiscal outlook 90 Fiscal outlook closing price of the FTSE All-Share index over the ten working days ending 25 February 2013. The starting point for share prices is expected to be 10 per cent higher than in our December forecast reflecting recent rises in UK and worldwide equity markets. Thereafter, share prices are between 8 to 10 per cent higher throughout the forecast. 4.16 The volume of taxable share transactions is an important determinant of receipts from stamp duty on shares. Stampable share transactions are expected to be lower than we assumed in December in the near term, reflecting lower volumes of trades reported to HMRC within the current financial year. In light of the recent downward trend in the volume of transactions, we now assume a slight fall across the forecast period. Property market 4.17 The residential property market is a key driver of receipts from stamp duty land tax and inheritance tax. House price inflation was higher than expected at the end of 2012. Residential property prices are assumed to grow in line with the median of independent forecasters. This suggests a slightly weaker rate of house price inflation in 2014. In the medium-term house prices are then expected to rise in line with average earnings, which we have revised down slightly in the later years of the forecast. 4.18 While we still expect strong growth in property transactions in 2013 and 2014, supported by the Funding for Lending Scheme (FLS) and other Government schemes, we have reduced our forecast relative to December to a level which is more consistent with other outside forecasts. Transactions are then expected to converge gradually to the long-run average rate of turnover. 4.19 Commercial property prices are expected to be higher in 2012-13 than we assumed in December, based on the latest information from HMRC. Thereafter, we expect prices to remain flat in 2013-14 and then increase by between 2 per cent and 4 per cent a year. The latest data for the volume of commercial property transactions have also been stronger than we expected in December. The higher starting point means that we now assume a higher number of transactions throughout the forecast. Oil and gas sector 4.20 Oil prices are assumed to move in line with the prices implied by futures markets. For our forecast we took an average of the futures curve over the ten working days ending 25 February 2013. Oil prices are therefore assumed to be slightly higher than in our December forecast in the early years of the forecast period, but return to similar levels to our December forecast towards the later years of the 91 Economic and fiscal outlook Fiscal outlook forecast horizon. Gas prices are assumed to follow the trend in oil prices, but with a considerably higher starting point as a result of recent rises in wholesale prices. 4.21 Oil and gas production forecasts are based on the central projection published by the Department of Energy and Climate Change (DECC). Oil and gas production in 2013 is expected to remain at a similar level to last year. Thereafter production is expected to be broadly flat across the remainder of the forecast period. Overall, production is expected to be slightly lower than we expected at the time of our December EFO. Interest rates 4.22 We use the 3-month sterling interbank rate as a benchmark for our short-term interest rate determinant. Our forecast incorporates the average forward rates for the ten working days to 25 February 2013. The futures curve is slightly higher than in December in most years across the forecast period. 4.23 Our forecast assumes gilt rates move in line with market expectations based on the average of the rates prevailing over the ten days up to and including 25 February 2013. Relative to our December assumptions, gilt rates are between 0.1 and 0.5 basis points higher in each year of the forecast. Policy announcements, risks and classifications 4.24 The Government publishes estimates of the direct impact of tax and spending policy decisions on the public finances in its Budget policy decisions table. We provide independent scrutiny and certification of these costings and explain if we agree with them. If we disagree, we use our own estimate of costings in our forecast. We are also responsible for assessing any indirect effects of policy measures on the economic forecast. These are discussed in Box 3.1 in Chapter 3. We also note any significant policy commitments that are not quantifiable at the current time as risks to the fiscal forecast. In this section we also set out the impact of any significant statistical classifications. Direct effect of new policy announcements on the public finances 4.25 Annex A reproduces the Treasury's table of the direct effect on public sector net borrowing (PSNB) of policy decisions in the Budget or announced since the Autumn Statement in December 2012. The OBR has endorsed all of the tax and AME expenditure costings in the Treasury's table as being reasonable central estimates of the measures themselves. As we explain in more detail in our annex to the Treasury's Budget 2013 policy costings document, a number of these costings are highly uncertain, in particular the announcements on tax repatriation from Isle of Man, Jersey and Guernsey, other anti-avoidance measures, stamp Economic and fiscal outlook 92 Fiscal outlook duty on shares, employee shareholder status, right-to-buy, and the single tier pension. 4.26 The top section of Table 4.3 summarises the Treasury's Budget policy decisions table. A positive figure means an improvement in PSNB, i.e. higher receipts or lower expenditure. The measures shown in the Treasury table are neutral overall in their impact on public sector net borrowing across the forecast horizon. Reductions in expenditure and tax avoidance measures drive a small fiscal tightening in 2013-14. These are offset from 2014-15 by the increase in the personal allowance, the introduction of a ?2000 employer NICS allowance, and the full-year effect of the cancellation of the September 2013 fuel duty increase, leading to a small fiscal loosening in 2014-15 and 2015-16. In 2016-17 and 2017-18 the revenue from ending contracting-out means that overall there is a small fiscal tightening in these years. 4.27 In addition to the measures set out in the Treasury's Budget policy decisions table, the Government has taken action to ensure that central government departments spend less in 2012-13 than set out in plans at the start of the year. As we discuss from paragraph 4.114, this has a number of elements: money that the Treasury has allowed departments to move into future years; money that the Treasury has not allowed departments to bring forward from future years; money that departments do not now expect to spend either this year or in the future; and payments that were due to be made late in the current financial year (for example payments to international institutions), but which are being delayed into 2013-14. 4.28 As set out in Table 4.3, we estimate this has reduced borrowing in 2012-13 by at least ?1.6 billion. This is a minimum figure because, as we explain in paragraph 4.119, the Government's actions will also have accounted for further additional underspends, but we cannot easily distinguish this from normal departmental underspending. These actions have transferred some spending to 2013-14 and 2014-15, which we estimate increases borrowing by ?1.0 billion in 2013-14 and ?0.5 billion in 2014-15, in addition to the effects of the policies shown in the Treasury's Budget policy decisions table. 4.29 The Government has also announced two housing measures - extensions to the Help to Buy and Build to Rent schemes - which are classified as financial transactions and so do not affect PSNB. These will increase the Government's net cash requirement and public sector net debt by ?1.3 billion in 2013-14 and ?1.9bn in 2014-15 and 2015-16. 93 Economic and fiscal outlook Fiscal outlook Table 4.3: Summary of the effect of policy measures ? billion Forecast 2012-13 Effects of receipts measures of which: Income tax and NICs Onshore corporation tax Stamp duty Bank levy Fuel duty Other Effects of expenditure measures1 of which: Current DEL Current AME of which: Net public service pension payments Social security benefits Tax credits Capital DEL Capital AME of which: LA other capital income Other departmental expenditure (capital) Total direct effect of policy measures on PSNB Total direct effect of policy measures on current balance Other policy changes to departmental expenditure Financial transactions 1 2013-14 2014-15 2015-16 2016-17 2017-18 0.0 -0.3 -2.7 -2.8 1.7 1.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.3 0.0 0.0 -0.5 -0.2 -2.0 0.5 -0.3 0.2 -0.8 -0.3 -1.8 0.1 -0.3 0.2 -0.8 -0.3 3.2 -0.3 -0.3 0.2 -0.9 -0.2 2.8 -0.3 -0.4 0.2 -0.9 -0.1 0.0 1.6 1.1 0.0 0.0 0.0 0.0 0.0 1.4 0.0 1.2 0.1 2.9 0.1 3.0 0.0 2.9 0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.1 0.1 0.1 0.1 -0.1 -0.2 0.0 0.1 0.1 -0.1 -3.0 0.0 0.0 0.1 -0.1 -3.1 0.1 0.0 0.2 -0.1 -3.1 0.1 0.0 0.0 0.0 0.0 0.1 0.1 0.0 0.1 -0.1 -0.1 0.0 0.0 0.0 1.3 -1.6 -2.8 1.7 1.3 0.0 1.1 -1.4 0.2 4.7 4.3 1.6 -1.0 -0.5 0.0 0.0 0.0 0.0 1.3 1.9 1.9 0.0 0.0 Expenditure categories are equivalent to PSCE in RDEL, PSCE in AME, PSGI in CDEL and PSGI in AME in Table 4.18 Note: Annex A reproduces the Treasury's full policy decisions table. Our online supplementary tables also reproduce the policy decisions table with the full classifications consistent with our forecast. Note: this table uses the Treasury scorecard convention that a positive figure means an improvement in the PSNB, CGNCR and PSND. Projected Asset Purchase Facility flows 4.30 In November 2012 the Government announced that the excess cash held in the Bank of England's Asset Purchase Facility (APF) would be transferred to the Exchequer on an ongoing basis. At the time of our December forecast, the Office for National Statistics had not decided how to classify the resulting financial flows and we had to judge for ourselves how this was likely to be done. The ONS have now announced their decision and the impact is as follows: as we expected the ONS has decided that all transactions will affect the net cash requirement and therefore net debt; Economic and fiscal outlook 94 Fiscal outlook transfers from the APF to the Treasury up to the level of the previous year's income will be treated as dividends and so will affect public sector net borrowing. Any amount over this threshold will be classified as a financial transaction and hence not affect public sector net borrowing. We had assumed this distinction would be based on the current year's income. The ONS's income calculation will also only take account of interest flows and not capital gains or losses following the redemption of gilts; payments from the Treasury to the APF will be classified as capital grants (and therefore capital expenditure), increasing net borrowing but not the current budget deficit. This is line with our original assumption; transfers will materialise a few days after the quarter they relate to. We had assumed they would be accrued back to the previous quarter; and the ONS will treat the APF as an arm of the Bank, rather than a separate body. The calculations will therefore take into account the Bank's wider activities and payments to the Treasury. 4.31 Alongside these decisions the ONS has also reclassified the one-off ?2.3 billion proceeds from the Special Liquidity Scheme (SLS) as dividends from the Bank to the Treasury, rather than a capital grant. 4.32 The biggest impact on our projections comes from the final decision on the income calculation and the reclassification of the SLS. The impact on borrowing in 2012-13 is now based on the Bank's income in 2011-12 of ?9.1 billion (rather than ?11.5 billion we projected in December). Including the SLS around ?2.7 billion of non-APF proceeds have been transferred to the Treasury this year. That means that only ?6.4 billion of APF transfers can be scored as reducing net borrowing in 2012-13 before the income threshold of ?9.1 billion is reached, with the remainder scoring as a financial transaction. This is ?5.1 billion less than we assumed in our December forecast. 4.33 Using the previous year's income as the benchmark also changes the picture in 2017-18, but not materially in the intervening period. We project the APF to make an accrued loss in 2017-18, but as net cash transfers to the Treasury will exceed 2016-17 income, net borrowing and the current budget deficit will be lower. As only the flows into the Treasury affect the current budget, and not the flows out, the current budget deficit is now forecast to be ?1.5 billion smaller. 4.34 To estimate the size of future flows between the APF and the Treasury, we have to make assumptions about when quantitative easing (QE) will be unwound and how quickly. Our approach to this is unchanged since December. We assume QE purchases remain at their current level and that it begins to be unwound once 95 Economic and fiscal outlook Fiscal outlook Bank Rate rises above 1 per cent, with sales evenly paced at ?10 billion per quarter thereafter. We also assume redemptions will not be reinvested once sales begin (so the actual drawdown of QE will be larger in any given period when redemptions occur). This is broadly in line with monetary policy tightening equally between Bank Rate rises and QE withdrawal. 4.35 The first sale is now projected to be in the second quarter of 2016, a quarter earlier than assumed in our December forecast. Our projection for the total sum of transfers to the Treasury is broadly unchanged since December, at around ?71 billion. Payments out of the Treasury are now projected to be around ?26 billion, up from the ?18 billion we projected in December. 4.36 Our projections assume that gilt rates move in line with current market expectations. Larger projected transfers in later years can be almost entirely explained by higher gilt rates relative to previous market expectations, as higher gilt rates imply lower gilt prices at the point of sale and therefore greater capital losses. Estimates of the overall net transfer to the Treasury are therefore currently projected to be around ?45 billion, down from our projection of ?55 billion in the December EFO. 4.37 Table 4.4 shows that under our central projection the eventual net direct impact of QE would be to reduce PSND by roughly 2 per cent of GDP in 2022-23 - a small amount relative to the uncertainty surrounding any projections of PSND over this 10 year horizon. In the counterfactual where the Government had not decided to change the treatment of these flows, there would have been no transfers until the end of the scheme in 2022-23 at which point a single payment of around ?45 billion would have been made to the Exchequer - presumably treated as a financial transaction. 4.38 As we noted in December, as the overall transfer to the Exchequer is expected to be positive, debt interest costs will be lower over this projection period. But the Government is now likely to issue fewer gilts in the near term and more in the longer term than it otherwise would have done, leaving it more exposed to future yield curve movements. As gilt rates are expected to rise, debt interest payments will be higher beyond the horizon presented in this projection, possibly outweighing lower costs in the preceding years. 4.39 It is also important to again emphasise that there is huge uncertainty about the timing and pace of QE unwinding and our assumptions should be regarded as a way of illustrating the potential fiscal impact of the APF decision rather than as a firm prediction of how the Bank of England is likely to behave. It is not based on any guidance from the Bank regarding its plans. Economic and fiscal outlook 96 Fiscal outlook 4.40 As we illustrated in our December EFO, if the unwinding of QE was to begin earlier, or were to be faster than in our central projection, the eventual overall impact on net debt would be little affected. But as we also showed, estimates of the overall net transfer to the Treasury are highly sensitive to changes in gilt rates. 4.41 Gilt rates may be higher than currently projected if, for example, the withdrawal of QE has not been fully priced into the markets, or if demand for safe assets falls as economic uncertainty recedes. In a scenario where gilt rates rise by 200 basis points, the Treasury would receive ?66 billion up to the beginning of 2016, only to pay back ?57 billion over the following years, giving an overall net transfer of ?9 billion. Table 4.4: Projected APF flows and the impact on the fiscal forecast ? billion up to12-13 12-13 13-14 14-15 15-16 16-17 17-18 18-19 19-20 20-21 21-22 22-23 Income Interest payments Redemptions Sales Net flow Cumulative flow 23.8 23.8 Receipts Capital spending Net borrowing Current budget Net cash requirement Public sector net debt Memo: Illustrative effect on debt interest payments 14.0 -1.8 -0.5 0.0 11.7 35.5 14.5 -1.9 -0.3 0.0 12.3 47.8 14.5 -1.9 -2.0 0.0 10.6 58.4 14.7 -2.8 -4.0 0.0 7.8 66.2 13.7 -4.3 -1.5 -3.5 4.3 70.5 11.3 -5.3 -4.0 -4.4 -2.3 68.3 8.6 -5.2 -2.0 -5.0 -3.5 64.7 6.1 -4.3 -1.8 -5.5 -5.5 59.2 3.8 -3.0 -0.2 -6.0 -5.4 53.8 1.8 -1.5 -2.1 -5.5 -7.3 46.5 0.1 -0.1 0.0 -1.1 -1.1 45.4 6.4 12.2 11.2 0.0 0.0 0.0 -6.4 -12.2 -11.2 6.4 12.2 11.2 -11.5 -32.2 -11.2 -11 -44 -55 8.4 0.0 -8.4 8.4 -8.4 -63 6.2 0.0 -6.2 6.2 -6.2 -69 1.5 0.8 -0.7 1.5 -0.7 -70 0.0 2.9 2.9 0.0 2.9 -67 0.0 5.9 5.9 0.0 5.9 -61 0.0 6.0 6.0 0.0 6.0 -55 0.0 7.1 7.1 0.0 7.1 -48 0.0 2.8 2.8 0.0 2.8 -45 -2.3 -2.4 -2.2 -1.9 -1.7 -0.5 0.0 -0.5 -1.3 -1.7 -2.0 Net borrowing -0.4 -0.8 -0.7 -0.5 -0.3 0.0 0.1 0.3 0.3 0.3 0.1 Current budget 0.4 0.8 0.7 0.5 0.3 0.1 0.0 0.0 0.0 0.0 0.0 -0.7 -2.7 -3.2 -3.6 -3.8 -3.6 -3.3 -2.9 -2.5 -2.1 -1.9 Memo: Per cent of GDP: Net debt 97 Economic and fiscal outlook Fiscal outlook Table 4.5: Changes in projected APF flows and the impact on the fiscal forecast since December ? billion up to12-13 12-13 13-14 14-15 15-16 16-17 17-18 18-19 19-20 20-21 21-22 22-23 Income Interest payments Redemptions Sales Net flow Cumulative flow 0.0 0.2 0.0 0.0 0.2 0.2 0.0 0.0 0.0 0.0 0.0 0.2 0.0 0.0 0.0 0.0 0.0 0.2 0.1 -0.3 0.0 0.0 -0.2 0.1 -0.2 -0.4 0.1 -1.7 -2.3 -2.3 -0.4 -0.6 0.2 -1.2 -2.0 -4.2 -0.4 -0.6 0.2 -1.2 -2.0 -6.2 -0.4 -0.4 0.2 -1.1 -1.7 -7.9 Receipts Capital spending Net borrowing Current budget Net cash requirement Public sector net debt -5.1 0.0 5.1 -5.1 0.0 0 -0.1 0.0 0.1 -0.1 -0.2 0 0.5 0.0 -0.5 0.5 0.0 0 0.5 0.0 -0.5 0.5 0.1 0 -0.4 0.0 0.4 -0.4 1.9 2 1.5 0.5 -1.0 1.5 2.0 4 0.0 1.3 1.3 0.0 2.1 6 0.0 2.1 2.1 0.0 1.8 8 0.0 2.1 2.1 0.0 1.5 9 0.0 0.5 0.5 0.0 0.9 10 0.0 0.9 0.9 0.0 -0.8 9 Memo: Illustrative effect on debt interest payments 0.0 0.0 0.0 -0.1 -0.1 -0.1 0.0 0.1 0.1 0.2 0.1 Net borrowing 0.3 0.0 0.0 0.0 0.0 -0.1 0.1 0.1 0.1 0.0 0.0 Current budget -0.3 0.0 0.0 0.0 0.0 0.1 0.0 0.0 0.0 0.0 0.0 0.0 -0.1 -0.1 -0.1 0.0 0.1 0.2 0.3 0.3 0.4 0.3 0.0 0.0 -0.4 -0.4 -0.1 0.2 0.0 0.5 -1.0 -1.0 -1.5 -0.7 -9.4 -10.2 -0.2 0.1 0.0 0.9 0.9 -9.3 Memo: Per cent of GDP: Net debt Currently unquantifiable policy commitments 4.42 Consistent with the Charter for Budget Responsibility, our projections do not include the impact of policies where there is insufficient detail or certainty of implementation to quantify the impact and allocate it to particular years. Where significant, these are noted as fiscal risks: the Government has made proposals on minimum alcohol pricing which were subject to a period of consultation. As no final decisions have been taken we have not included an estimate of the impact in our central forecast. If the policy is confirmed there is likely to be an impact on our forecast of inflation, alcohol duties and VAT; and we only include the impact of asset sales in our medium-term forecasts once details of the nature, size and timing of the transactions are sufficiently firm for the effects to be quantified with reasonable accuracy. In this forecast we include the final proceeds from the auction of 4G spectrum. No other substantive announcements have been made that would allow us to quantify the effects of other proposed sales with reasonable accuracy. This includes the Government's intention to attract private capital into Royal Mail. 4.43 There are both upside and downside risks to the forecast from these policies. If the Government was to sell some more of its financial assets, this would reduce Economic and fiscal outlook 98 Fiscal outlook PSND initially, but the impact on net borrowing would depend on the future income flows associated with the assets. At current market prices, as set out in Box 4.2, the sale of the public sector banks would lead to a significant loss to the taxpayer. 4.44 In previous EFOs we have identified the Coalition Agreement's long-term objective to raise the personal allowance to ?10,000 as a specific fiscal risk, on the grounds that additional policy action would be required to achieve it within our forecast horizon. In this Budget the Government has announced an increase in the personal allowance to ?10,000 in 2014-15. Classification changes from ESA 2010 4.45 The National Accounts and Public Sector Finance statistics released by the ONS are currently based on the European System of Accounts (ESA) 1995, which is the National Accounts framework currently used by all European countries. In the 2014 Blue Book, the ONS are due to base their National Accounts and Public Sector Finance statistics on the new ESA 2010 framework. This is likely to change the definitions of some aspects of the public finances, and affect all of the fiscal aggregates. Eurostat have not yet completed their work on ESA 2010 and they have yet to produce a revised Manual on Government Deficit and Debt. The ONS will provide full details of the final effects on the public finances when they have all the necessary Eurostat guidance, and we will provide an update on this process and any guidance issued by the ONS in future EFOs. 99 Economic and fiscal outlook Fiscal outlook Public sector receipts 4.46 Table 4.6 summarises our central forecast for the major taxes as a share of GDP. Table 4.7 shows our detailed forecast for individual taxes and other receipts, and Table 4.8 shows how our forecast has changed since December. 4.47 Public sector current receipts rise as a proportion of GDP in 2012-13 and 201314 driven mainly by 'interest and dividend receipts' and 'other taxes'. They then remain broadly flat over the remainder of the forecast period. National Accounts taxes follow a broadly flat profile from 2013-14 to 2015-16, before rising by 0.5 per cent of GDP in 2016-17, largely as a result of the abolition of the NIC contracting out rebate. Table 4.6: Major taxes as a per cent of GDP Per cent of GDP Forecast Outturn 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Income tax and NICs Value added tax Onshore corporation tax UK oil and gas receipts Fuel duties Business rates Council tax Excise duties Capital taxes Other taxes National Accounts taxes Interest and dividend receipts Other receipts Current receipts 4.48 16.7 6.4 2.2 0.7 1.8 1.6 1.7 1.3 1.1 2.5 36.0 0.4 1.1 37.5 16.5 6.5 2.3 0.4 1.7 1.7 1.7 1.3 1.0 2.7 35.8 1.0 1.2 38.0 16.4 6.5 2.2 0.4 1.6 1.7 1.7 1.2 1.2 3.1 36.0 1.2 1.2 38.4 16.5 6.5 2.0 0.4 1.6 1.7 1.7 1.3 1.3 2.9 35.8 1.1 1.2 38.2 16.7 6.4 1.9 0.3 1.6 1.7 1.7 1.2 1.3 3.0 35.8 1.0 1.2 38.1 17.3 6.4 1.9 0.3 1.6 1.7 1.7 1.2 1.4 2.9 36.3 0.9 1.2 38.4 17.5 6.3 1.9 0.2 1.6 1.7 1.6 1.2 1.5 2.9 36.4 0.7 1.2 38.3 Within this overall profile the following receipts are expected to rise as a share of GDP over the forecast period: income tax and NICs, reflecting policy changes and fiscal drag in the later years of the forecast. Once earnings start to rise faster than tax thresholds and allowances, people will find more of their income taxed at higher rates. Additionally the decision in this Budget to abolish the NIC contracting-out rebate increases receipts from 2016-17; capital taxes, mainly reflecting rising equity prices; Economic and fiscal outlook 100 Fiscal outlook other taxes, particularly in 2013-14. This reflects receipts from the UK Swiss agreement and new revenues from environmental levies and the EU Emissions Trading Scheme; and interest and dividend receipts rise sharply in 2012-13 reflecting the transfers from the Asset Purchase Facility and then start to fall as these payments decline. Underlying interest and dividend receipts rise gradually across the forecast period as interest rates rise and interest payments on student loans increase. 4.49 The following receipts are expected to fall as a share of GDP: oil and gas revenues, due to a drop in oil and gas prices and continued high levels of capital and operating expenditures that offset tax liabilities; fuel duties, reflecting policy changes, improvements in vehicle efficiency and because duty rates are revalorised in line with RPI which grows at a slower rate than GDP; onshore corporation tax, reflecting the staggered reduction in the corporation tax rate; and VAT, due to a slight fall in the share of consumer spending in GDP and the effect of fiscal consolidation on government procurement. 101 Economic and fiscal outlook Fiscal outlook Table 4.7: Current receipts ? billion Forecast Outturn 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Income tax (gross of tax credits)1 of which: Pay as you earn Self assessment Tax credits (negative income tax) National insurance contributions Value added tax Corporation tax2 of which: Onshore Offshore Corporation tax credits3 Petroleum revenue tax Fuel duties Business rates Council tax VAT refunds Capital gains tax Inheritance tax Stamp duty land tax Stamp taxes on shares Tobacco duties Spirits duties Wine duties Beer and cider duties Air passenger duty Insurance premium tax Climate change levy Other HMRC taxes4 Vehicle excise duties Bank levy Licence fee receipts Environmental levies Swiss capital tax EU ETS auction receipts Other taxes National Accounts taxes Less own resources contribution to EU budget Interest and dividends Gross operating surplus Other receipts Current receipts 152.7 132.0 20.3 -4.7 101.6 98.1 43.1 33.8 9.2 -0.9 2.0 26.8 24.9 26.0 14.0 4.3 2.9 6.1 2.8 9.9 2.9 3.4 3.8 2.6 3.0 0.7 5.9 5.9 1.8 3.1 0.5 0.0 0.0 6.2 549.5 150.5 130.7 20.6 -3.1 103.8 100.7 40.3 35.5 4.8 -1.0 1.7 26.6 25.7 26.3 14.0 3.9 3.1 6.9 2.3 9.6 2.9 3.5 3.7 2.8 3.0 0.7 5.9 5.9 1.6 3.1 2.0 0.0 0.3 6.7 553.7 154.7 133.7 20.3 -2.8 106.7 103.3 39.3 34.6 4.7 -1.0 2.1 26.1 26.7 27.4 14.6 5.1 3.3 7.7 2.9 9.8 2.9 3.6 3.5 2.9 3.1 1.5 6.3 5.9 2.7 3.1 2.3 3.2 0.7 6.8 574.3 165.5 137.7 27.4 -2.4 108.6 107.2 38.1 33.7 4.4 -0.9 1.7 26.3 28.1 28.3 14.6 6.5 3.5 8.4 2.7 10.2 3.1 3.9 3.6 3.0 3.1 2.0 6.6 5.7 2.9 3.2 2.8 0.0 0.7 7.0 594.0 174.4 147.8 26.4 -1.3 113.9 111.2 36.6 33.5 3.1 -0.8 1.6 27.1 29.6 29.1 14.7 7.2 3.6 9.3 2.7 10.3 3.3 4.2 3.6 3.3 3.2 2.5 7.0 5.6 2.9 3.2 3.1 0.0 0.8 7.1 619.1 186.7 158.0 28.2 -0.5 125.5 115.2 38.2 34.9 3.3 -0.8 1.5 28.3 30.5 30.0 14.5 7.9 3.9 10.5 2.8 10.5 3.4 4.6 3.6 3.5 3.2 2.5 7.2 5.6 2.9 3.2 3.5 0.0 0.8 7.2 655.8 198.9 168.6 29.9 -0.3 132.0 119.3 39.5 36.5 3.0 -0.9 1.3 29.3 31.2 31.0 14.2 8.7 4.1 11.7 2.9 10.8 3.6 5.0 3.7 3.8 3.3 2.5 7.4 5.5 2.9 3.3 4.0 0.0 0.9 7.1 686.9 -5.2 -5.4 -5.3 -5.1 -5.3 -5.6 -5.9 5.7 23.6 -1.0 572.6 14.8 24.2 -0.6 586.8 18.9 25.3 -0.9 612.4 18.5 26.7 -1.0 633.1 17.1 27.8 -1.0 657.6 16.3 28.8 -1.1 694.1 13.4 29.7 -1.1 723.0 4.8 4.3 11.3 6.5 6.8 6.1 4.7 Memo: UK oil and gas revenues 5 Includes PAYE and self assessment and also includes tax on savings income and other minor components 2 National Accounts measure, gross of enhanced and payable tax credits 3 Includes enhanced company tax credits 4 Consists of landfill tax, aggregates levy, betting and gaming duties and customs duties and levies 5 Consists of offshore corporation tax and petroleum revenue tax Note: Table is on accruals basis in line with national accounts definitions Table 2.8 in the supplementary table presents receipts on a cash basis 1 Economic and fiscal outlook 102 Fiscal outlook Table 4.8: Changes to current receipts since December ? billion Forecast Outturn 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Income tax (gross of tax credits)1 of which: Pay as you earn Self assessment Tax credits (negative income tax) National insurance contributions Value added tax Corporation tax2 of which: Onshore Offshore Corporation tax credits3 Petroleum revenue tax Fuel duties Business rates Council tax VAT refunds Capital gains tax Inheritance tax Stamp duty land tax Stamp taxes on shares Tobacco duties Spirits duties Wine duties Beer and cider duties Air passenger duty Insurance premium tax Climate change levy Other HMRC taxes4 Vehicle excise duties Bank levy Licence fee receipts Environmental levies Swiss capital tax EU ETS auction receipts Other taxes National Accounts taxes Less own resources contribution to EU budget Interest and dividends Gross operating surplus Other receipts Current receipts 1 0.0 -0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 -0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.3 0.2 -3.4 -1.5 -2.1 0.8 -0.4 -0.4 0.5 0.9 -0.4 -0.1 -0.5 0.4 0.0 0.0 0.0 0.2 0.0 0.4 -0.1 -0.3 0.1 0.1 0.0 0.0 -0.1 0.0 -0.1 0.0 -0.2 0.0 0.0 -0.3 -0.1 0.0 -3.5 -6.9 -3.4 -3.5 1.0 -1.2 -0.8 0.4 0.3 0.1 -0.1 0.0 -0.4 -0.1 0.2 0.0 0.5 0.0 0.2 0.3 -0.1 0.1 0.0 -0.3 0.0 -0.1 0.0 0.0 0.0 -0.1 0.0 0.0 0.3 -0.2 -0.1 -7.3 -6.5 -4.5 -2.0 0.8 -2.5 -1.0 -0.6 -0.7 0.1 -0.1 0.0 -0.8 -0.1 0.3 0.0 1.1 0.0 -0.2 -0.1 0.2 0.1 0.0 -0.3 0.0 -0.1 0.2 -0.1 -0.2 0.1 0.0 0.0 0.0 -0.2 -0.1 -10.2 -7.1 -4.7 -2.5 0.5 -3.1 -1.3 -2.1 -2.0 -0.1 -0.1 -0.1 -0.8 -0.1 0.3 0.1 1.1 0.0 -0.4 -0.1 0.2 0.1 0.0 -0.3 -0.1 -0.1 0.1 -0.1 -0.1 0.1 0.0 -0.2 0.0 -0.1 0.2 -13.5 -7.2 -5.0 -2.4 0.2 2.0 -1.6 -3.0 -3.1 0.1 -0.1 0.0 -0.7 0.0 0.3 0.1 1.2 0.1 -0.5 -0.2 0.2 0.1 0.0 -0.3 -0.1 -0.1 0.1 -0.1 -0.1 0.1 0.0 -0.3 0.0 -0.1 0.3 -9.9 -7.6 -5.2 -2.4 -0.2 1.8 -2.1 -3.3 -3.2 0.0 -0.1 -0.1 -0.7 0.0 0.3 -0.1 1.3 0.2 -0.5 -0.3 0.2 0.1 0.0 -0.3 -0.1 -0.1 0.1 -0.1 -0.1 0.1 0.0 -0.2 0.0 -0.1 0.4 -11.4 0.0 0.0 -0.1 0.4 0.3 0.2 0.2 2.8 0.1 0.0 3.1 -2.8 -1.0 0.3 -7.1 0.0 -0.8 0.0 -8.2 0.7 -0.7 0.0 -9.9 -0.1 -0.7 0.0 -13.9 -1.7 -0.7 0.0 -12.0 0.3 -0.3 0.0 -11.2 0.0 -0.8 0.1 0.1 -0.2 0.1 Memo: UK oil and gas revenues 5 Includes PAYE and self assessment receipts, and also includes tax on savings income and other minor components -0.1 2 National Accounts measure, gross of enhanced and payable tax credits 3 Includes enhanced company tax credits 4 Consists of landfill tax, aggregates levy, betting and gaming duties and customs duties and levies. 5 Consists of offshore corporation tax and petroleum revenue tax. 103 Economic and fiscal outlook Fiscal outlook Changes in the 2012-13 receipts forecast since December 4.50 Our forecast for current receipts in 2012-13 is ?7.1 billion lower than in December. Around ?5.1 billion of this shortfall relates to lower APF dividend income following the ONS classification decision, which is explained in more detail in paragraph 4.30. 4.51 Excluding the impact of the APF transfers, receipts are ?2.0 billion lower than in December. However, this includes the impact of two fiscally-neutral reclassifications from expenditure to receipts: the ?2.3 billion Special Liquidity Scheme (SLS) payment and a ?0.8 billion reduction in the share of income tax credits treated as negative tax in the National Accounts. Excluding these reclassifications, underlying receipts are ?5.1 billion lower than we forecast in December. 4.52 The largest downward revisions in 2012-13 are in income tax and NICs, which account for ?3.8 billion of the difference. There are also downward revisions of ?1.0 billion in the gross operating surplus of public corporations, ?0.8 billion in UK oil and gas revenues and ?0.4 billion in VAT receipts. These are partly offset by strength in year-to-date receipts for onshore corporation tax, stamp duty land tax and fuel duties, and the inclusion of LIBOR fines. Changes in the medium-term receipts forecast since December 4.53 Current receipts are expected to be lower in every year of the forecast, with the difference reaching ?13.9 billion in 2015-16. Table 4.8 shows the changes by receipts stream and Table 4.9 shows the key drivers of these differences. In the next section in this chapter we explain changes to individual taxes in more detail. 4.54 In summary, there are downward revisions since December to most of the main receipts streams: income tax and NICs are lower in each year with the difference peaking at ?10.2 billion in 2015-16. This primarily reflects the lower path for average earnings from next year, as well as lower-than-expected receipts in early 2013 being assumed to persist throughout the forecast. From 2016-17 this is partly offset by the decision in this Budget to abolish the NIC contractingout rebate; onshore corporation tax is lower due to the lower path for company profits, which offsets the impact of higher-than-expected receipts in 2012-13; Economic and fiscal outlook 104 Fiscal outlook offshore corporation tax receipts are lower, largely as a result of much higher assumptions for capital and operating expenditure which offset tax liabilities; VAT receipts are weaker, reflecting lower profiles for nominal consumer expenditure, GDP and government procurement. Lower receipts in the yearto-date are also assumed to persist throughout the forecast; and capital taxes are generally higher due to recent increases in equity price levels. Table 4.9: Changes to the receipts forecast since December December forecast March forecast Change of which: Income and expenditure Wages and salaries Non-financial company profits Consumer expenditure Dividend income North Sea Production and expenditure Sterling oil and gas prices Market assumptions Property market Equity prices Prices Other economic determinants Other assumptions IT and NICs receipts and modelling APF and SLS flows Corporation tax receipts and modelling NRAM and B&B interest income VAT gap Public sector gross operating surplus Tax credits Other judgements and modelling Budget measures 2012-13 2013-14 593.8 620.6 586.8 612.4 -7.1 -8.2 0.0 0.0 0.0 0.0 0.0 -0.2 -0.2 0.0 0.1 0.1 0.0 0.0 -0.2 -6.7 -3.6 -2.8 0.9 -0.3 -0.4 -1.0 0.8 -0.3 0.0 105 -1.9 -0.9 -0.5 -0.2 -0.2 0.3 -2.0 2.3 0.8 0.0 0.8 0.3 -0.9 -6.5 -6.8 -0.1 0.2 -0.2 -0.1 -0.8 1.0 0.2 -0.3 ? billion Forecast 2014-15 2015-16 2016-17 2017-18 643.0 671.4 706.1 734.2 633.1 657.6 694.1 723.0 -9.9 -13.9 -12.0 -11.2 -4.2 -1.5 -1.4 -0.4 -1.0 0.2 -1.6 1.8 1.2 -0.4 1.5 0.4 0.4 -5.1 -5.8 0.5 -0.2 -0.2 -0.1 -0.7 0.8 0.5 -2.7 -5.5 -2.0 -2.0 -0.5 -0.9 -0.2 -1.8 1.7 1.0 -0.6 1.6 0.3 -0.1 -6.6 -6.0 0.5 -0.5 -0.7 -0.1 -0.7 0.5 0.4 -2.8 -6.6 -2.2 -2.8 -0.5 -1.1 0.0 -1.7 1.7 0.9 -0.7 1.6 0.5 0.2 -8.6 -6.0 -0.4 -0.4 -1.1 -0.1 -0.6 0.2 -0.2 1.7 -7.6 -2.4 -3.4 -0.6 -1.3 -0.8 -2.0 1.2 1.0 -0.7 1.7 0.5 0.4 -6.1 -6.0 1.5 0.0 -1.0 -0.1 -0.3 -0.2 0.0 1.3 Economic and fiscal outlook Fiscal outlook Tax by tax analysis Income tax and NICs 4.55 Receipts of income tax and NICs are expected to be ?3.8 billion lower in 201213 than assumed in the December EFO, reflecting lower-than-expected receipts over recent months. Around half of this shortfall reflects lower SA income tax and half reflects lower PAYE and NIC1 receipts on employee salaries. Table 4.10: Key changes to income tax and NICs receipts since December ? billion Forecast 2012-13 December forecast March forecast Change of which: (by economic determinant) Average earnings Employee numbers SA determinants Other determinants (by other category) Latest PAYE and NIC1 receipts data Latest SA income tax receipts data Revised PAYE forestalling estimate Lower SA effective tax rate Other Budget measures 2013-14 2014-15 2015-16 2016-17 2017-18 258.1 254.3 -3.8 269.4 261.3 -8.1 283.1 274.1 -9.0 298.5 288.3 -10.2 317.4 312.2 -5.2 336.8 331.0 -5.8 0.0 0.0 0.0 0.0 -1.5 0.6 -0.1 -0.2 -1.9 0.5 0.6 -0.4 -2.3 0.3 0.3 -0.7 -2.5 0.3 0.7 -0.7 -2.6 0.2 0.9 -0.9 -2.9 -1.9 0.7 0.0 0.4 0.0 -3.0 -2.0 -0.7 -1.2 0.0 0.0 -3.0 -1.7 0.0 -0.9 -0.3 -2.0 -3.0 -1.7 0.0 -1.0 -0.3 -1.8 -3.1 -1.7 0.0 -1.1 -0.2 3.2 -3.2 -1.7 0.0 -1.2 -0.1 2.8 4.56 While employment has continued to rise over the past year, wages and salaries growth has moderated further, because of lower average earnings. Average weekly earnings were up only 1.4 per cent in the final quarter of 2012 from a year earlier. Slow earnings growth, which also reduces the average effective income tax rate, is likely to be the main factor behind the weakness in PAYE and NIC1 receipts, particularly in the non-financial sector, since our last forecast. Based on initial data on receipts from financial sector bonuses, we have continued to assume a 10 per cent fall in bonuses in 2012-13. 4.57 The final outturn for PAYE and NIC1 receipts in 2012-13 remains uncertain. The majority of bonuses are usually paid in February and March, with HMRC receiving the tax in March and April. In addition, there are uncertainties on the extent of 'reverse forestalling' ahead of the reduction in the additional rate of income tax to 45p from April 2013. Some taxpayers are expected to shift taxable income from 2012-13 to 2013-14 to take advantage of the lower rate. Economic and fiscal outlook 106 Fiscal outlook 4.58 We expect only a modest pick up in PAYE and NIC1 receipts in 2013-14. Earnings growth is expected to remain subdued for longer, reflecting recent outturns and a weaker forecast for productivity. The ?1,335 rise in the personal allowance in April 2013 and a further 5 per cent fall in receipts from financial sector bonuses will also constrain receipts growth during 2013-14. 4.59 Receipts growth is then expected to pick up, with the income tax and NICs to GDP ratio rising by 1.0 per cent of GDP between 2014-15 and 2017-18. This is driven by our forecast that earnings growth will rise to around 4 per cent in the final three years of the forecast period. With earnings rising faster than tax thresholds and allowances, there will also be an effect from fiscal drag as taxpayers find more of their income taxed at higher rates. The decision in this Budget to abolish the NIC contracting-out rebate also increases receipts from 2016-17. 4.60 The final payments for 2011-12 SA income tax liabilities were due at the end of January and were lower than expected. As a result, we have reduced SA income tax receipts by ?2.1 billion in 2012-13. SA income tax receipts are now expected to have risen by just 1.3 per cent in 2012-13, compared with our December EFO forecast of 11 per cent growth. 4.61 SA receipts were depressed last year by the unwinding of the forestalling that took place ahead of the introduction of the 50 per cent additional rate. Any further unwinding was expected to be substantially lower this year, which we expected to boost the annual growth rate. Initial analysis of SA returns suggests that tax from individuals with incomes above ?150,000 did rise from last year, consistent with our judgement about unwinding from the forestalling. 4.62 The weakness in receipts instead seems to reflect lower-than-expected income from those self-employed who pay tax at either the basic or higher rate. This is despite a rise of around 200,000 in self-employment in the year to the first quarter of 2012. This indicates a fall in the effective tax rate on these incomes, with many of the newly self-employed, as well as some of the existing selfemployed, not earning sufficient incomes to pay much tax. We have allowed for a further fall in the effective tax rate on 2012-13 SA liabilities. This takes around ?1 billion off the SA forecast from 2013-14 onwards. The reverse forestalling mentioned earlier will depress 2012-13 liabilities (paid in 2013-14) and boost 2013-14 liabilities (paid in 2014-15). 107 Economic and fiscal outlook Fiscal outlook Value added tax 4.63 Accrued VAT receipts are expected to have grown by 2.7 per cent in 2012-13, slightly lower than growth in nominal consumer spending, the main driver of VAT receipts. This implies a higher VAT gap - the difference between the theoretical level of VAT payments and actual receipts received by HMRC. The VAT gap is assumed to have risen from its historically low level of 9.5 per cent in 2011-12 to 10.7 per cent in 2012-13. The estimate of the VAT gap remains provisional and may change with updated ONS information. Table 4.11: Key changes to VAT receipts since December December forecast March forecast Change of which: Outturn VAT receipts VAT debt SRS of consumer spending Consumer spending Other spending Other (including modelling) 2012-13 2013-14 101.1 104.1 100.7 103.3 -0.4 -0.8 -0.4 0.0 0.0 0.0 -0.2 0.2 -0.5 0.4 -0.2 -0.3 -0.5 0.3 ? billion Forecast 2014-15 2015-16 2016-17 2017-18 108.3 112.5 116.8 121.5 107.2 111.2 115.2 119.3 -1.0 -1.3 -1.6 -2.1 -0.5 0.4 -0.2 -0.4 -0.6 0.4 -0.5 0.4 -0.3 -0.5 -0.7 0.4 -0.5 0.4 -0.5 -0.5 -0.9 0.4 -0.5 0.5 -0.9 -0.6 -1.0 0.4 4.64 Compared to December we have reduced the accrued VAT forecast by ?0.4 billion in 2012-13 and by around ?2.1 billion by 2017-18. The increasing deterioration reflects weaker growth in the tax base. Growth in nominal consumer spending is a little lower than we forecast in December, with slower real consumer spending growth in 2013 and 2014 only partly offset by higher inflation. The weaker UK economy also has an effect on other elements of the tax base such as the exempt and housing sectors. VAT on government procurement is being squeezed by the further reductions in the Government's expenditure plans. 4.65 A key assumption for the VAT forecast is the proportion of consumer spending subject to the standard rate of VAT. This rose marginally in 2012-13, aided by strong growth in new car sales. From a slightly higher starting point, we expect the share to be lower than in December by the end of the forecast period, reflecting modelling changes and a modestly higher path for interest rates pushing up mortgage interest payments and squeezing spending on standard rated goods. This has the effect of reducing VAT receipts by ?0.9 billion by 201718 relative to the December forecast. Economic and fiscal outlook 108 Fiscal outlook Onshore corporation tax 4.66 Overall corporation tax receipts were ?2.8 billion (or 6.3 per cent) lower in 2012-13 than in 2011-12, but this fall is more than explained by lower receipts from oil and gas companies. Receipts from onshore firms are expected to be up by ?1.7 billion over the year. Although there was only modest profit growth in both the financial and non-financial sectors, repayments relating to liabilities from past years were around ?1.8 billion less than in 2011-12, more than offsetting the effect of the reduction in the main rate of corporation tax from 26 per cent to 24 per cent. Relative to the December forecast, onshore receipts are expected to be ?0.9 billion higher in 2012-13. Table 4.12: Key changes to onshore CT receipts since December ? billion Forecast 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 December forecast March forecast Change of which: Industrial and commercial company profits Financial company profits Investment Other economic determinants Latest receipts data Modelling changes Budget measures 34.7 35.5 0.9 34.3 34.6 0.3 34.5 33.7 -0.7 35.6 33.5 -2.0 38.0 34.9 -3.1 39.7 36.5 -3.2 0.0 0.0 0.0 0.0 0.7 0.2 0.0 -0.5 0.0 0.0 0.3 0.5 -0.4 0.3 -1.4 -0.1 0.1 0.3 0.6 -0.8 0.5 -2.0 -0.1 0.3 0.2 0.6 -1.1 0.1 -2.8 -0.1 0.4 0.0 0.6 -1.1 -0.3 -3.4 -0.1 0.5 0.0 0.7 -0.7 -0.3 4.67 We expect onshore corporation tax receipts to fall each year until 2015-16, mainly because of the staggered reduction in the main rate of corporation tax from 24 per cent in 2012-13 to 20 per cent in 2015-16 and the effects of policy measures such as the Patent Box and the temporary increase in the annual investment allowance. In the absence of these measures, we would have expected onshore corporation tax receipts to rise, reflecting forecast increases in profits. 4.68 Compared to December our forecast for onshore corporation tax is lower in every year from 2014-15. Our reduced forecast for company profit growth takes around ?3.5 billion off the forecast by 2017-18. The announcement of the reduction in the main corporation tax rate to 20 per cent in 2015-16 and a number of measures to combat tax avoidance by companies have the combined effect of reducing receipts by ?0.3 billion by 2017-18. 4.69 Corporation tax from the financial sector is expected to be ?5.0 billion in 201213, close to our estimate in the December EFO. We expect receipts from the sector by the end of the forecast period to be only around half the peak in receipts received in 2006-07. Receipts are being held back by sluggish profit 109 Economic and fiscal outlook Fiscal outlook growth, the reduction in the tax rate and by large losses from the financial downturn being set against future profits. UK oil and gas revenues 4.70 Oil and gas revenues are expected to fall by over 40 per cent in 2012-13 from the previous year. This is despite oil and gas prices in 2012 being almost unchanged from their 2011 levels. The sharp decline in receipts reflects a 14 per cent drop in production, the result of high levels of maintenance and the unplanned temporary closure of several large fields during 2012. Higher maintenance levels, along with cost pressures and spending on several major, large scale projects are responsible for a sharp rise in capital expenditure in 2012, up around a third on 2011. With 100 per cent first year allowances available to oil and gas firms, higher investment leads to an immediate reduction in receipts. Table 4.13: Key changes to oil and gas revenues since December December forecast March forecast Change of which: Oil and gas production Expenditure Sterling oil price Gas price Inflation Latest outturns and modelling 2012-13 2013-14 7.3 6.7 6.5 6.8 -0.8 0.1 -0.3 0.0 0.0 0.0 0.0 -0.6 -0.3 -1.7 1.2 1.0 0.0 -0.2 ? billion Forecast 2014-15 2015-16 2016-17 2017-18 6.0 4.9 4.6 4.4 6.1 4.7 4.8 4.3 0.1 -0.2 0.1 -0.1 -0.1 -1.5 0.8 1.0 0.1 -0.2 -0.1 -1.7 0.6 1.0 0.1 -0.1 -0.1 -1.6 0.6 1.1 0.1 0.0 0.0 -2.0 0.5 0.8 0.1 0.5 4.71 Oil and gas revenues are expected to be ?0.8 billion lower in 2012-13 than in our December forecast. Offshore corporation tax and petroleum revenue tax each account for around half of the lower receipts. 4.72 Oil and gas revenues are expected to decline further over the forecast period, from ?6.5 billion to ?4.3 billion, between 2012-13 and 2017-18. This reflects the declining path for oil prices, as determined by futures markets, which fall from $113 to $93 per barrel between 2013 and 2017. Gas prices are assumed to follow a similar path to oil prices. DECC's latest forecasts for oil and gas production are broadly flat between 2013 and 2017, with the high levels of capital expenditure assumed to prevent further declines in production over this period. Relative to our December forecast, the effect on revenues from a higher path for oil and gas prices is largely offset by significantly higher capital, exploration and operating expenditure across the forecast period. This reflects Economic and fiscal outlook 110 Fiscal outlook recent industry data collected by DECC and Oil & Gas UK. This leaves oil and gas revenues broadly unchanged from the December forecast. Fuel duties 4.73 The forecast for fuel duties is affected by the duty rate and the demand for fuel. The announcement in the Budget of the cancellation of the September 2013 rise in fuel duty is the main factor behind a lower projection than in our December EFO from 2013-14 onwards. 4.74 Even with fuel duty expected to be ?0.4 billion higher in 2012-13 than assumed in December, receipts will still have fallen for the second consecutive year. This reflects the continued decline in duty paid consumption since its peak in 2007-08 and the absence of any duty changes since April 2011 (when the duty rate was cut by 1p). Duty-paid consumption is assumed to continue to decline over the forecast period, in part because of the improvements in the fuel efficiency of cars. Our forecast assumes RPI-related rises in duty rates to apply in September 2014 and 2015, and from April 2016 onwards. These rises start to reverse the decline in fuel duty receipts from 2014-15 onwards, with receipts above their 2010-11 peak by 2016-17. Taxes on capital 4.75 Capital gains tax (CGT) is paid in the final quarter of the financial year following the year in which the gains from the sale of an asset were realised. This means that CGT receipts in 2012-13 reflect asset disposals in 2011-12. CGT receipts are expected to fall from ?4.3 billion to ?3.9 billion between 2011-12 and 201213. It is likely that forestalling ahead of the June 2010 rate increase boosted disposals in 2010-11, partly at the expense of lower disposals in 2011-12. 4.76 The CGT forecast is very sensitive to equity prices, as around three-quarters of chargeable gains are on financial assets and CGT is charged on the gain rather than the overall price. CGT receipts are expected to increase sharply from current levels over the rest of the forecast period. CGT is expected to rise to ?5.1 billion in 2013-14 and to ?8.7 billion in 2017-18. A higher path for equity prices in our latest forecast adds around ?1.2 billion to the forecast in 2017-18 compared to the December EFO. 4.77 We expect growth in inheritance tax to average around 6 per cent over the forecast period. Inheritance tax is charged on the value of estates notified for probate and will be driven by house prices, equity prices and the stock of household deposits. Inheritance tax receipts are expected to be higher than our December forecast due to the extension of the freeze in the inheritance tax threshold for three years from 2015-16 onwards. 111 Economic and fiscal outlook Fiscal outlook Stamp duties 4.78 Receipts from stamp duty land tax (SDLT) are expected to be ?0.4 billion higher in 2012-13 than assumed in December, in part reflecting that receipts from commercial property have held up better than anticipated. We expect SDLT receipts to grow from ?6.9 billion in 2012-13 to ?11.7 billion by 2017-18. This rise is particularly driven by a recovery in residential property transactions to a rate consistent with a long-run average rate of property turnover. However, we expect this recovery in transactions to be a little slower than we assumed in December. This is the main reason that SDLT receipts are forecast to be ?0.5 billion lower by 2017-18 than in our previous forecast. 4.79 Stamp duty on shares is expected to be ?0.1 billion lower in 2012-13 than we expected in December. This reflects continued weakness in receipts in the year to date, which we expect to continue throughout the forecast. However, we expect receipts to be around ?0.3 billion higher in 2013-14 due to higher equity prices. Higher equity prices increase receipts throughout the forecast, but are increasingly offset by a decline in the volume of taxable share transactions and the effect from the Budget announcements on the abolition of the Schedule 19 charge and the abolition of stamp duty on AIM and other junior shares. Alcohol and tobacco duties 4.80 Alcohol duty is expected to be flat between 2011-12 and 2012-13, having been revised up by ?0.1 billion in 2012-13 to reflect recent strength in receipts from wine and spirits duty. The rises in duty in Budget 2012 were offset by a fall in overall alcohol consumption. From 2013-14 onwards, alcohol duties are expected to be around ?0.2 billion lower than in December, reflecting the Budget announcement of a 1p reduction in beer duty for 2013-14 and a RPI increase for 2014-15. Alcohol duties increase from ?10.2 billion in 2012-13 to ?12.3 billion in 2017-18, reflecting pre-announced duty rises for other types of alcohol of 2 per cent above RPI inflation to 2014-15 and by RPI inflation thereafter. 4.81 We expect receipts from tobacco duty to fall by ?0.3 billion to ?9.6 billion in 2012-13, before rising over the rest of the period, to ?10.8 billion in 2017-18 as increases in duty rates raise revenues by more than they are offset by declining cigarette consumption. Receipts are expected to be around ?0.2 billion higher in each year from 2014-15 than we expected in December. This reflects our revised forecast for RPI inflation and the recent depreciation of sterling against the euro, which is assumed to discourage cross-border shopping. Economic and fiscal outlook 112 Fiscal outlook Other taxes 4.82 Our forecast for business rates is similar to our December forecast. The downward effect from updated information on liabilities is offset by the effect of higher RPI inflation on the multiplier. Business rates bills are calculated by multiplying the rateable value of a non-domestic property by the multiplier, which is uprated in line with RPI inflation. 4.83 The assumptions used in the council tax projection are described in paragraph 4.147. The revised assumptions add around ?0.3 billion to the council tax forecast by the end of the forecast period. Changes to council tax are broadly offset by changes to locally financed expenditure, so are largely fiscally neutral. 4.84 For households claiming tax credits, the amount of credits that notionally offsets their income tax payments is treated as a negative tax in the National Accounts. The share assumed to be negative tax is expected to be lower than previously assumed, raising receipts by between ?0.8 billion and ?1.0 billion between 2012-13 and 2014-15. This change is fiscally neutral with higher receipts offset by higher AME spending. 4.85 VAT refunds to central and local government are fiscally neutral as receipts are fully offset within AME. The forecast for VAT refunds largely reflects the path of government procurement and investment plans. The VAT refund forecast is largely similar to the forecast in December. 4.86 We forecast air passenger duty (APD) revenues to rise by around ?1.0 billion over the forecast period, from ?2.8 billion in 2012-13 to ?3.8 billion in 2017-18. This is slightly lower than we expected in December due to our revised forecast for household disposable income and updates to our methodology for forecasting passenger numbers. The rise in receipts over the forecast period reflects growth in passenger numbers and that duty rates are assumed to rise in line with inflation. 4.87 Vehicle excise duty (VED) revenues are expected to fall from ?5.9 billion in 201213 to ?5.5 billion by 2017-18. The decline in VED receipts in part reflects lower new car CO2 emissions which cause a gradual shift in the stock of road vehicles to lower VED bands over time. It also reflects a cut in VED rates for Heavy Goods Vehicles from April 2014, as part of a package that introduces a lorry road user levy. The VED cut is intended to ensure that UK hauliers are no worse off following the introduction of the charge. The lorry road user levy has been included in the 'other taxes' line in Table 4.7. 4.88 Combined receipts from environmental levies, which includes levy funded spending policies such as the Renewables Obligation (RO), Feed-in tariffs and Warm Homes Discount, as well as revenues from the Carbon Reduction Commitment. Strong growth in revenues across the forecast reflects the expected 113 Economic and fiscal outlook Fiscal outlook increase in electricity generation from renewable sources. Of the four environmental levies included in our forecast only RO receipts are currently included in ONS outturn data. 4.89 Environmental taxes include receipts from the climate change levy, aggregates levy, landfill tax and the EU Emissions Trading Scheme. Combined receipts are expected to increase from ?2.4 billion to ?4.9 billion over the forecast period, which is close to our December forecast. Receipts from the EU Emissions Trading Scheme do not yet appear in ONS outturn data but are incorporated into our forecast years from 2012-13 as we expect this to be rectified in the future. 4.90 The UK-Swiss agreement, in which deposits of UK residents held in Swiss bank accounts become liable to a withholding tax to cover UK taxation, came into force on 1 January 2013. The Swiss authorities made an initial payment of ?0.3 billion to the Exchequer in January 2013. In December we assumed that this payment would be accrued to the month in which it had been received, however, the ONS have announced that this payment would accrue in May 2013. The estimated ?3.2 billion one-off element of the Swiss agreement will be scored as a capital tax in 2013-14, whilst any other ongoing revenues are incorporated within the income tax, capital gains tax and inheritance tax revenue totals. 4.91 Our forecast for proceeds from the bank levy in the current financial year has been revised down by ?0.2 billion, based on the latest information from actual receipts and likely full-year liabilities. We expect some of this weakness in receipts to continue through the forecast, but is offset from 2014-15 onwards by the Budget announcement of a further rise in the bank levy rate. 4.92 We have included ?0.3 billion from LIBOR fines in 2012-13 following the announcement that revenue from regulatory fees in excess of enforcement case costs will go to the Exchequer rather than being used to reduce Financial Services Authority (FSA) fees from the financial sector in the following year. We have not assumed any effect from fines in future years. These are included in the 'other receipts' line in Table 4.7. 4.93 We incorporate a provision for losses related to tax litigation cases in our receipts forecast. Once cases are settled, and their effects in particular years can be quantified, they are incorporated into forecasts of specific taxes. The magnitude and timing of actual losses is difficult to forecast as it depends on the legal process and final judgement. Even when a case is lost, the impact on receipts depends on the nature of the judgement and the response from the Government, and in some cases represent an upside risk to the Government. We assume that future tax litigation losses across all taxes will total ?3.6 billion over the five-year forecast period, slightly lower than our December forecast as losses in the current financial year should now be incorporated into individual tax forecasts. Economic and fiscal outlook 114 Fiscal outlook Other receipts 4.94 Interest and dividend receipts capture the interest income on the stock of financial assets held by the Government. They also include the proceeds from the APF and interest income (largely from mortgage interest payments) that Bradford & Bingley and Northern Rock (Asset Management) receive as the latter are now classified as central government by the ONS. These two elements are the primary drivers of changes since December. The ?2.8 billion shortfall in interest and dividend receipts in 2012-13 compared with December reflects the impact of the final ONS classification decision on the APF and SLS, as discussed in paragraphs 4.30 and 4.31. As noted earlier, the profile for APF dividend income beyond 2012-13 has changed following the ONS classification decision. We have also included a lower path for interest income for Bradford & Bingley and Northern Rock (Asset Management), particularly in the later years of the forecast. 4.95 The gross operating surplus (GOS) forecast is lower by ?0.3 billion by 2017-18 compared to the December forecast. This is mostly driven by the Housing Revenue Account (HRA). GOS is revised down in every year of the forecast as a result of lower outturn data for 2011-12. This is partly offset by an upward revision of the Transport Trading Limited gross trading surplus forecast on the basis on the latest business plan published earlier this year. Public sector expenditure 4.96 This section explains our central projections for public sector expenditure, which are based on the National Accounts aggregates for public sector current expenditure (PSCE), public sector gross investment (PSGI), and Total Managed Expenditure (TME), which is the sum of PSCE and PSGI. The Treasury plans public spending using two further administrative aggregates: departmental expenditure limits (DELs)3 - mostly spending on public services and administration, which can be planned some years in advance. Our forecast is based on the Government's latest plans for DELs, which have been set out up to 2014-15, plus our view of the extent to which departments might underspend against these limits; and annually managed expenditure (AME) - categories of spending less amenable to multi-year planning, such as social security spending and debt 3 Our presentation of expenditure only shows those components of RDEL and CDEL and AME that are included in the fiscal aggregates of PSCE and PSGI. For budgeting purposes HM Treasury also includes other components in DEL such as non-cash items. A reconciliation between HM Treasury's DEL figures and ours is published in the supplementary fiscal tables on our website. 115 Economic and fiscal outlook Fiscal outlook interest. We forecast these categories of spending out to 2017-18, based on determinants derived from our economic forecast. 4.97 Beyond the current Spending Review period, our projections for total spending in the period 2015-16 to 2017-18 are based on the Government's stated policy assumption, which is set out in paragraph 4.104. We continue to forecast AME components for these years and then subtract them from the Government's overall spending assumption to derive implied DELs. This top-down approach means that higher AME spending beyond 2014-15 on, for example, debt interest or APF transfers, is offset by cuts in the residual implied DEL totals. 4.98 Chart 4.1 shows TME as a percentage of GDP since 2007-08, and how this splits between DEL and AME. TME increased sharply as a share of GDP through the recession of 2008-09 and 2009-10, reaching a peak of 47 per cent of GDP in 2009-10. With DELs fixed in cash terms through to 2010-11 in the 2007 Comprehensive Spending Review, this increase mainly reflected the sharp fall in nominal GDP in 2008-09 and 2009-10. However AME spending on social security and debt interest also increased over this period, as a result of the recession. 4.99 TME fell from 47 per cent of GDP in 2009-10 to 45 per cent of GDP in 2011-12 due mainly to the reductions in expenditure under the Government's fiscal consolidation plan. The further decline between 2011-12 and 2012-13 mainly reflects the transfer to the public sector of the Royal Mail pension fund assets and 4G spectrum auction receipts, which score as negative expenditure. Excluding these factors, TME is forecast to be broadly flat between 2011-12 and 2013-14. Nominal GDP growth over this period is expected to be relatively weak which acts to increase expenditure (much of which is fixed in cash terms) as a share of the economy. TME is then expected to start to decline again due to the combined effect of the forecast pick-up in economic growth and the continued reductions in expenditure in the Government's fiscal consolidation plans. Economic and fiscal outlook 116 Fiscal outlook Chart 4.1: DEL and AME components of TME 50 Forecast 45 40 Per cent of GDP 35 30 25 20 15 10 5 0 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 TME in DEL (including SUME) TME in AME Total TME Source: ONS, OBR Summary of the expenditure forecast 4.100 Table 4.14 summarises our latest forecast for public expenditure. TME is expressed as a share of the economy, but not all of TME contributes directly to the calculation of GDP, as it comprises benefit payments, debt interest and other cash transfers rather than the production or consumption of goods and services. Table 4.15 shows how TME is split between DEL and AME over the forecast period, and the main components of AME. 4.101 AME is forecast to be relatively flat as a share of GDP over the forecast period. Social security payments are forecast to fall as a share of GDP as the economy recovers, while debt interest payments rise due to high levels of borrowing. From 2012-13, total AME spending is expected to exceed DEL for the first time. 4.102 Local authority spending is split between spending financed by central government grants (in DEL), and spending financed by local authorities' own sources of income (in AME). Spending has been transferred from DEL to AME from 2013-14 onwards, reflecting the new policy under which local authorities retain around half of their business rates income, which pushes up the AME forecast in 2013-14 and later years. 4.103 Public sector gross investment falls sharply in 2012-13 due to the transfer of the Royal Mail pension assets and the spectrum auction receipts, which are classified as negative capital expenditure. 117 Economic and fiscal outlook Fiscal outlook Table 4.14: Expenditure as a per cent of GDP Per cent of GDP Forecast Outturn 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Total managed expenditure of which: Public sector current expenditure Public sector gross investment Total public sector expenditure that contributes directly to GDP 1 of which: General government consumption General government gross fixed capital formation Public corporations gross fixed capital formation 1 45.5 43.6 45.2 44.0 43.1 41.8 40.5 42.2 3.3 42.5 1.0 42.2 3.0 41.0 3.0 40.2 2.9 39.0 2.8 37.8 2.8 24.7 24.5 24.1 23.4 22.5 21.4 20.2 22.2 22.1 21.9 21.0 20.2 19.1 18.1 2.1 2.0 1.9 2.0 1.9 1.9 1.8 0.4 0.4 0.4 0.4 0.3 0.3 0.3 GDP at market prices Table 4.15: TME split between DEL and AME Per cent of GDP Forecast Outturn 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 TME in DEL 1,2,3 TME in AME of which: Social security 2 Debt interest Locally-financed current expenditure 3 Other PSCE in AME PSGI in AME 1 23.8 21.7 21.2 22.4 22.5 22.6 21.6 22.4 20.5 22.6 19.3 22.5 18.0 22.5 11.5 3.1 11.8 3.0 11.3 3.1 11.1 3.1 10.9 3.3 10.7 3.6 10.5 3.8 1.4 1.5 2.3 2.3 2.3 2.3 2.3 4.7 1.0 5.2 0.8 5.1 0.8 5.1 0.8 5.1 0.8 5.2 0.8 5.1 0.8 In relation to table 4.18, TME in DEL is defined as PSCE in RDEL plus PSGI in CDEL plus SUME, and TME in AME is defined as PSCE in AME plus PSGI in AME minus SUME. SUME is single use military equipment. 2 From 2013-14, TME in RDEL contains grants to local authorities to finance the localised council tax reduction scheme, which replaces grants to local authorities to finance council tax benefits previously contained within social security. 3 From 2013-14, locally-financed current expenditure contains the business rates that local authorities will retain, and there is an offsetting reduction in the grant in RDEL which distributes business rates to local authorities. Economic and fiscal outlook 118 Fiscal outlook 4.104 Beyond the current Spending Review period, our projections for the period 201516 to 2017-18 are based on the Government's stated policy assumption that TME should continue to fall at the same average real rate as over the Spending Review period, with PSGI flat in real terms. The Government has specified a number of exclusions when making these calculations.4 4.105 Applying the Government's assumption, TME is projected to fall by an average of 0.4 per cent a year in real terms in the Spending Review period, compared with the 0.6 per cent fall implied by the Government's policy assumption in our December forecast. The fall is less than in December largely due to the reduction in our forecast of the GDP deflator. A lower deflator implies higher real spending growth over the Spending Review period for a given set of nominal spending totals. Our GDP deflator forecast is also lower after 2014-15, which decreases nominal expenditure in 2015-16, 2016-17 and 2017-18 compared to the December forecast. These two GDP deflator effects partly offset each other. 4.106 Within TME, the Budget measure that increases PSGI by ?3 billion each year from 2015-16 to 2017-18 effectively increases PSGI in CDEL, since that is derived by residual from PSGI less PSGI in AME. And this measure reduces PSCE by ?3 billion in each of these years, since that is derived by residual from TME less PSGI. This reduction in PSCE then knocks through to PSCE in RDEL, since that is derived by residual from PSCE less PSCE in AME. 4.107 Table 4.16 shows that as a result of these assumptions and the Budget measure increasing PSGI, against a baseline that includes all spending in 2014-15: in 2015-16, TME increases in real terms by 0.2 per cent, PSGI still declines by 1.7 per cent and PSCE increases by 0.3 per cent; in 2016-17, TME now declines in real terms by 0.4 per cent, PSGI declines by 0.1 per cent and PSCE declines by 0.4 per cent; and in 2017-18, TME now declines in real terms by 0.4 per cent, PSGI declines by 0.1 per cent and PSCE declines by 0.4 per cent. 4.108 On the basis of current policy, including the policy measures announced in this Budget, we expect total AME to rise in real terms by 2.9 per cent in 2015-16, 2.5 4 The Government has stated that the growth rate should be projected forward using a baseline that excludes our forecast underspends in DEL, all the spending measures announced in the Autumn Statement 2012 and in the March Budget 2013, and the capital measures announced in the Autumn Statement 2011. Growth over the Spending Review period includes the capital measures announced in the Autumn Statement 2011, but excludes our forecast underspends in DEL, and excludes the measures announced in the Autumn Statement 2012 and in the March Budget 2013. 119 Economic and fiscal outlook Fiscal outlook per cent in 2016-17, and 2.7 per cent in 2017-18. For these years, we have derived implied levels for our definitions of RDEL and CDEL by subtracting the forecasts for AME from the forecasts for total PSCE and total PSGI. On the basis of our latest forecast for TME in DEL, including our estimates of departments' shortfall in spending against DEL plans in 2014-15: implied PSCE in RDEL falls in real terms by 2.7 per cent in 2015-16, 3.8 per cent in 2016-17, and 4.3 per cent in 2017-18. In the December forecast the equivalent falls in PSCE in RDEL were 1.6 per cent in 2015-16, 3.5 per cent in 2016-17, and 4.1 per cent in 2017-18; and implied PSGI in CDEL falls in real terms by 3.9 per cent in 2015-16, 0.5 per cent in 2016-17, and 1.1 per cent in 2017-18. In the December forecast the equivalent falls were 8.6 per cent in 2015-16 and 0.3 per cent in 201617, and real terms growth of 0.4 per cent in 2017-18. 4.109 In the Budget the Government has announced that the totals set out here for PSCE and PSGI in 2015-16 will form the envelope for the summer spending round. In the Autumn 2013 EFO we will therefore produce a bottom-up forecast of 2015-16 total expenditure based on the plans set out in the summer and our latest AME forecast, rather than deriving it on the basis of the Government's spending growth assumption. Economic and fiscal outlook 120 Fiscal outlook Table 4.16: Spending real growth rates and as a per cent of GDP Spending Review years 2011-12 to 2014-15 Total change Real terms growth rate (%) Total managed expenditure of which: PSCE PSGI TME in AME TME in DEL of which: PSCE in RDEL PSGI in CDEL Per cent of GDP Total managed expenditure of which: PSCE PSGI TME in AME TME in DEL of which: PSCE in RDEL PSGI in CDEL Average annual change Post Spending Review years Total change between Change in Change in Change in 2010-11 and 2015-16 2016-17 2017-18 2017-18 -2.2 -0.5 0.2 -0.4 -0.4 -2.7 -0.5 -20.4 8.7 -11.4 -0.1 -5.6 2.1 -3.0 0.3 -1.7 2.9 -2.7 -0.4 -0.1 2.5 -3.5 -0.4 -0.1 2.7 -3.9 -0.9 -21.9 14.6 -16.7 -9.8 -21.1 -2.5 -5.8 -2.7 -3.9 -3.8 -0.5 -4.3 -1.1 -19.2 -25.4 -2.7 -0.7 -1.0 -1.3 -1.3 -6.3 -1.8 -0.9 1.0 -3.7 -0.5 -0.2 0.2 -0.9 -0.8 -0.1 0.1 -1.1 -1.2 -0.1 -0.1 -1.2 -1.2 -0.1 0.0 -1.3 -5.1 -1.2 1.0 -6.0 -2.9 -0.7 -0.7 -0.2 -0.9 -0.1 -1.2 -0.1 -1.2 -0.1 -6.2 -1.0 121 Economic and fiscal outlook Fiscal outlook Summary of changes to the expenditure forecast since December 4.110 Table 4.17 shows the main reasons for the changes in our forecast of public sector expenditure since December. Tables 4.18 and 4.19 show the detailed spending forecasts and the changes in these forecasts since the December EFO. These are explained in more detail in the subsequent sections. In summary the main drivers of changes since the December forecast are: changes to the economic determinants. In particular, a higher RPI inflation forecast has increased debt interest payments from 2013-14 onwards, a lower claimant count unemployment forecast decreases social security payments, and a reduction in our forecast of the sterling/euro exchange rate increases the UK contribution to the EU; the Government's decision to reduce departmental expenditure in 2012-13, partly by pushing some spending into 2013-14 and 2014-15. Further details are set out in the DEL section below; in 2012-13, the Special Liquidity Scheme capital receipt has been reclassified by the ONS from spending to current receipts, hence this increase in spending is offset by an increase in receipts; the new EU Multi-annual Fiscal Framework deal that sets EU budgets from 2014 to 2020 is lower than we had assumed, hence reducing our forecast of the UK payments to the EU. Further details are set out in the EU contributions section; changes to the implied DELs in 2015-16 to 2017-18 resulting from applying the government's spending growth assumption and increases in AME spending; changes to the modelling of some social security benefits, mainly housing benefit and state pension, which increase social security spending. Further details are set out in the section on social security spending below; and the policy changes announced in the March Budget, which are summarised in Table 4.3 and set out in full in Annex A. Economic and fiscal outlook 122 Fiscal outlook Table 4.17: Changes to the spending forecast since December ? billion Forecast 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 December forecast March forecast Change of which: Economic determinants Inflation Unemployment State pension uprating Exchange rate Average earnings Market assumptions Gilt rates Short rates Other assumptions/changes Changes to DEL underspend assumptions Changes to implied DEL Social security modelling changes Special Liquidity Scheme reclassification Debt interest costs from financing CGNCR EU Multi-annual Fiscal Framework deal Other Budget measures 674.3 673.3 -1.0 719.9 720.0 0.2 731.0 730.4 -0.5 744.7 744.7 0.0 755.1 754.9 -0.2 765.5 765.1 -0.4 -0.5 -0.3 -0.1 0.0 0.0 0.0 0.0 0.0 0.0 -0.6 0.6 1.0 -0.4 0.0 -0.1 0.2 0.1 0.1 0.0 1.1 0.4 0.5 -0.3 0.2 0.0 0.1 0.1 0.1 0.0 0.0 1.2 0.9 -0.3 0.2 0.3 0.1 0.5 0.4 0.1 -1.7 1.8 1.5 -0.3 0.1 0.4 0.1 1.1 1.0 0.1 -3.1 2.1 1.6 -0.3 0.1 0.6 0.1 1.7 1.5 0.3 -4.2 -3.4 1.0 0.5 - - - 0.3 2.3 1.0 - 1.1 - -2.3 1.4 - -4.1 0.9 - -6.0 1.2 - 0.0 -0.2 -0.1 0.4 0.8 1.3 0.0 0.3 0.0 -0.6 -0.1 -1.6 -1.4 -0.1 -1.1 -0.7 -0.5 0.0 -0.2 -0.6 0.0 -0.6 -0.1 0.0 123 Economic and fiscal outlook Fiscal outlook Table 4.18: Total managed expenditure ? billion Outturn Forecast 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Public sector current expenditure (PSCE) PSCE in RDEL 1 PSCE in Annually Managed Expenditure of which: Social security benefits Tax credits Net public service pension payments of which: CG unfunded pension schemes LG police and fire pension schemes National lottery current grants BBC domestic services current expenditure Fees associated with financial interventions Other PSCE items in departmental AME Expenditure transfers to EU institutions Locally-financed current expenditure Central government gross debt interest Depreciation Current VAT refunds Single use military expenditure Environmental levies Other National Accounts adjustments Total public sector current expenditure Public sector gross investment (PSGI) PSGI in CDEL 1 PSGI in Annually Managed Expenditure of which: National lottery capital grants Other PSGI items in departmental AME Locally-financed capital expenditure Public corporations capital expenditure Other National Accounts adjustments Total public sector gross investment Less depreciation Public sector net investment Total managed expenditure 1 322.6 321.2 319.5 337.7 320.8 352.1 317.2 362.8 314.2 380.1 307.4 396.3 299.1 413.9 174.9 27.2 8.0 6.7 1.4 1.1 3.8 -2.0 1.1 5.9 21.6 47.9 16.0 11.7 5.5 0.5 -2.2 643.8 182.8 28.6 10.5 8.9 1.6 1.1 3.4 -0.6 2.0 7.4 23.8 46.5 16.9 11.6 4.7 1.3 -2.4 657.2 180.4 29.0 11.1 9.5 1.6 1.2 3.5 -0.3 1.4 6.5 36.1 49.5 17.7 12.3 4.7 1.7 -2.6 672.9 184.4 29.8 12.4 10.7 1.6 1.3 4.0 -0.2 1.2 5.7 38.0 51.8 18.4 12.3 4.2 2.1 -2.6 680.0 189.1 31.3 13.6 11.9 1.8 1.5 3.7 0.0 1.1 6.1 39.5 57.8 19.2 12.4 4.7 2.6 -2.5 694.2 193.1 33.2 14.9 12.9 1.9 1.6 3.8 0.0 1.1 5.9 41.0 64.4 19.9 12.2 4.7 3.1 -2.5 703.7 197.6 34.4 16.2 14.1 2.0 1.7 3.9 0.0 1.2 6.0 43.1 71.3 20.6 11.8 4.7 3.8 -2.4 713.0 34.8 15.0 3.3 12.8 33.7 13.5 36.9 13.5 36.1 14.4 36.5 14.7 36.7 15.4 0.4 -7.0 16.5 6.7 -1.6 49.8 -21.1 28.7 693.6 0.4 0.8 7.1 6.2 -1.7 16.1 -22.1 -6.0 673.3 0.5 0.8 6.4 5.9 -0.1 47.2 -23.0 24.2 720.0 0.6 0.9 6.3 5.9 -0.2 50.4 -23.8 26.6 730.4 0.6 0.8 6.8 6.0 0.2 50.4 -24.6 25.8 744.7 0.7 0.7 7.0 6.2 0.2 51.3 -25.4 25.8 754.9 0.7 1.3 6.7 6.4 0.2 52.1 -26.3 25.8 765.1 Implied DEL numbers for 2015-16, 2016-17 and 2017-18. Calculated as the difference between PSCE and PSCE in AME in the case of PSCE in RDEL, and between PSGI and PSGI in AME in the case of PSGI in CDEL. Economic and fiscal outlook 124 Fiscal outlook Table 4.19: Changes to total managed expenditure since December ? billion Outturn Forecast 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Public sector current expenditure (PSCE) PSCE in RDEL 1 PSCE in Annually Managed Expenditure of which: Social security benefits Tax credits Net public service pension payments of which: CG unfunded pension schemes LG police and fire pension schemes National lottery current grants BBC domestic services current expenditure Fees associated with financial interventions Other PSCE items in departmental AME Expenditure transfers to EU institutions Locally-financed current expenditure Central government gross debt interest Depreciation Current VAT refunds Single use military expenditure Environmental levies Other National Accounts adjustments Total public sector current expenditure Public sector gross investment (PSGI) PSGI in CDEL 1 PSGI in Annually Managed Expenditure of which: National lottery capital grants Other PSGI items in departmental AME Locally-financed capital expenditure Public corporations capital expenditure Other National Accounts adjustments Total public sector gross investment Less depreciation Public sector net investment Total managed expenditure 1 0.0 0.7 -2.9 -0.6 -0.4 1.3 -0.4 -1.1 -4.6 1.4 -6.3 3.1 -7.6 4.4 0.0 0.0 0.0 0.0 0.2 0.8 -0.4 -0.4 0.5 1.1 -0.2 -0.2 0.9 1.2 -0.4 -0.4 1.2 0.9 -0.3 -0.3 0.8 0.7 -0.2 -0.2 0.9 0.3 -0.1 -0.1 0.0 0.0 0.0 0.0 1.1 0.0 0.0 0.8 0.0 -0.1 0.0 0.0 -1.1 0.7 0.0 0.0 -0.2 0.0 0.3 0.1 0.6 -0.6 0.0 -0.1 -0.4 0.0 -0.9 -3.5 0.0 0.1 0.1 0.0 0.1 -0.1 0.1 0.9 0.0 -0.2 0.0 0.0 -1.0 1.0 -0.1 0.1 0.3 0.0 0.0 -1.6 0.2 0.0 0.1 -0.2 -0.5 0.0 -1.1 -1.5 -0.1 0.2 0.0 0.0 0.0 -0.5 0.3 1.2 0.1 -0.1 -0.1 -0.2 -1.1 -3.1 0.0 0.3 0.0 0.0 -0.1 0.1 0.4 2.8 0.1 -0.1 -0.1 -0.4 -1.1 -3.2 0.0 0.4 0.0 0.0 -0.1 0.0 0.4 4.2 0.1 -0.2 -0.2 -0.5 -0.9 -3.2 0.0 2.0 0.9 1.5 -0.6 -0.2 0.7 0.3 2.3 0.8 2.2 0.8 1.6 1.3 0.0 0.6 0.5 0.0 0.9 2.0 0.0 2.0 2.7 -0.1 2.3 0.9 -1.6 0.0 2.4 0.1 2.5 -1.0 0.0 -0.3 1.6 -1.4 0.0 -0.8 0.1 -0.8 0.2 0.0 -0.1 1.4 -0.9 0.0 0.9 0.1 1.0 -0.5 0.0 -0.2 1.5 -0.9 0.3 3.1 0.1 3.2 0.0 0.1 -0.2 1.4 -0.7 0.2 3.0 0.1 3.1 -0.2 0.1 0.2 1.3 -0.6 0.2 2.9 0.1 3.0 -0.4 Implied DEL numbers for 2015-16, 2016-17 and 2017-18. Calculated as the difference between PSCE and PSCE in AME in the case of PSCE in RDEL, and between PSGI and PSGI in AME in the case of PSGI in CDEL. 125 Economic and fiscal outlook Fiscal outlook Expenditure in 2012-13 4.111 Our forecast for TME in 2012-13 is ?1.0 billion lower than in the December EFO, comprising a ?3.5 billion reduction in PSCE and a ?2.4 billion increase in PSGI. The increase in PSGI mainly reflects the fiscally neutral reclassification of the ?2.3 billion capital receipt from the SLS from expenditure to tax. Excluding this reclassification, PSGI is broadly unchanged from December while PSCE is around ?3.5 billion lower primarily reflecting the Government's decisions to reduce expenditure by central government departments, which are discussed below. 4.112 Detailed sectoral breakdowns of our forecasts are shown in the supplementary fiscal tables on our website. Overall, compared to December, we have decreased our expenditure forecast by ?0.7 billion for central government and by ?0.6 billion for public corporations, and increased it by ?0.4 billion for local government. 4.113 The February release of the monthly Public Sector Finance statistics showed that central government expenditure in the first ten months of 2012-13 was 2.7 per cent higher than the same period last year, which is higher than our forecast of 2.1 per cent growth for the full year in this EFO. However, as we pointed out in our commentary on the February release, at least 0.3 per cent of the increase in the spending in the first 10 months is accounted for by timing differences on spending on EU payments and grants to local authorities. These payments have been made earlier than last year and so spending on these transfers is expected to be lower over the next two months. We are also expecting the usual end-year surge in spending to be lower this year given the Government's actions to reduce end-year spending which are explained in the following section on DELs. Departmental expenditure limits (DELs) 4.114 Table 4.20 summarises the changes in our forecasts for PSCE in RDEL and PSGI in CDEL since December. The main changes result from the Government's decision to reduce spending by central government departments in 2012-13, partly by pushing some spending forward into future years. These are described in detail below. Other changes include a ?1.2 billion increase in CDEL in 2012-13, because the 4G spectrum auction receipts (which score as negative capital spending) were lower than expected. Economic and fiscal outlook 126 Fiscal outlook Table 4.20: Key changes to DEL since December ? billion Implied DEL Forecast 2012-13 SUME (CDEL in PSCE in AME)3 December forecast March forecast Change of which: Changes to underspends1 Other 1 2017-18 321.1 320.8 -0.4 317.6 317.2 -0.4 318.7 314.2 -4.6 313.7 307.4 -6.3 306.7 299.1 -7.6 -0.8 -2.1 0.0 0.0 0.8 0.0 -1.4 0.2 0.5 0.0 -1.2 0.3 -2.9 -1.7 - -3.0 -3.3 - -2.9 -4.7 - 34.3 33.7 -0.6 36.2 36.9 0.7 33.8 36.1 2.3 34.3 36.5 2.2 35.2 36.7 1.6 -0.8 0.6 0.0 1.2 0.0 - 0.2 0.0 -0.1 -0.7 - 0.5 0.0 0.2 0.0 - 3.0 -0.6 3.1 -0.8 3.1 -1.5 4.7 4.7 0.0 4.7 4.2 -0.5 4.7 4.7 -0.1 4.8 4.7 -0.1 5.0 4.7 -0.2 -0.4 0.0 Policy changes affecting underspends Other changes to underspend1 Budget measures Change to 4G Spectrum receipt Fiscal to non-fiscal switches Other changes to implied DEL2 2016-17 5.0 4.7 -0.4 PSGI in CDEL December forecast March forecast Change of which: 2015-16 2.3 3.3 0.9 Policy changes affecting underspends Other changes to underspend1 Budget measures Other changes to implied DEL2 Other 2014-15 322.4 319.5 -2.9 PSCE in RDEL December forecast March forecast Change of which: 2013-14 0.0 0.0 -0.5 0.0 -0.1 -0.1 -0.2 The overall underspend assumptions in this forecast, including SUME, are as follows: 2012-13 2013-14 2014-15 PSCE in RDEL -7.4 -1.2 -1.0 SUME -1.7 -1.0 -1.0 PSGI in CDEL -1.9 -1.3 -1.0 TME in DEL -10.9 -3.5 -3.0 2 Changes to implied RDEL are calculated as changes to total PSCE less changes to PSCE in AME. Changes to implied CDEL are calculated as changes to total PSGI less changes to PSGI in AME. 3 SUME is part of CDEL but is included in PSCE in AME in our tables because SUME is classified as current expenditure in the National Accounts. TME in DEL is defined as PSCE in RDEL plus PSGI in CDEL plus SUME. 127 Economic and fiscal outlook Fiscal outlook 4.115 In our December EFO, we forecast total underspends of ?7.5 billion for TME in DEL in 2012-13, relative to the plans set out by the Treasury in the Public Expenditure Statistical Analysis (PESA) document in July 2012. We have now updated this estimate, based on the amount of spending that the Treasury agreed to allow departments to carry forward in future years under its Budget Exchange arrangements, some additional spending reductions revealed in the Supplementary Estimates presented to Parliament in February, plus information from the Treasury on further spending reductions that it has agreed with departments subsequently. 4.116 On the basis of this evidence, plus the fact that on average departments typically underspend even against the final plans they agree with the Treasury, we have increased the total forecast underspend against the 2012 PESA plans to ?10.9 billion. 4.117 It is very rare for the Government to underspend the departmental plans it has set out less than a year ago by such a large margin. To ensure that our forecast is a central one, we have asked the Treasury for a detailed breakdown of the spending reductions that it expects departments to deliver, which we publish in Table 4.22. 4.118 Our overall forecast of under-spending has a number of elements: money that the Treasury has agreed to allow departments to move into future years; money that the Treasury has not allowed departments to bring forward from future years; money that departments thought they would spend this year, but which they do not now expect to spend either this year or in the future; and payments (for example to some international institutions) that were due to be made late in the current financial year, but which are being delayed into 2013-14. In the last of these cases, departments have assumed that these payments will be accrued to 2013-14 rather than 2012-13, although we see some risk that this may not always be the case and some could be accrued to the original date. 4.119 In more detail, our forecast of the total underspend is built up as follows: Supplementary Estimates presented to Parliament in February showed that departments had reduced their spending plans for TME in DEL in 2012-13 by ?5.1 billion against PESA plans, adjusted for policy changes announced in the Autumn Statement. This included ?3.9 billion that departments surrendered to take forward into 2013-14 and 2014-15 under the Treasury's Budget Exchange scheme. This was more than we had assumed in December, and much more than the ?0.8 billion that departments surrendered under Budget Exchange in 2011-12, its first year of operation; Economic and fiscal outlook 128 Fiscal outlook Supplementary Estimates are departments' final spending plans for the year and form an absolute upper limit. Departments face severe sanctions if they exceed them and so they typically underspend them by some margin. Underspends against these final plans have been in the range of ?4 billion to ?6 billion over the past five years, but that was mostly before the introduction of Budget Exchange. Given that departments surrendered ?3.9 billion of their underspends in Budget Exchange in their Supplementary Estimates this year, we would have expected smaller underspends against these final plans that we have seen on average in the past; however, departments' February forecasts of their spending over the whole of 2012-13 showed that they nonetheless expected to deliver further reductions of ?5.3 billion against their final spending plans.5 These reductions included departments' estimates of their further underspends, plus additional reductions agreed with the Treasury. We estimate that at least ?1.6 billion of the further shortfall in departments' February forecasts is the direct result of the Government's actions to reduce spending in 201213 by pushing money forward into future years. The Government's actions will probably account for even more of the remaining ?3.7 billion of shortfall in department's forecasts of outturn - in practice this will reflect a mixture of departments' normal drive to remain safely below their final spending limits, and the further results of Government pressure to deliver further underspends. But we have no way of distinguishing these effects; and finally departments usually underspend even against their February forecasts - last year by a further ?1.4 billion. Our forecast for 2012-13 assumes an additional further underspend of only ?0.5 billion, given the large underspends and reductions already agreed against final plans. 4.120 As a result of all this information, we are forecasting a total underspend of ?10.9 billion against TME in DEL in 2012-13. This consists of underspends of ?7.4 billion for PSCE in RDEL, ?1.9 billion for PSGI in CDEL, and ?1.7 billion for Single Use Military Expenditure (SUME), which is part of CDEL but is included in current expenditure in the National Accounts. The detailed components of the underspends are set out in footnote 1 of Table 4.20. 5 Departments submit forecast outturn data each month to the Treasury, which includes their outturns and forecast outturns for all 12 months of 2012-13. Their forecast outturn returns in February reflect their best view of their spending for the whole year, including their underspends against their final plans. This year, the forecast outturn data reflected the additional agreements to reduce spending, and the Treasury further supplemented the data with further reductions agreed after departments submitted their returns. 129 Economic and fiscal outlook Fiscal outlook Table 4.21: Components of shortfall against DEL plans 2012-13 PSCE in RDEL PESA plans at start of year PSGI in CDEL TME in DEL 1 328.2 8.8 343.3 -1.4 -2.4 -3.7 -1.3 -1.3 -7.4 -1.9 -10.9 Changes to plans published in Supplementary Estimates2 -4.2 0.8 -5.1 Shortfall against revised plans in departments' February full year forecast outturn2,3 -3.0 -2.4 -5.3 OBR estimate of allowance for further shortfall -0.3 -0.3 -0.5 319.5 3.3 327.4 Autumn Statement measures Classification change of European Investment Bank OBR assumption of shortfall against PESA plans (post AS measures and classification change) of which: OBR forecast in March EFO 1 TME in DEL includes SUME. 2 Approximate estimates of fiscal spending in RDEL and CDEL. Reflects departments estimates of forecast outturn in February 2013 plus additional reductions agreed with HM Treasury. 3 4.121 Table 4.22 sets out the total reductions in spending that the Treasury expects departments to deliver in 2012-13. It also shows the additional spending carried forward into 2013-14 and 2014-15 by individual departments under Budget Exchange. The table also shows the ?1.6 billion of additional spending that the Treasury expects to fund from the DEL reserves as a result of the additional agreements it reached with departments after the Supplementary Estimates, which transferred spending into 2013-14 and 2014-15. Economic and fiscal outlook 130 Fiscal outlook Table 4.22: Reductions in DEL spending in 2012-13, and spending carried forward to 2013-14 and 2014-15 ? billion CDEL2 RDEL excl depreciation Estimated under- Budget exchange4 3 spends 12-13 Education NHS (Health) Transport CLG Communities Home Office Defence International Development Work and Pensions Other5 Total Remove non fiscal spending Total fiscal RDEL and CDEL Carry forward agreements 6 1 13-14 TME in DEL Estimated under- Budget exchange4 3 spends 14-15 12-13 13-14 14-15 Estimated under- Budget exchange4 3 spends 12-13 13-14 14-15 -1.0 -1.4 -0.7 -0.5 -0.7 -0.5 0.4 0.0 0.1 0.2 0.1 0.5 0.2 0.0 0.0 0.0 0.0 0.8 0.0 -0.8 -0.2 -0.3 -0.1 -2.5 0.1 0.0 0.3 0.0 0.0 0.1 0.0 0.0 0.1 0.0 0.0 0.2 -1.1 -2.2 -0.9 -0.8 -0.8 -3.0 0.5 0.0 0.4 0.2 0.1 0.6 0.2 0.0 0.1 0.0 0.0 1.0 -0.5 -0.7 -1.6 -7.6 0.1 0.0 0.4 1.7 0.0 0.0 0.2 1.2 0.0 0.1 0.0 -3.8 0.0 0.0 0.6 1.1 0.0 0.0 0.1 0.4 -0.5 -0.7 -1.6 -11.5 0.1 0.0 1.0 2.9 0.0 0.0 0.3 1.6 0.3 0.0 0.0 0.3 -0.5 0.0 0.6 -0.5 0.0 -7.4 1.7 1.2 -3.5 0.6 0.4 -10.9 2.4 1.6 0.4 0.4 0.4 0.4 0.8 0.8 These changes exclude measures from this Budget and Autumn Statement 2012. 2 Changes in Capital DEL control totals including Single Use Military Equipment (SUME), which scores as current spending in National Accounts. SUME reduced by ?1.7 billion in 2012-13. 3 The difference between plans published at Budget 2012 and departments' latest estimates of their full-year position. These are the amounts carried forward from 2012-13 through Budget Exchange, presented in the Spring Supplementary Estimates. 4 5 Includes changes to all other departments, the Reserve, Special Reserve and Budget Exchange adjustments. 6 Carry forward agreements identified post Supplementary Estimates; provisional figures. 4.122 In 2013-14 and 2014-15, there are now additional pressures from spending transferred from 2012-13, as shown in Table 4.22. Table 4.20 also shows that Budget policy decisions have reduced DEL spending plans by ?0.5 billion in 2013-14 and 2014-15.6 In the light of the remaining additional pressures on the Treasury's DEL reserves in 2013-14 and 2014-15, we have reduced our underspend assumptions by ?1.0 billion and ?0.5 billion in these years respectively, compared with our December forecast. This means that we are now 6 This includes 'Budget measures', 'policy changes affecting underspends' and 'changes to underspend assumptions in SUME' in Table 4.20. 131 Economic and fiscal outlook Fiscal outlook forecasting total underspends on TME in DEL of ?3.5 billion in 2013-14, and ?3 billion in 2014-15, relative to the DEL plans set out in PESA 2012. 4.123 Table 4.20 shows that, in the years after the 2010 Spending Review, the implied RDEL envelope has been reduced by ?4.6 billion, ?6.3 billion and ?7.6 billion through 2015-16 to 2017-18. The implied CDEL envelope has increased by ?2.3 billion, ?2.2 billion and ?1.6 billion through 2015-16 to 2017-18. This includes the Budget measure to increase CDEL spending by ?3 billion in each of these years, which is offset by reductions in RDEL. Annually managed expenditure 4.124 Table 4.18 sets out our latest central projections of AME spending to 2017-18, based on our economic forecast, the latest estimates of agreed policy commitments, and the measures announced in the Budget. Social security 4.125 Table 4.15 shows that social security expenditure is forecast to fall from 11.8 per cent of GDP to 10.5 per cent over the forecast period, as the economy recovers and unemployment falls, and as policy measures take effect. 4.126 Social security spending is forecast to be higher than we forecast in December, with the difference reaching ?1.2 billion by 2015-16, as shown in Table 4.23. The main changes arising from our economic forecast are driven by: our forecast of CPI between 2014-15 and 2016-17 is higher than we expected in December. Excluding the impact on state pension uprating, the higher CPI increases social security spending by ?0.3 billion in 2016-17 and 2017-18. For 2014-15 and 2015-16, the higher CPI only affects benefits which are not affected by the Autumn Statement announcement to uprate working age discretionary benefits by 1 per cent for 3 years, and to increase local housing allowance for two years from 2014-15; the decrease in our claimant count unemployment forecast, which reduces benefit payments by a maximum of ?0.4 billion in 2013-14; our forecast of average earnings growth in 2014-15 and 2016-17 is lower than we expected in December, and excluding the impact on state pension uprating, the lower earnings growth reduces social security spending by ?0.2 billion from 2014-15 onwards; and our higher CPI forecast in 2013-14 increases state pension costs by ?0.2 billion in 2014-15 and 2015-16, but our lower average earnings forecast in 2016-17 reduced the overall impact to an increase of ?0.1 billion in 2016Economic and fiscal outlook 132 Fiscal outlook 17 and 2017-18 (the state pension is uprated by the highest of 2.5 per cent, average earnings growth, and CPI inflation). Table 4.23: Key changes to social security since December ? billion Forecast 2012-13 December forecast March forecast Change1 of which: CPI Claimant count unemployment State pension uprating Average earnings Universal Credit modelling State pension modelling Disability benefits modelling Housing benefit modelling Budget measures 2 Other 2013-14 2014-15 2015-16 2016-17 2017-18 182.6 182.8 0.2 179.8 180.4 0.5 183.5 184.4 0.9 187.9 189.1 1.2 192.3 193.1 0.8 196.6 197.6 0.9 0.0 -0.1 0.0 0.0 0.0 0.1 0.0 0.0 0.0 0.2 0.0 -0.4 0.0 0.0 0.0 0.3 -0.1 0.5 0.0 0.2 0.2 -0.3 0.2 -0.2 0.0 0.5 -0.2 0.6 -0.1 0.1 0.2 -0.3 0.2 -0.2 -0.1 0.8 -0.4 0.8 -0.1 0.2 0.3 -0.3 0.1 -0.2 -0.4 1.0 -0.7 0.8 -0.1 0.2 0.3 -0.3 0.1 -0.2 -0.5 1.3 -0.9 1.0 -0.2 0.3 1 For 2012-13 to 2014-15, child allowances in income support and jobseekers' allowance have been included in tax credits and excluded from social security benefits. 2 Budget measures are shown in Annex A. 4.127 There are a number of modelling changes in universal credit, including refinements to the modelling of the number of in work claimants receiving the universal credit disability additions, and more detailed modelling using DWP's INFORM model, which lowered our forecast of universal credit spending by up to ?0.5 billion in 2017-18. 4.128 There are also some significant changes as a result of new estimates of awards for housing benefit, state pension, and disability benefits: higher state pension caseloads increase spending by up to ?1.3 billion in 2017-18. Recent administrative data suggests that inflows to the state pension are higher, and mortality rates are lower than previously assumed; housing benefit spending is higher by around ?1.0 billion in 2017-18. Around three quarters of the change reflects more detailed modelling of the housing benefit incapacity group by benefit type, and more detailed modelling of housing benefit entitlement to reflect differences in population and rent growth in different regions; and Attendance Allowance (AA) expenditure has been reduced by up to ?0.9 billion in 2017-18. Recent administrative data suggests that inflows to AA will be lower than previously thought. 133 Economic and fiscal outlook Fiscal outlook Tax credits 4.129 Tax credit expenditure falls as a share of GDP over the forecast period, largely because of the intention to uprate the main personal elements by 1 per cent or CPI inflation in the medium term. Compared to our December forecast, expenditure on personal tax credits is broadly unchanged, with slightly lower spending this year being offset by weaker earnings growth in future years. 4.130 Where claimants pay income tax, the amount of personal tax credit that offsets all or some of the tax they would otherwise have paid is classified as negative tax and any remaining amount is treated as spending. Changes in income tax and tax credit thresholds have led to a larger fall in the negative tax share in 2012-13 than we anticipated in earlier forecasts and we now expect a bigger drop next year. As Universal Credit payments will be entirely classified as spending, the negative tax share falls dramatically in later years as claimants migrate onto the new benefit. Table 4.24: Key changes to tax credits since December ? billion Forecast 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 December forecast March forecast Change 1, 2 of which: Average earnings growth 2012-13 in-year expenditure and model calibration Company tax credits changes Budget measures 3 Other 31.7 31.7 0.0 31.7 31.7 0.0 31.8 32.1 0.4 32.3 32.7 0.4 33.3 33.8 0.5 34.2 34.7 0.5 0.0 0.2 0.2 0.3 0.3 0.3 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 0.1 0.0 0.0 0.1 0.0 -0.1 0.1 0.1 0.0 0.2 0.1 0.0 0.2 0.1 0.1 0.2 0.1 0.0 1 This table shows changes to total tax credits, which are split between current receipts (shown in table 4.7) and AME current spending (shown in table 4.18). This split is shown below. Changes to tax credits treated as AME spending Changes to tax credits treated as negative tax 0.8 1.1 1.2 0.9 0.7 0.3 -0.8 -1.0 -0.8 -0.5 -0.2 0.2 2 For 2012-13 to 2014-15, child allowances in income support and jobseekers' allowance have been included in tax credits and excluded from social security benefits. 3 Budget measures are shown in Annex A. Economic and fiscal outlook 134 Fiscal outlook Box 4.1: Universal credit Universal credit has to date been included within our forecast for social security in AME only as an additional cost on top of what would be spent on the existing social security benefits and tax credits system if that system was left in place. Over time people will migrate from the old system to the new and we have been working with DWP and HMRC to show this shift in expenditure in our forecasts (leaving the total cost unaffected). Table A, shown below, compares the current presentation, which reflects how the forecasts are currently produced, with the new presentation, which shows the build up of universal credit. This new presentation is still work in progress, and it is only another way of viewing our existing forecast for total tax credits and DWP benefits in AME, which is still forecast using previous systems, plus the forecast for the marginal, additional costs of universal credit. There are still a number of uncertainties around the new methodology. The figures shown in Table A for the new presentation are therefore not yet robust enough to be used for monitoring, and we will work with DWP and HMRC to improve the new methodology further, for our Autumn 2013 forecast. Table A: Social security, tax credits and UC: current presentation and new presentation including the build-up of UC ? billion Forecast 2013-14 2014-15 2015-16 2016-17 2017-18 Current presentation; PSCE in AME currently includes: DWP benefits in social security, which include: DWP existing benefits, forecast before UC Additional costs of Universal Credit Tax credits, which include: Personal tax credits, forecast before UC 1 Total DWP benefits and personal tax credits New presentation; PSCE in AME will include: DWP benefits in social security, which will include: Universal Credit Remaining DWP benefits Tax credits, which will include: Remaining personal tax credits 2 Total DWP benefits and personal tax credits 163.3 163.3 0.0 167.2 167.1 0.0 171.4 171.3 0.1 175.0 174.7 0.3 179.2 178.9 0.3 27.3 190.6 27.7 194.9 29.3 200.8 31.2 206.2 32.3 211.5 163.3 0.3 163.0 171.7 11.8 159.9 187.7 36.2 151.5 200.5 52.3 148.2 208.8 63.3 145.5 27.3 190.6 23.2 194.9 13.1 200.8 5.7 206.2 2.7 211.5 1 Includes personal tax credits which will become UC, but which were previously included as negative tax 2 All personal tax credits will be replaced by UC by 2018-19 The additional cost of universal credit is expected to be lower than we forecast in December. Table B shows the total movement in the estimate of the additional costs of universal credit. A number of factors have contributed to this change, including: changes in the economic assumptions; policies announced in the 2012 Autumn Statement, including finalising the 135 Economic and fiscal outlook Fiscal outlook universal credit disregards and changes to the uprating of working age discretionary benefits, tax credits and housing benefit, which significantly reduced the costs of universal credit. The total impact of these measures were included in our social security and tax credit forecasts in December, but we do not disaggregate the impact into different components of the social security and tax credit forecasts until after each fiscal event, and therefore the March forecast of the additional costs of universal credit presented in table B also excludes the impact of policy measures announced in the 2013 Budget, which are described in table 4.3; refinements to the methodology and assumptions used for the universal credit forecast, including more detailed modelling using DWP's INFORM model; and changes to a number of policy parameters for universal credit, including small changes to the transitional profile in 2013-14, and how the disability additions within universal credit will be phased in. The revised forecast for the additional costs of universal credit is still subject to significant uncertainties, which we described in Box 4.3 of our December EFO. Table B: Additional costs of universal credit, included within social security in PSCE in AME ? billion Forecast 2013-14 2014-15 2015-16 2016-17 2017-18 -0.1 0.0 December forecast March forecast 0.1 0.0 1.0 0.1 1.8 0.3 2.2 0.3 Public service pensions 4.131 The net public service pensions expenditure forecast is prepared on a National Accounts basis and measures benefits paid less employer and employee contributions received. It includes central government pay-as-you go public service pension schemes and locally administered police and fire-fighters' pension schemes.7 A breakdown for the major schemes covered is included in the supplementary tables on our website. Table 4.25 shows the main changes since the December EFO. 7 The police and firefighters' pension schemes are administered at a local level, however pensions in payment are funded from AME in the same way as other public service pension schemes so they are included in the pensions forecast. Economic and fiscal outlook 136 Fiscal outlook Table 4.25: Key changes to public service pensions since December ? billion Forecast 2012-13 Net public service pensions December forecast March forecast Change Expenditure December forecast March forecast Change of which: CPI Other Income December forecast March forecast Change of which: Budget measures 1 Other 1 2013-14 2014-15 2015-16 2016-17 2017-18 11.0 10.5 -0.4 11.3 11.1 -0.2 12.8 12.4 -0.4 14.0 13.6 -0.3 15.0 14.9 -0.2 16.3 16.2 -0.1 35.2 34.6 -0.6 36.9 36.4 -0.5 38.8 38.2 -0.5 40.5 40.0 -0.5 42.4 42.0 -0.4 44.5 44.1 -0.3 0.0 -0.6 0.0 -0.5 0.1 -0.6 0.1 -0.6 0.2 -0.5 0.2 -0.5 -24.2 -24.1 0.2 -25.6 -25.3 0.3 -25.9 -25.8 0.1 -26.5 -26.4 0.1 -27.3 -27.1 0.2 -28.2 -27.9 0.3 0.0 0.2 0.0 0.3 -0.1 0.2 -0.1 0.2 0.0 0.2 0.0 0.3 Budget measures are shown in Annex A. 4.132 Gross expenditure rises steadily across the forecast as the age profile of each scheme's membership changes and people live longer. The reduction in expenditure since the December forecast largely reflects latest outturn and in-year information, particularly on lump sums, which feeds through to all later years. There has been a very small impact from the increase in our forecast of CPI. 4.133 The income of each pension scheme is almost entirely made up of employer and employee pension contributions, and is largely driven by the pensionable paybill. The small reduction in pensions income since the December forecast also reflects latest outturn and in-year information. 4.134 The forecast does not take account of the Public Service Pensions Bill that is still passing through Parliament, which will lead to new schemes being implemented in April 2015. We expect these changes to have a minimal impact on income and expenditure over this forecast period.8 8 Information on the new schemes is available at http://www.hm-treasury.gov.uk/tax_pensions_index.htm 137 Economic and fiscal outlook Fiscal outlook EU contributions 4.135 The main component of the AME transfer to EU institutions is the UK's gross national income (GNI) contribution, minus the UK's abatement. The forecast for the GNI-based contribution depends mainly on the level of the agreed EU Budget and the relative GNI of each member state. The UK abatement is affected by the UK's share of EU VAT and the UK's share of EU receipts.9 4.136 The changes in our latest forecast for these expenditure transfers are shown in Table 4.27. The largest change is as a result of the new Multi-annual Financial Framework (MFF) agreed at the February European Council (FEC), which reduces UK contributions to the EU by ?3.5 billion over the forecast period to 2017-18. 4.137 The new MFF sets the EU payment ceiling for the period 2014 to 2020 at EUR1,024 billion10, EUR50 billion lower than our previous modelling assumption of EUR1,074 billion. The agreed payment ceilings are used to derive annual budgets by applying assumed implementation rates each year. The assumed annual budgets over the period 2014 to 2020 are EUR994 billion, which is EUR24 billion lower than our December EFO. It is the assumed annual budgets that determine the UK contributions rather than the payment ceilings. 4.138 The table below shows the reductions in the payment ceilings agreed at the FEC, and changes in the assumed implementation rates and derived annual budgets, compared with the modelling assumptions used in our December EFO. In addition to lower payment ceilings and corresponding decreases in annual budgets, we have revised our implementation rates to assume higher implementation in the early years of the next MFF. This is because spending is likely to be much tighter, given the decreases in payment ceilings, and because we expect some existing projects to require finance in the next MFF. This explains the larger decreases in 2013-14 of ?0.6 billion and 2014-15 of ?1.4 billion, and then smaller decreases in later years. 9 A further supplementary fiscal table on our website provides further details of UK transactions with the EU, including how all these various contributions score in the National Accounts and in this forecast. 10 EUR908.4 billion in 2011 prices. Economic and fiscal outlook 138 Fiscal outlook Table 4.26: EU annual budget ? billion Forecast 20142020 total 2014 2015 2016 2017 2018 2019 2020 December forecast Payment ceilings Implementation rates Assumed Budget 164.2 90.7 148.9 163.7 90.7 148.6 145.4 94.0 136.7 142.1 97.3 138.2 146.5 97.3 142.5 159.0 97.2 154.6 153.2 97.3 149.0 1074 March forecast Payment ceilings 1 Implementation rates Assumed Budget 135.9 100.0 135.9 141.9 97.7 138.6 144.7 95.4 138.0 142.8 95.4 136.2 149.1 95.4 142.3 153.4 97.7 149.9 156.3 98.1 153.3 1024 1 1018 994 Total payment ceiling of EUR1,024 billion is equivalent to EUR908.4 billion in 2011 prices. 4.139 Although the MFF deal has been unanimously agreed by member states, it still requires agreement by the European Parliament before it comes into effect, which could mean further changes. We expect this to be agreed over the next few months, well in advance of our Autumn Statement forecast. 4.140 The forecast also shows an increase in the UK contribution in 2012-13 and 2013-14 of ?0.2 billion and ?0.7 billion as a result of us assuming an increase in the 2013 budget of EUR7 billion through amending budgets. This is based on there being significant pressure on the 2013 budget, the fact that the 2012 budget increased by EUR6.7 billion through amending budgets, and we expect the final stages of the MFF agreement process set out above to involve some trade offs with the 2013 budget. 4.141 Our forecast of the sterling/euro exchange rate is lower compared with December. This increases the UK's contributions in sterling terms from 2015-16 onwards. Table 4.27: Key changes to EU contributions since December ? billion Forecast 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 December forecast March forecast Change of which: 2013 Budget assumption New Multi-annual Fiscal Framework deal Exchange rate Other 7.3 7.4 0.1 6.6 6.5 -0.1 7.3 5.7 -1.6 6.6 6.1 -0.5 5.8 5.9 0.1 6.0 6.0 0.0 0.2 0.0 0.0 0.0 0.7 -0.6 -0.1 0.0 0.0 -1.4 0.0 -0.2 0.0 -0.7 0.3 -0.1 0.0 -0.2 0.4 -0.1 0.0 -0.6 0.6 0.0 139 Economic and fiscal outlook Fiscal outlook Locally financed expenditure 4.142 Locally financed expenditure consists mainly of local authority self-financed expenditure (LASFE) - local authority spending that is not financed by central government grants - and Scottish Government spending financed by local taxation. The main components of LASFE are spending financed by council tax and, from 2013-14 onwards, business rates that are retained by local authorities. 4.143 Table 4.28 summarises the main changes to our forecasts for current and capital LASFE. Further details on all the components of our local authorities spending forecasts, including LASFE, are given in the supplementary tables to our fiscal forecast that are on our website. These further tables also include a table which shows our detailed assumptions on council tax increases, which are explained further below. 4.144 Overall the medium-term changes compared to our December forecast are relatively small. On current expenditure the forecast is ?0.4 billion higher in 2017-18 but most of this is due to a change in our council tax forecast which is matched by an equivalent change to the receipts forecast. On capital expenditure the forecast is ?1.3 billion higher than December by 2017-18, but close to half of this is due to a change to local authority spending which is fiscally-neutral as it is offset by an equivalent change to our public corporations' capital expenditure forecast. 4.145 For 2012-13 we have revised our forecasts to be consistent with outturn data on local authority spending in the first three quarters of the year.11 The degree to which local authorities underspend against their budgets and add to their reserves is a particular area of uncertainty in the forecast. As we explained in our October 2012 Forecast evaluation report, the outturn for current LASFE in 201112 was much lower than we had previously forecast, because local authorities added ?2.7 billion to their revenue reserves, which reduced their spending. On the basis of the latest outturn data we now assume that local authorities add ?1.5 billion to their reserves in 2012-13, which is ?0.7 billion less than we assumed in our December EFO. Overall, for English local authorities, we assume that current spending will be ?3 billion below budgets, and that capital spending will be ?2 billion below budgets.12 11 The outturn data we have used are the quarterly Capital Payment Returns and Quarterly Revenue Outturns collected from English local authorities by the Department for Communities and Local Government (DCLG), and the quarterly Capital Return collected from Scottish local authorities by the Scottish Executive. 12 The budgets data we refer to for comparison purposes are the Revenue Budgets and the Capital Expenditure Returns collected from English local authorities by DCLG. We use similar data collected by the devolved administrations. Economic and fiscal outlook 140 Fiscal outlook 4.146 For future years we continue to assume that local authorities make net additions to their reserves. Evidence suggests that individual local authorities build up their reserves to act as buffers against future uncertainties and pressures on their finances. The uncertainties for local authorities are greater now with the additional flexibilities and potential pressures created by new schemes such as business rates retention and localised council tax reduction. The bulk of their reserves are held in earmarked funds which they set in the context of medium term financial plans. Our forecast assumes that authorities make net additions to their reserves of around ?1.0 billion in 2013-14 and 2014-15, reducing to ?0.5 billion by the end of the forecast period, which is broadly unchanged from our December forecast. 4.147 We have revised our forecasts of council tax increases in 2013-14 to reflect the latest CIPFA report of an expected overall increase in England of 0.8 per cent. For 2014-15 onwards, we continue to assume that council tax increases in England rise in line with our CPI forecast. This follows the Government's announcement that referenda would be triggered if English councils set their council tax increases at 2 per cent or above. We also assume this applies in Wales from 2013-14 onwards, and in Scotland from 2016-17 onwards. Council tax increases are assumed to be frozen in Scotland until the end of the current Scottish Parliament. 4.148 The forecast for council tax also contains an assumption for the increase in the council tax base, which is net of the various discounts and reductions offered by local authorities, for instance for students and empty homes. These reductions now include the new localised council tax reduction schemes, which start in 2013-14, and replace the previous system of council tax benefits. For England, Scotland and Wales we assume that the reductions offered by local authorities under this new scheme will be 90 per cent of the forecast for spending on the previous council tax benefit regime. This matches the additional funding that local authorities will receive. There is some risk that local authorities will offer higher reductions than this, at least initially, which could reduce council tax and LASFE. Our assumptions about increases in council tax are neutral for the overall fiscal aggregates as they are also applied to the council tax projections in our receipts forecast. 4.149 We have also revised our forecast of business rates retained by local authorities, which are included within LASFE from 2013-14 onwards, in line with the revised forecast for business rates included in the forecast for current receipts. 141 Economic and fiscal outlook Fiscal outlook Table 4.28: Key changes to locally financed expenditure since December ? billion Forecast 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Locally-financed current expenditure December forecast March forecast Change of which: Council tax 1 Net use of current reserves Other Locally-financed capital expenditure December forecast March forecast Change of which: Community Infrastructure Levy Unsupported borrowing Remove TfL and HRA capital spending 2 Other 23.2 23.8 0.6 36.0 36.1 0.1 37.8 38.0 0.2 39.2 39.5 0.3 40.6 41.0 0.4 42.7 43.1 0.4 0.0 0.7 0.0 0.2 -0.1 0.0 0.3 -0.1 0.0 0.3 0.0 0.0 0.3 0.0 0.1 0.3 0.0 0.2 6.2 7.1 0.9 4.8 6.4 1.6 4.9 6.3 1.4 5.3 6.8 1.5 5.6 7.0 1.4 5.4 6.7 1.3 -0.3 -0.8 1.9 0.0 -0.4 0.6 1.4 0.0 -0.1 0.6 0.9 0.0 0.0 0.6 0.9 0.0 0.0 0.6 0.7 0.0 0.1 0.6 0.6 0.1 1 includes changes to the council tax base and an increase in our assumed council tax increases in England in 2013-14 from 0.3% to 0.8%. 2 TfL and HRA capital spending included in the PC capital expenditure forecast, reflecting the classification of TfL and HRA in the National Accounts. 4.150 Our forecasts for local authority capital LASFE from 2013-14 onwards have changed for three main reasons. The largest changes are in respect of the adjustments that remove our forecasts of capital spending by Housing Revenue Accounts (HRAs) and Transport Trading Limited (TTL) subsidiaries, because these bodies are treated as public corporations in the National Accounts. We have increased our forecasts of capital spending by these bodies reflecting the latest information on 2011-12 outturns, and new forecasts received from Transport for London. These changes are neutral because they switch spending from LASFE to our forecast of public corporations net capital spending. 4.151 The other main change to our forecast for capital LASFE is that we have increased our forecast for local authorities unsupported borrowing from 2013-14 onwards. This reflects the latest information on English local authorities' plans for capital expenditure in 2013-14 collected by DCLG, and the latest information on Scottish local authorities' quarterly outturns for capital spending in 2012-13, which showed that there was additional unsupported borrowing which we had not previously included in our forecasts. We have also reduced our forecasts of capital spending financed from the new Community Infrastructure Levy, reflecting latest information that take-up of this new scheme has been lower than expected. Economic and fiscal outlook 142 Fiscal outlook Public corporations capital expenditure 4.152 Public corporations capital expenditure is lower in every year of the forecast period compared to the December EFO. The revision is mostly driven by the 2011-12 outturn for HRA net capital expenditure being ?0.9 billion lower than we expected in our December forecast, which is carried forward in every subsequent year of the forecast. 4.153 As in previous EFOs, we have revised the capital spending forecast of the TTL subsidiaries on the basis of detailed information supplied by Transport for London, which has enabled us to improve the accuracy of our forecast for capital spending by the TTL subsidiaries. 4.154 The revisions in our forecast of public corporations capital expenditure because of changes to TTL and HRA net capital expenditure are offset within our forecast for capital LASFE. This is because the finance for TTL and HRA net capital spending is initially included within the local authority sector but the final TTL and HRA spending is then switched into public corporations capital spending, reflecting the classification of TTL and HRA in the National Accounts. Debt interest 4.155 Central government debt interest payments are broadly flat as a share of GDP between 2011-12 and 2014-15 as existing debt is refinanced at current lower interest rates. Payments then rise as a share of GDP over the remainder of the forecast period, reflecting expected increases in interest rates and RPI inflation, and the rising stock of debt. 4.156 Compared to December, revisions to our RPI forecast reduce debt interest costs in 2012-13, but increase it in all subsequent years. The 2013-14 financing remit allows for greater Treasury bill issuance and lower gilt issuance than we had assumed, lowering debt interest costs slightly in that year. But a higher CGNCR, and market interest rates increase payments thereafter. 4.157 Following the reclassification of B&B and NRAM into the central government sector, our forecasts assume that the interest they pay on debt provided by the private sector increases central government debt interest payments. Interest rates have fallen relative to what had been assumed in earlier business plans, lowering projected payments in the medium term. 143 Economic and fiscal outlook Fiscal outlook Table 4.29: Key changes to debt interest since December ? billion Forecast 2012-13 December forecast March forecast Change of which: Financing Gilt rates Short rates Inflation B&B and NRAM Other 2013-14 2014-15 2015-16 2016-17 2017-18 47.1 46.5 -0.6 48.6 49.5 0.9 51.8 51.8 0.0 56.6 57.8 1.2 61.6 64.4 2.8 67.1 71.3 4.2 0.0 0.0 0.0 -0.3 0.0 -0.2 -0.2 0.1 0.0 1.0 -0.1 0.0 -0.1 0.1 0.0 0.3 -0.1 -0.1 0.4 0.4 0.1 0.6 -0.3 0.1 0.8 1.0 0.1 1.0 -0.4 0.3 1.3 1.5 0.3 1.1 -0.3 0.4 4.158 We include a breakdown of the debt interest forecast by financing component in the supplementary fiscal tables on our website, including a distinction between debt interest on conventional gilts for new and existing debt. Payments on the existing stock of conventional gilts are fixed for the lifetime of those gilts. With a long average maturity for UK conventional gilts, around half of the payments relate to static debt interest costs on existing conventional gilts. We also include a separate ready-reckoner table showing the approximate effect on debt interest of movements in interest rates, RPI inflation and the CGNCR. Other AME spending 4.159 Current and capital expenditure from National Lottery grants is forecast to be ?0.5 billion higher by 2017-18, compared with our December forecast. We now assume 5 per cent annual growth in lottery income, which is broadly consistent with increases seen recently in outturn, because we believe income will continue to increase as a result of the terms achieved in the third licence since February 2009, which more closely aligns the operator's commercial incentives with maximising returns to good causes. We assume that this additional income for good causes will be fully drawn down by Lottery distributors by 2016-17. 4.160 The main change to other PSCE items in departmental AME and other PSGI items in departmental AME is the inclusion in 2011-12 of Bradford & Bingley and Northern Rock (Asset Management) spending, which is consistent with the ONS including this for the first time in public sector finances. Our December EFO preempted this, so it was already included for the forecast years. In 2012-13, the Special Liquidity Scheme capital receipt has been re-classified by the ONS from spending to current receipts, so spending increases by ?2.3 billion, offset by an increase in receipts. 4.161 The forecast of expenditure by the BBC has decreased in 2012-13 and increased in 2013-14 and 2014-15 to reflect refinements in BBC spending plans. Some Economic and fiscal outlook 144 Fiscal outlook savings initiatives have come through earlier than expected, some costs have slipped back, and some additional spending is expected to be financed from cash reserves in the short term. 4.162 Table 4.18 shows a separate entry in PSCE in AME for single-use military expenditure (SUME). This expenditure is treated as capital DEL in the control framework, but is classified as current expenditure in the National Accounts. To align with National Accounts we therefore exclude this spending from PSGI in CDEL and add it to PSCE within current AME expenditure. 4.163 The reduction in SUME in 2012-13 of ?0.4 billion since our December forecast reflects in-year spending data submitted by departments, which shows more underspending than the ?1.3 billion we assumed in our December forecast. We have also revised our underspend assumption in 2014-15 so we now assume ?1 billion of underspend in both 2013-14 and 2014-15. SUME is only one component of the defence budget and underspends in SUME can be offset by increases in capital and current spending in the Ministry of Defence budget. 4.164 Environmental levies include spending on DECC levy-funded policies such as the Renewables Obligation, Feed-In Tariffs and Warm Homes Discount. Most of these are fiscally-neutral as they are balanced by receipts, and the forecasts are explained in the receipts section. The Renewable Heat Incentive policy, which is not offset by receipts, has decreased by ?0.2 billion by 2017-18 since December as a result of a slower take-up rate. 4.165 The change in our forecast of VAT refunds is explained in paragraph 4.85 of the receipts section of this chapter. 4.166 The AME forecast includes forecasts for the further adjustments that are included in the National Accounts definitions for PSCE and PSGI.13 Explanations and the background to all the National Accounts adjustments are given in Annex D to PESA 2012.14 4.167 Table 4.19 shows that our forecasts for current accounting adjustments have decreased by around ?1 billion in all years. This includes a ?0.5 billion revision to the forecast of the adjustment ONS make to reconcile different data sources for debt interest payments and a ?0.3 billion revision to the forecast of the HRA imputed subsidy. Our forecasts for capital accounting adjustments are largely unchanged over the forecast period. 13 Further details and data for these National Accounts adjustments are provided in the supplementary fiscal tables on our website. 14 See HM Treasury, July 2012, Public Expenditure Statistical Analyses 2012. 145 Economic and fiscal outlook Fiscal outlook Loans and other financial transactions 4.168 Public sector net borrowing (PSNB) is the difference between total public sector receipts and expenditure each year measured on an accrued basis. As we show in Table 4.30, and as we explain in greater detail in the next section, we forecast that PSNB will fall from ?86 billion in 2012-13 to ?42 billion in 2017-18. 4.169 But the public sector's fiscal position also depends on the flow of financial transactions, which are mainly loans and repayments between Government and the private sector. These do not directly affect PSNB, but they do lead to changes in the Government's cash flow position and stock of debt. 4.170 The public sector net cash requirement (PSNCR) is the widest measure of the public sector's cash flow position in each year.15 It drives the forecast of public sector net debt (PSND), which is largely a cash measure. Estimating the PSNCR also allows us to estimate the central government net cash requirement (CGNCR), which in turn largely determines the Government's net financing requirement - the amount it needs to raise from treasury bills, gilt issues and National Savings. 4.171 Differences between the PSNCR and PSNB can be split into the following categories: Loans and repayments: loans that the public sector make to the private sector and that it expects to be repaid do not directly affect PSNB, but the cash flows do affect the PSNCR; Cash flow timing effects: PSNB is an accruals measure of the budget deficit in which, where possible, spending and receipts are attributed to the year that they relate to. In contrast PSNCR is a cash measure in which spending and receipts are attributed to the year in which the cash flow takes place; Transactions in company securities: the public sector may buy or sell company securities, such as corporate bonds or equities. When it swaps one asset for an equivalent cash asset the transaction does not affect PSNB, but the associated cash flow will affect PSNCR; and Other: this category includes one-off financial transactions that do not fall into the categories above and some other adjustments. 15 Consistent with the measures of debt and deficit used in this forecast, PSNCR excludes the temporary effects of financial sector interventions. Economic and fiscal outlook 146 Fiscal outlook 4.172 Table 4.30 shows the steps from PSNB to PSNCR while Table 4.31 highlights the changes since our December forecast. Table 4.30: Reconciliation of PSNB and PSNCR ? billion Forecast 2012-13 Public sector net borrowing Loans and repayments of which: Student loans1, 2 Financial sector interventions3 DfID Ireland Green Investment Bank Business Finance Partnership Business Bank Budget lending measures Other Cash flow timing effects of which: Student loan interest2 PAYE income tax and NICs Indirect taxes Other receipts Index-linked gilts3 Conventional gilts Other expenditure Transactions in company securities of which: Northern Rock plc Royal Mail pension asset disposal Other of which: Royal Mail transfer Asset Purchase Facility proceeds Manchester Airport Group Public sector net cash requirement 2013-14 2014-15 2015-16 2016-17 2017-18 86 10.4 108 14.5 97 14.9 87 14.0 61 11.7 42 11.5 5.8 -1.3 1.0 1.2 0.2 0.0 0.0 0.0 3.3 -1.9 7.3 0.0 1.7 0.8 0.7 0.5 0.1 1.3 2.1 9.6 8.6 0.0 1.1 0.0 0.9 0.4 0.3 1.9 1.8 -2.7 9.3 0.0 1.1 0.0 0.0 0.3 0.3 1.9 1.0 -4.1 9.6 0.0 1.1 0.0 0.0 0.1 0.3 0.0 0.7 6.9 9.6 0.0 1.1 0.0 0.0 0.0 0.2 0.0 0.6 4.2 0.8 0.6 0.7 0.1 -8.5 3.4 0.8 -9.1 1.1 1.3 0.6 0.8 1.4 3.6 0.8 -1.0 1.6 0.8 0.9 0.6 -10.6 3.3 0.8 0.0 2.4 1.8 1.0 0.4 -13.4 2.9 0.8 0.0 3.2 2.5 0.8 0.4 -3.4 2.6 0.8 0.0 4.2 1.9 1.0 0.4 -6.7 2.5 0.8 0.0 -0.1 -9.0 19.0 0.0 -1.0 -19.7 0.0 0.0 0.3 0.0 0.0 0.3 0.0 0.0 0.3 0.0 0.0 0.3 23.5 -5.1 0.4 0.0 -20.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 105 111 110 97 80 58 A breakdown based on ONS classifications is available on our website. 1 The table shows the net flow of student loans and repayments. This can be split out as follows: Cash spending on new loans 7.8 9.6 11.2 12.3 12.9 13.4 Cash repayments 2.0 2.3 2.6 2.9 3.4 3.8 2 Cash payments of interest on student loans are included within 'Loans and repayments' as we cannot easily separate them from repayments of principal. To prevent double counting the 'Student loan interest' timing effect therefore simply removes accrued interest. 3 These reconciliations to the net cash requirement do not affect public sector net debt (ex). 147 Economic and fiscal outlook Fiscal outlook Table 4.31: Changes in the reconciliation of PSNB and PSNCR since December ? billion Forecast 2012-13 Public sector net borrowing Loans and repayments of which: Student loans1, 2 Financial sector interventions3 DfID Ireland Green Investment Bank Business Finance Partnership Business Bank Budget lending measures Other Cash flow timing effects of which: Student loan interest2 PAYE income tax and NICs Indirect taxes Other receipts Index-linked gilts3 Conventional gilts Other expenditure Transactions in company securities of which: Northern Rock plc Royal Mail pension asset disposal Other of which: Royal Mail transfer Asset Purchase Facility proceeds Manchester Airport Group Public sector net cash requirement 2013-14 2014-15 2015-16 2016-17 2017-18 6 -1.2 8 2.0 9 2.3 14 1.7 12 -0.4 11 -0.6 0.1 0.0 0.0 -0.4 -0.6 -0.2 0.0 0.0 0.0 0.8 -0.1 0.0 0.5 0.4 -0.3 0.0 0.0 1.3 0.2 -0.8 -0.3 0.0 0.0 0.0 0.9 0.0 0.0 1.9 -0.1 0.0 -0.5 0.0 0.0 0.0 0.0 0.2 0.0 1.9 0.0 -0.8 -0.5 0.0 0.0 0.0 0.0 0.1 0.0 0.0 0.1 -0.8 -0.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 -2.2 0.0 -0.2 -0.1 -0.4 0.6 0.6 0.3 0.0 0.0 -0.9 -0.2 0.3 -1.1 0.6 0.4 0.0 0.0 0.0 -0.1 -0.1 -0.4 0.2 0.3 0.0 0.0 -0.1 -0.1 0.0 -0.7 -0.3 0.4 0.0 0.0 0.6 -0.1 0.0 -1.3 -0.5 0.4 0.0 0.1 -0.1 -0.2 0.0 -1.5 -1.0 0.4 0.0 0.0 0.0 -4.7 0.0 0.0 -0.3 0.0 0.0 0.5 0.0 0.0 0.6 0.0 0.0 1.4 0.0 0.0 3.0 0.0 -5.1 0.4 0.0 -0.3 0.0 0.0 0.5 0.0 0.0 0.6 0.0 0.0 1.4 0.0 0.0 3.0 0.0 1 9 12 15 12 11 A breakdown based on ONS classifications is available on our website. 1 The table shows the net flow of student loans and repayments. This can be split out as follows: Cash spending on new loans 0.1 -0.1 -0.4 -0.5 -0.5 -0.6 Cash repayments 0.0 0.0 0.0 0.0 0.0 0.0 2 Cash payments of interest on student loans are included within 'Loans and repayments' as we cannot easily separate them from repayments of principal. To prevent double counting the 'Student loan interest' timing effect therefore simply removes accrued interest. 3 These reconciliations to the net cash requirement do not affect public sector net debt (ex). Economic and fiscal outlook 148 Fiscal outlook Loans and repayments 4.173 PSNCR is higher than PSNB in each year of our forecast, which largely reflects net lending by the Government to the private sector, in particular for student loans. The recent student loan reforms have increased the size of upfront loans, with repayments being made over a more prolonged period. In our July 2012 Fiscal sustainability report we showed that on current policy settings we might expect the difference between new loans and repayments to peak around 2030 and then fall away. 4.174 For the English scheme, we assume that the initial average loan per student for tuition fees was ?7,000 and the average maintenance loan in 2012-13 was ?3,300. Final details on the average loan per student are yet to be confirmed, but overall spending on loans has broadly been in line with our earlier forecasts. In line with recent announcements, we assume the maximum loan amounts rise by 1 per cent in 2014-15. The number of part-time students has fallen by more than expected and we project lower numbers in the future, reducing overall spend in future years. Repayments are also slightly lower due to lower earnings growth. 4.175 Other loans include lending through the Green Investment Bank (GIB) and the Department for International Development's (DfID) contributions to multilateral development banks, as well as loans to Ireland and a range of other schemes. Loans issued in the current year to Ireland and through the GIB and Business Finance Partnership have been lower than forecast and we now expect the originally planned outlays to be made up in following years. Budget measures relating to the Help to Buy and Build to Rent schemes also increase lending between 2013-14 and 2015-16. Cash flow timing effects 4.176 As discussed above, to move from PSNB to PSNCR it is necessary to make an adjustment for the likely impact of timing differences between cash flows and accruals. If receipts are forecast to rise over time, the cash received in any given year will generally be lower than the accrued tax receipts, and the difference increases over time. 4.177 A large component of the receipts timing adjustment relates to the interest on student loans. This is notionally included in the accrued measure of public sector current receipts as soon as the loan is issued. However, cash repayments are not actually received until the point at which students earn sufficient income. 4.178 Since our December forecast, the ONS has announced its intention to accrue Swiss Tax payments made in January into May 2013. Cash income tax payments in 2013-14 are also expected to be weaker relative to accrued receipts. 149 Economic and fiscal outlook Fiscal outlook 4.179 Similar timing adjustments are made for expenditure. The largest adjustment is for the timing of payments on index-linked gilts. These adjustments are very sensitive to RPI inflation, as well as to the profile of redemptions, which is not smooth. Positive RPI inflation raises the amount the Government is committed to pay on index-linked gilts, and this commitment is recognised in PSNB each year. But the actual cash payments will not occur until redemption of the gilt which may be many years in the future. Higher RPI inflation in the medium term increases the size of the necessary accruals adjustments. 4.180 There are also lags due to the timing of cash payments through the year and from auction price effects, which affect conventional gilts. For gilts sold at a premium, the cash payments to cover coupons will be larger than the amounts accrued in debt interest. The accruals adjustment for the current year is larger than we assumed in December, but as we now expect gilts to be sold at less of a premium in the future, accruals effects decline over time. 4.181 Timing effects relating to other elements of cash spending are much more difficult to forecast and the figures are subject to large revisions. We therefore assume that the adjustment over the forecast period is equal to the historical average. Transactions in company securities 4.182 Consistent with the Charter for Budget Responsibility, and our wider approach to policy announcements, we only include the impact of financial asset sales or purchases once firm details are available that allow the effects to be quantified with reasonable accuracy. The Government intends to sell the non-gilt liquid assets that it received in April alongside the transfer of Royal Mail's historic pension liabilities within two years. We do not make any assumptions for the sales of illiquid assets as it is not possible to do so with reasonable accuracy. Other factors 4.183 The transfer of the Royal Mail pension fund assets reduced PSNB by ?28 billion in April 2013. However, only ?4.5 billion was liquid cash that reduced PSNCR, so the initial transfer reduced net borrowing by ?23.5 billion more than it reduced PSNCR. 4.184 The ONS has now announced how it will treat transfers between the Treasury and the Asset Purchase Facility (APF). Although the overall cash consequences are as we assumed in December, the final treatment does affect what scores as public sector net borrowing versus financial transactions (see from paragraph 4.30). 4.185 Manchester Airport Group (MAG) completed its purchase of Stansted Airport in February. MAG had previously been owned by the public sector and classified as a public corporation, but the newly expanded body will be an equal joint venture Economic and fiscal outlook 150 Fiscal outlook between local authorities and the private sector. The accounting treatment of the new body is yet to be announced by the ONS, but for this forecast we have assumed that half of the company will remain on the public sector balance sheet. This raises public sector net debt by around ?0.4 billion in 2012-13. Central government net cash requirement 4.186 The other important cash measure is the central government net cash requirement (CGNCR). The inclusion of Bradford & Bingley and Northern Rock (Asset Management) in the central government sector means that this is no longer simply a measure of the cash required by the Exchequer to fund its operations, which forms the basis for the Government's net financing requirement.16 We separate out transactions involving Bradford & Bingley and Northern Rock (Asset Management) in Table 4.32. 4.187 The table also shows how CGNCR relates to PSNCR and Table 4.33 sets out the changes in this relationship since the December forecast. The CGNCR is derived by adding and removing transactions that are associated with local authorities and public corporations from the PSNCR. Excluding Bradford & Bingley and Northern Rock (Asset Management), changes in the CGNCR forecast closely follow changes to our PSNCR forecast. We expect local authorities and public corporations to be marginal net lenders from 2013-14 onwards. Table 4.32: Reconciliation of PSNCR and CGNCR ? billion Forecast Outturn 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Public sector net cash requirement of which: Local authorities and public corporations NCR Central government NCR own account CGNCR own account Net lending within the public sector Central government net cash requirement Net lending from B&B and NRAM to the rest of CG CGNCR excl. B&B and NRAM 124 105 111 110 97 80 58 7 1 0 -1 -1 -1 -2 118 103 111 111 98 81 60 118 103 111 111 98 81 60 9 2 3 2 2 2 2 127 105 114 113 100 83 61 3 102 3 111 3 110 2 98 1 82 3 59 16 The Government is publishing a financing remit for 2013-14 alongside the Budget. The OBR provides the Government with the forecast of the CGNCR for this purpose, but plays no further role in the derivation of the net financing requirement. 151 Economic and fiscal outlook Fiscal outlook Table 4.33: Changes in the reconciliation of PSNCR and CGNCR since December ? billion Forecast Outturn 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Public sector net cash requirement 0 1 9 12 15 12 11 0 1 1 1 1 1 1 0 -1 8 11 14 11 10 CGNCR own account 0 -1 8 11 14 11 10 Net lending within the public sector 0 -1 1 0 0 0 0 0 -1 9 11 14 11 10 0 -1 0 8 0 11 0 15 0 12 0 11 of which: Local authorities and public corporations NCR Central government NCR own account Central government net cash requirement Net lending from B&B and NRAM to the rest of CG CGNCR excl. B&B and NRAM Economic and fiscal outlook 152 Fiscal outlook Box 4.2: Fiscal impact of the financial interventions We have certified the Treasury's approach for calculating the net cost or benefit to the taxpayer of the interventions to stabilise the financial sector. In particular, these are: equity injections into RBS, Lloyds (LBG) and Northern Rock plc; the Asset Protection Scheme (APS); bank financing support through the Special Liquidity Scheme (SLS) and Credit Guarantee Scheme (CGS); holdings in Bradford & Bingley (B&B) and Northern Rock (Asset Management) (NRAM); and other loans through the Financial Services Compensation Scheme (FSCS) and various wholesale and depositor guarantees. The APS, SLS and CGS have all now closed, with net gains to the Exchequer of ?5 billion, ?2.3 billion and ?4.3 billion respectively. These figures have already been captured in public sector net borrowing. Changes in the market prices of the Government's shareholdings in RBS and LBG are not reflected in PSNB and PSND. There will be impacts on PSND (and possibly PSNB) when the shares are sold, but the eventual cost or benefit is highly uncertain. The Treasury uses market prices to value these shares. On the basis of the latest volume weighted average market prices this implies a loss of ?19.8 billion on these investments, relative to an implied loss of ?28.1 billion reported in the December EFO. As the shares were overall bought at above market prices, public sector net debt is already ?12.4 billion higher as a result of these transactions. The Treasury continue to assume that the other interventions, including holdings in B&B and NRAM will not materially affect the aggregate cost or benefit. Although the Exchequer is expected to recover its support for B&B and NRAM in cash terms, there may be a net present value cost once risk and the delay in proceeds are considered. Overall, their approach implies an estimated direct loss to the taxpayer on the financial interventions of ?8.2 billion. This is smaller than the December estimate of a loss of ?16.5 billion, as RBS' and Lloyds' equity values have since risen. If all interventions were financed through debt, the Treasury estimate that additional debt interest costs would have totalled ?14.7 billion over the 55 months to date. 153 Economic and fiscal outlook Fiscal outlook The key fiscal aggregates 4.188 Our central forecast for the key fiscal aggregates is presented in Table 4.34. These incorporate the forecasts for receipts, expenditure and financial transactions set out earlier in this chapter. In this section we explain the changes in four key fiscal aggregates: public sector net borrowing: the difference between total public sector receipts and expenditure on an accrued basis each year. As the widest measure of borrowing it is a key indicator of the fiscal position and useful for illustrating the reasons for changes since the previous forecast; the current budget: the difference between public sector current expenditure and receipts each year. In other words this is public sector net borrowing excluding borrowing to finance investment; the cyclically-adjusted current budget: the surplus on the current budget adjusted to remove the estimated effect of the economic cycle. It represents an estimate of the underlying or 'structural' surplus on the current budget, in other words the current budget we would see if the output gap was zero. It is used as the target measure for the Government's fiscal mandate; and public sector net debt: a stock measure of the public sector's net liability position i.e. its liabilities minus its liquid assets. It is broadly the stock equivalent of public sector net borrowing, but measured on a cash rather than an accrued basis. It is also the fiscal measure used for the Government's supplementary fiscal target Economic and fiscal outlook 154 Fiscal outlook Table 4.34: Fiscal aggregates Per cent of GDP Forecast Outturn 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Receipts and expenditure 37.5 Public sector current receipts (a) 45.5 Total managed expenditure (b) of which: 42.2 Public sector current expenditure (c) 1.9 Public sector net investment (d) 1.4 Depreciation (e) Deficit 7.9 Public sector net borrowing (b-a) -6.0 Surplus on current budget (a-c-e) Cyclically-adjusted net borrowing 6.0 Primary balance -5.1 -3.2 Cyclically-adjusted primary balance Fiscal mandate and supplementary target Cyclically-adjusted surplus on current -4.2 budget 71.8 Public sector net debt1 Financing Central government net cash 8.3 requirement Public sector net cash requirement 8.1 Stability and Growth Pact 7.8 Treaty deficit3 2 5.9 Cyclically-adjusted Treaty deficit 3 86.0 Treaty debt ratio Surplus on current budget Net investment Public sector net borrowing Central government net cash requirement Public sector net debt Underlying PSNB PSNB ex. Royal Mail and APF (? billion) PSNB ex. Royal Mail and APF (per cent of GDP) Cyclically-adjusted PSNB ex. Royal Mail and APF (per cent of GDP) Memo: Output gap (per cent of GDP) 38.0 43.6 38.4 45.2 38.2 44.0 38.1 43.1 38.4 41.8 38.3 40.5 42.5 -0.4 1.4 42.2 1.5 1.4 41.0 1.6 1.4 40.2 1.5 1.4 39.0 1.4 1.4 37.8 1.4 1.4 5.6 -6.0 3.6 -3.5 -1.5 6.8 -5.2 4.3 -4.8 -2.3 5.9 -4.3 3.3 -3.8 -1.2 5.0 -3.5 2.7 -2.6 -0.3 3.4 -1.9 1.3 -0.6 1.4 2.2 -0.9 0.6 0.9 2.5 -4.0 -2.8 -1.7 -1.2 0.1 0.8 75.9 79.2 82.6 85.1 85.6 84.8 6.8 7.1 6.8 5.8 4.6 3.3 6.8 7.0 6.6 5.6 4.4 3.1 5.6 3.6 90.7 6.8 4.4 94.9 5.2 2.8 100.8 3.5 1.5 100.8 2.3 0.7 99.4 -61 26 87 -35 26 61 -16 26 42 -92 29 121 -93 -6 86 6.0 3.4 98.6 ? billion -84 -71 24 27 108 97 127 105 114 113 100 83 61 1104 1189 1286 1398 1502 1580 1637 121 121 120 108 96 67 43 7.9 7.8 7.5 6.5 5.5 3.7 2.3 6.0 5.9 5.1 4.0 3.2 1.7 0.7 -2.7 -2.9 -3.7 -3.6 -3.3 -2.7 -2.1 1 Debt at end March; GDP centred on end March 2 General government net borrowing on a Maastricht basis 3 General government gross debt on a Maastricht basis 155 Economic and fiscal outlook Fiscal outlook Public sector net borrowing 4.189 Public sector net borrowing (PSNB) is estimated to have fallen from its post-war peak of ?159 billion or 11.2 per cent of GDP in 2009-10 to ?121 billion or 7.9 per cent of GDP in 2011-12. This decline was driven by the recovery of the economy from the trough of the 2009 recession, the withdrawal of the temporary stimulus measures put in place by the previous Government, and by the current Government's fiscal consolidation plans including the increase in the standard rate of VAT in 2010-11 and reductions in expenditure. 4.190 Comparisons of PSNB outturn data and forecasts have been complicated recently by a number of policy and statistical classification decisions. These include the Government's decisions to transfer the Royal Mail's historic pension assets to the public sector and to transfer the excess balances from the Asset Purchase Facility (APF) to the Exchequer, as well as ONS decisions to reclassify Bradford & Bingley and Northern Rock (Asset Management) from the private sector to central government, and to reclassify the transfer to the Exchequer of the proceeds from the Special Liquidity Scheme (SLS). In Table 4.36 we show how PSNB outturns and forecasts are affected by removing the same combinations of these special factors that we showed in the December EFO, and also by removing the Royal Mail, the APF and the SLS (which the ONS and HM Treasury showed for the 2012-13 year-to-date in the February 2013 Public Sector Finances release). 4.191 The Royal Mail and APF transfers have significant effects on the headline measure of PSNB particularly in the early years of the forecast. If we look at an underlying measure of PSNB, excluding the Royal Mail and APF transfers, we forecast that this will be ?121.0 billion or 7.9 per cent of GDP in 2011-12, ?120.9 billion or 7.8 per cent of GDP in 2012-13 and ?120 billion or 7.5 per cent of GDP in 2013-14. This would leave underlying PSNB essentially flat, in both cash terms and as a share of the economy, between 2011-12, 2012-13 and 2013-14. Given the uncertainty surrounding all public finance forecasts - and the typical size of revisions to PSNB outturn data - the small decline forecast over this period is fiscally and statistically insignificant. 4.192 Nominal GDP growth over this period is expected to be relatively weak, constraining cash receipts growth and increasing expenditure (much of which is fixed in cash terms) as a share of the economy. The Government's fiscal consolidation plan in June 2010 envisaged total expenditure falling to 42.2 per cent of GDP in 2013-14. Our latest forecast is that it will be 3 per cent of GDP higher than this at 45.2 per cent of GDP, only slightly lower than its level in 2011-12. 4.193 Our central forecast is that PSNB will start to fall again in 2014-15, reaching 2.2 per cent of GDP in 2017-18. As shown in Chart 4.2, as the economy recovers we Economic and fiscal outlook 156 Fiscal outlook expect public sector expenditure to start to fall as a share of GDP largely as a result of the Government's fiscal consolidation plan. Public sector receipts are expected to be broadly flat as a share of GDP over the forecast period. Chart 4.2: Total public sector spending and receipts 49 Forecast 47 Per cent of GDP 45 43 41 39 37 35 33 1978-79 1982-83 1986-87 1990-91 1994-95 1998-99 2002-03 2006-07 2010-11 2014-15 PSCR (December forecast) PSCR (March forecast) TME (December forecast) TME (March forecast) Source: ONS, OBR Public sector net borrowing in 2012-13: changes since December 4.194 Our new forecast for headline PSNB in 2012-13 is ?86 billion or 5.6 per cent of GDP. Underlying PSNB, excluding the Royal Mail and APF transfers, is forecast at ?120.9 billion, or 7.8 per cent of GDP.17 This is ?1.0 billion higher than the estimate we made in December. Table 4.35 shows that the main drivers of the change since our previous forecast are: our underlying forecast of tax receipts this year has weakened by ?5.1 billion compared to December (excluding the impact of fiscally-neutral reclassifications), reflecting lower-than-expected receipts in recent months. In particular there have been significant shortfalls in payments from UK oil and gas revenues and in receipts from income tax and NICs from both selfassessment and PAYE; 17 The ONS has now reclassified the 2012-13 SLS payment as a dividend but has not formally announced how this payment would be treated in a scenario where the payments from the APF to Government were not occurring. The ONS have provided initial guidance that it would continue to score as dividend payments rather than financial transactions and we have treated it this way. If it were instead treated as a financial transaction then borrowing on this measure would be ?2.3bn higher in 2012-13. 157 Economic and fiscal outlook Fiscal outlook forecasting changes to expenditure (again excluding fiscally-neutral reclassifications) reduce borrowing by ?0.7 billion in 2012-13 compared to December. Higher-than-expected expenditure due to the shortfall in spectrum auction receipts and by local authorities, has been offset by lowerthan-expected debt interest, public sector pensions and spending by public corporations; and in addition we now expect larger departmental underspends in 2012-13, mainly as a result of action taken by the Government to reduce and/or delay departmental expenditure. We now anticipate that departmental underspends will be ?3.4 billion larger than we expected in December. 4.195 Our forecast implies that there will be very low expenditure at the end of this year compared to previous years. However, we know that end-year spending will be lower because EU payments and local government grants have been paid earlier this year than last year. We also expect that it will be lower as a result of the Government's actions to reduce spending. The final outturn for the current year usually remains a little uncertain even in forecasts this close to the end of the year. The average in-year error for PSNB at Budget forecasts over the past twenty years has been 0.3 per cent of GDP or about ?5 billion. The ONS's initial outturn estimates are typically revised for several months as further data becomes available. Table 4.35: Changes to public sector net borrowing since December ? billion Forecast Outturn 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Public sector net borrowing excluding Royal Mail and APF transfers December forecast March forecast Change of which: Receipts forecast1 Expenditure forecast1 Measures in the Treasury's policy decision table Changes to departmental underspends2 121.4 121.0 -0.4 119.9 120.9 1.0 112 120 8.3 99 108 9.9 81 96 14.3 56 67 11.4 31 43 11.8 -3.1 2.7 5.1 -0.7 8.9 -0.3 8.6 -0.9 11.9 -0.5 13.5 -0.4 14.1 -1.0 0.0 0.0 -1.3 1.6 2.8 -1.7 -1.3 0.0 -3.4 1.0 0.5 0.0 0.0 0.0 1 Excluding fiscally neutral switches including the reclassification of SLS transfers and changes in the proportion of tax credits treated as negative tax 2 Including as a result of action taken by the Government to reduce and/or delay expenditure Economic and fiscal outlook 158 Fiscal outlook Public sector net borrowing from 2013-14: changes since December 4.196 Compared to our December forecast, underlying PSNB excluding the Royal Mail and APF transfers is considerably higher each year from 2013-14, with the difference reaching around ?12 billion in 2017-18. Table 4.35 shows that this is driven by the following factors: forecasting changes increase borrowing by ?13 billion in 2017-18. This is primarily driven by lower expected receipts, due to our weaker economic forecast. In particular our forecast for income tax and NICs is ?6 billion lower by 2017-18 due to a lower forecast for labour income growth and the weakness of these receipts seen in recent months; a number of forecasting changes have left medium-term expenditure broadly unchanged from December; and policy measures on the Treasury's Budget policy decisions table are neutral over the forecast horizon, with a small fiscal tightening of ?1.3 billion in 2017-18. 4.197 Table 4.36 sets out our how our forecast for PSNB is affected by a number of one-off and temporary effects. PSNB excluding just the Royal Mail transfer is ?6.0 billion higher in 2012-13 than in December. This largely reflects the ?5.1bn impact of the final ONS decision on the reclassification of the APF transfers, as set out in paragraph 4.30. The impact of excluding the Royal Mail and APF transfers is discussed above. Further, excluding the impact of the reclassification of Bradford & Bingley and Northern Rock (Asset Management) would only make a small difference to the forecast. Excluding the impact of the Royal Mail, APF and the SLS would increase borrowing in 2012-13 by a further ?2.3 billion, with all other years unaffected. 159 Economic and fiscal outlook Fiscal outlook Table 4.36: Special factors affecting public sector net borrowing ? billion Forecast Outturn 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 PSNB December forecast March forecast Change excluding Royal Mail December forecast March forecast Change excluding Royal Mail and APF transfers December forecast March forecast Change excluding Royal Mail, APF and B&B and NRAM classifications December forecast March forecast Change excluding Royal Mail, APF and SLS transfers March forecast 121.4 121.0 -0.4 80.5 86.5 6.0 99.3 107.7 8.4 87.9 97.3 9.3 73.3 87.1 13.8 49.0 60.8 11.8 31.2 42.0 10.8 121.4 121.0 -0.4 108.5 114.5 6.0 99.3 107.7 8.4 87.9 97.3 9.3 73.3 87.1 13.8 49.0 60.8 11.8 31.2 42.0 10.8 121.4 121.0 -0.4 119.9 120.9 1.0 111.6 119.8 8.3 98.6 108.4 9.9 81.2 95.5 14.3 55.6 67.0 11.4 30.9 42.7 11.8 121.5 - 120.3 120.9 0.6 112.1 120.3 8.2 99.0 108.9 9.9 82.0 96.2 14.2 56.7 67.7 11.0 32.2 43.5 11.3 121.0 123.2 119.8 108.4 95.5 Per cent of GDP 67.0 42.7 Forecast Outturn 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 PSNB December forecast March forecast Change excluding Royal Mail December forecast March forecast Change excluding Royal Mail and APF transfers December forecast March forecast Change excluding Royal Mail, APF and B&B and NRAM classifications December forecast March forecast Change excluding Royal Mail, APF and SLS transfers March forecast Economic and fiscal outlook 7.9 7.9 0.0 5.1 5.6 0.4 6.1 6.8 0.6 5.2 5.9 0.7 4.2 5.0 0.9 2.6 3.4 0.7 1.6 2.2 0.6 7.9 7.9 0.0 6.9 7.4 0.5 6.1 6.8 0.6 5.2 5.9 0.7 4.2 5.0 0.9 2.6 3.4 0.7 1.6 2.2 0.6 7.9 7.9 0.0 7.7 7.8 0.2 6.9 7.5 0.6 5.8 6.5 0.7 4.6 5.5 0.9 3.0 3.7 0.7 1.6 2.3 0.7 7.9 - 7.7 7.7 0.0 6.9 7.4 0.5 5.9 6.4 0.6 4.7 5.5 0.8 3.1 3.7 0.6 1.7 2.2 0.6 7.9 8.0 7.5 6.5 5.5 3.7 2.3 160 Fiscal outlook 4.198 All fiscal forecasts are subject to significant uncertainty. Chart 4.3 shows our median (central) forecast for PSNB with successive pairs of shaded areas around it representing 20 per cent probability bands. The bands show the probability of different outcomes if past official forecasting errors are a reasonable guide to likely future forecasting errors. Chart 4.3: PSNB fan chart 12 10 Per cent of GDP 8 6 4 2 0 -2 -4 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Source: ONS, OBR March 2013 EFO central forecast Current budget 4.199 The current budget, which is borrowing excluding net investment spending, is forecast to move from a deficit of ?93 billion, or 6.0 per cent of GDP, this year to a deficit of ?16 billion, or 0.9 per cent of GDP in 2017-18. Compared to our December forecast, the deterioration in the current budget is slightly smaller than the deterioration in PSNB, due to changes in investment spending. Cyclically-adjusted current budget 4.200 The cyclically-adjusted current budget (CACB) moves from a deficit of 4.0 per cent of GDP in 2012-13 to a surplus of 0.8 per cent of GDP in 2017-18. The CACB in 2017-18 has deteriorated by 0.2 per cent of GDP compared to our December forecast. While the headline current budget has deteriorated by 0.4 per cent of GDP compared to December, we expect the output gap in that year to be 0.4 per cent of GDP wider, which means that much of the deterioration is assumed to be cyclical. This reflects our judgement that most of the additional weakness in the economy compared to our December forecast is cyclical rather 161 Economic and fiscal outlook Fiscal outlook than structural. Further detail on changes to the CACB since December is provided in Chapter 5. Public sector net debt 4.201 In our latest forecast, PSND rises as a share of GDP in each year up to and including 2016-17, peaking at 85.6 per cent of GDP, before falling to 84.8 per cent of GDP in 2017-18. PSND in 2017-18 is now expected to be around 7.5 per cent of GDP higher than we forecast in December. Table 4.36 breaks down this change as follows: the level of nominal GDP over the past year has been lower than we forecast in December, and we expect lower nominal GDP growth in the future. By reducing the denominator we use when calculating PSND as a share of GDP, this increases PSND by 2.2 per cent of GDP in 2017-18; and our forecast for PSND in cash terms is also higher than in December, by 5.3 per cent of GDP in 2017-18. This is a consequence of: higher net borrowing (excluding APF transfers) over the forecast period which leads to a rise in PSND of ?56 billion by 2017-18; for the purposes of calculating net debt, gilts are valued at their nominal value rather than their market value. In the past, the Debt Management Office (DMO) has typically sold gilts at close to their nominal value. However, with gilt rates at such low rates in the past couple of years, some of the gilts that the DMO has issued have been sold at a market value significantly above the nominal value, i.e. at a 'premium'. In our December EFO, we revised our forecast to reflect the likelihood that the DMO will continue to issue gilts at a premium. Since then, gilt rates have risen and we have also reassessed our modelling. We now expect the premium to fall more considerably and for gilts to be sold much closer to par from 2014-15. This increases our forecast of PSND by ?28 billion by 2017-18; larger net transfers from the Treasury to the APF increase PSND by around ?4 billion by 2017-18; and other changes increase PSND by ?15 billion in 2017-18. Budget measures that affect financial transactions increase net debt by around ?5 billion by 2015-16. The stock of Bradford & Bingley and Northern Rock (Asset Management) liabilities winds down more slowly in later years. These public sector bodies have also been included in 2011-12 outturns for the first time. Economic and fiscal outlook 162 Fiscal outlook Table 4.37: Changes to public sector net debt since December Per cent of GDP Forecast Outturn 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 December forecast March forecast Change of which: Change in nominal GDP1 Change in cash level of net debt 66.4 71.8 5.5 74.7 75.9 1.2 76.8 79.2 2.3 0.4 5.1 1.0 0.2 1.3 1.0 December forecast March forecast Change in cash level of net debt of which: Changes in net borrowing (ex. APF) Auction price effects Asset purchase facility Financial transactions and other 1025 1104 78 1186 1189 3 0 0 0 79 1 2 0 1 1 79.0 82.6 3.7 79.9 85.1 5.1 79.2 85.6 6.4 77.3 84.8 7.5 1.5 2.2 ? billion 1270 1362 1286 1398 17 36 1.8 3.4 2.0 4.4 2.2 5.3 1442 1502 60 1498 1580 82 1534 1637 103 33 17 0 10 44 23 2 13 56 28 4 15 9 5 0 3 19 12 0 6 Non-seasonally-adjusted GDP centred end-March. 163 Economic and fiscal outlook Fiscal outlook Table 4.38: Changes to the fiscal forecast ? billion Forecast Outturn 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Surplus on current budget June 2010 forecast December 2012 forecast Change March 2013 forecast Net investment June 2010 forecast December 2012 forecast Change March 2013 forecast Net borrowing June 2010 forecast December 2012 forecast Change March 2013 forecast -88 -95 2 -92 -65 -89 -3 -93 -40 -74 -9 -84 -17 -62 -8 -71 0 -51 -11 -61 -26 -9 -35 -8 -8 -16 27 27 2 29 24 -9 3 -6 20 25 -1 24 21 26 1 27 21 23 3 26 23 3 26 23 3 26 116 121 0 121 89 80 6 86 60 37 99 88 8 9 108 97 Per cent of GDP 20 73 14 87 49 12 61 31 11 42 3.5 6.1 0.6 6.8 2.1 5.2 0.7 5.9 1.1 4.2 0.9 5.0 2.6 0.7 3.4 1.6 0.6 2.2 -0.7 -2.2 -0.6 -2.8 0.3 -1.4 -0.4 -1.7 0.8 -0.8 -0.4 -1.2 0.4 -0.3 0.1 0.9 -0.2 0.8 1.8 3.8 0.6 4.3 0.8 2.9 0.4 3.3 0.3 2.0 0.6 2.7 0.9 0.5 1.3 0.3 0.3 0.6 70.3 76.8 2.3 79.2 69.4 79.0 3.7 82.6 67.4 79.9 5.1 85.1 79.2 6.4 85.6 77.3 7.5 84.8 Net borrowing June 2010 forecast 7.5 5.5 December 2012 forecast 7.9 5.1 0.4 Change 0.0 March 2013 forecast 7.9 5.6 Cyclically-adjusted surplus on current budget June 2010 forecast -3.2 -1.9 December 2012 forecast -4.3 -3.6 Change 0.1 -0.5 March 2013 forecast -4.2 -4.0 Cyclically-adjusted net borrowing June 2010 forecast 5.0 3.4 December 2012 forecast 6.0 3.0 Change 0.0 0.6 March 2013 forecast 6.0 3.6 Net debt1 June 2010 forecast 67.2 69.8 74.7 December 2012 forecast 66.4 Change 5.5 1.2 March 2013 forecast 71.8 75.9 1 Debt at end March; GDP centred on end March. Economic and fiscal outlook 164 Fiscal outlook Box 4.3: Use of Whole of Government Accounts The Whole of Government Accounts (WGA) contains information on future fiscal liabilities that are relevant for our forecast. These include: public service pensions, where the future costs of providing pension benefits that have already been earned are treated as current costs, and charged to each year's accounts; provisions for future liabilities that have resulted from past events, where the liabilities are expected to happen. The WGA information also shows the time period when the liabilities might fall due; and contingent liabilities, which are possible future liabilities that have resulted from past events, but which are less likely or unlikely to happen. The Treasury will publish the 2011-12 WGA later this year, and we will report on the latest picture it shows for future liabilities in our 2013 Fiscal sustainability report (FSR). However, we already know government departments' provisions and future liabilities at the end of 2011-12, from their published accounts. This box explains how we have ensured that those liabilities that are expected to affect the public finances in the next five years are reflected in our forecast. For future liabilities on spending, this forecast includes the latest forecasts for net payments for public service pensions out to 2017-18. Forecasts to 2062-63 will be contained in our 2013 FSR. Most of the future payments for which departments make provisions are included within departments' DELs. These include the largest provisions for nuclear decommissioning and clinical negligence, where the future nuclear decommissioning payments are contained within the DELs for the Department of Energy and Climate Change (DECC) and the Ministry of Defence (MOD) and where the future clinical negligence payments are contained within the DEL for the Department of Health. Other provisions for future liabilities at 31 March 2012 include: HMRC provisions of ?2.1 billion for legal disputes over taxes, reduced from ?4.4 billion at 31 March 2011. Our forecast assumes payments of ?3.6 billion over the next five years, for these existing provisions and further provisions in future years' accounts; DWP provisions of ?3.9 billion relating to the Financial Assistance Scheme. Payments under this scheme are contained within DWP's DEL. Receipts of ?1.4 billion under this scheme are included in our forecast of capital accounting adjustments; and HM Treasury provisions of ?1.3 billion for the Equitable Life Payments 165 Economic and fiscal outlook Fiscal outlook Scheme. Our forecast assumes payments of ?0.9 billion under this scheme over the next five years. The main contingent liabilities at 31 March 2012 include: HM Treasury's contingent commitments associated with financial stability interventions. Our central forecasts do not include any of these potential costs, because they are judged more likely not to be paid than to be paid. In Box 4.2 we assess the potential fiscal cost of these interventions; and HMRC contingent liabilities of ?20 billion for reductions in petroleum revenue tax and corporation tax where losses on decommissioning oil fields are set off against these taxes, reducing current receipts. Although these future losses of revenue are classified as contingent liabilities rather than provisions in HMRC's accounts, we include a negative effect from oil and gas revenues from decommissioning expenditure of between ?0.7 billion and ?1.4 billion a year over the forecast period to 2017-18. Comparisons with external forecasts Average of independent forecasts 4.202 The latest of average independent forecast for public sector net borrowing was ?88.5 billion for 2012-13, ?105.9 billion for 2013-14 and ?96.0 billion in 2014-15. Forecasters generally expect a higher PSNB than we do for 2012-13. Recent public finance releases have shown higher spending growth and lower receipts growth than our forecast assumed in December. However, the departmental underspends which we have incorporated into our latest forecast are not likely to be seen in the public finance statistics until April or later. The shortfall in receipts growth is unlikely to be reversed, which is reflected in our lower current receipts forecast. Economic and fiscal outlook 166 Fiscal outlook Table 4.39: Comparisons with external forecast of key aggregates ? billion Forecast 2012-13 2013-14 80.5 85.5 86.7 88.5 86.5 99 103 108 106 108 -3.6 -3.9 -2.9 -4.0 -2.2 -2.4 -1.3 -2.8 -1.4 -1.5 -0.6 -1.7 74.7 75.0 75.6 75.9 76.8 77.3 78.7 79.2 79.0 79.8 81.6 82.6 Public sector net borrowing OBR December IFS February baseline IFS February Oxford Economics central Average of independent forecasters1 OBR March Cyclically-adjusted surplus on current budget OBR December IFS February baseline IFS February Oxford Economics central OBR March Public sector net debt OBR December IFS February baseline IFS February Oxford Economics central OBR March 1 2014-15 2015-16 2016-17 2017-18 88 73 93 73 97 77 96 79 97 87 Per cent of GDP 49 48 48 64 61 31 30 27 42 -0.8 -0.7 0.2 -1.2 0.4 0.4 1.4 0.1 0.9 1.0 2.1 0.8 79.9 80.6 82.7 85.1 79.2 79.9 81.9 85.6 77.3 77.9 79.7 84.8 HM Treasury, Forecasts for the UK economy , February and March 2013 IFS Green Budget 4.203 The Institute for Fiscal Studies is the only other organisation that produces a bottom-up forecast for the UK public finances. The Green Budget, published in February, includes forecasts up to 2017-18. 4.204 The IFS baseline scenario uses the economic determinants which we incorporated into our December 2012 forecast. The baseline scenario forecast for PSNB in 2012-13 was ?4.9 billion more than our December 2012 forecast, due to ?3.3 billion less receipts and ?1.6 billion more expenditure. The main area of difference on the spending side is that our forecast assumes much higher departmental underspends, as mentioned above. Lower receipts from income tax, VAT and corporation tax explain the differences between our current receipts forecasts. Our forecasts for PSNB retain a similar gap until 2014-15, again, due to the difference between our assumptions for departmental underspends. From 2015-16 and beyond, our forecasts for PSNB are very similar, given the uncertainties surrounding forecasts over this time horizon. 4.205 The IFS also produced forecasts based on the Oxford Economics central scenario, which uses much the same economic determinants as the IFS baseline and our December forecast. The key difference is their assumption about the size of the output gap. As a result, the main differences between the December 2012 EFO forecast and the Oxford Economics central scenario is that a larger proportion of 167 Economic and fiscal outlook Fiscal outlook borrowing is due to cyclical factors and that the fiscal mandate target would be met a year earlier than our forecast implied in December. International comparisons 4.206 International organisations, such as the European Commission and the IMF, provide forecasts of deficit and debt levels of different countries on a comparable basis. These are based on general government debt and borrowing and are presented on a calendar year basis. To facilitate international comparisons, Tables 4.40 and 4.41 provide UK forecasts on a basis which is comparable to other international organisations forecasts. With both modelling and reporting of much tax and spend done primarily on a financial year basis only, the calendar year forecasts are illustrative and have been generated by weighting the financial year forecasts appropriately. 4.207 Table 4.40 compares our forecasts for Treaty deficit and debt against the latest forecasts from the European Commission, published in February. Their forecast was based on a Treaty deficit measure which excluded APF. On this basis, our calendar year forecast for 2013 is very similar to the Commission's forecast. The UK's Treaty deficit remains high relative to major European countries. The UK's Treaty debt to GDP ratio is now in line with the euro area average. Prior to the downturn, the UK had a debt ratio 20 per cent of GDP less than the euro area average. Table 4.40: Comparison with European Commission forecasts Per cent of GDP UK (March EFO) UK (EC)3 Germany France Italy Spain Euro area 3 1 2014 6.9 6.0 0.0 3.9 2.1 7.2 2.7 General government net borrowing 2 Treaty Deficit 2012 2013 6.5 7.6 6.3 7.4 -0.1 0.2 4.6 3.7 2.9 2.1 10.2 6.7 3.5 2.8 1 General government net debt 3 Treaty deficit excluding APF flows Source: OBR, European Commission, European Economic Forecast , Winter 2013 Economic and fiscal outlook 168 Treaty Debt2 2012 2013 89.6 93.9 89.8 95.4 81.6 80.7 90.3 93.4 127.1 128.1 88.4 95.8 93.1 95.1 2014 97.8 97.9 78.3 95.0 127.1 101.0 95.2 Fiscal outlook Table 4.41: Comparison with IMF forecasts UK (March EFO)1 UK (IMF)1 Germany France Italy Japan U.S. 1 Per cent of GDP General Government Net Borrowing General Government Net Debt 2012 2013 2017 2012 2013 2017 6.5 7.6 2.7 81.0 85.3 92.1 8.2 7.3 1.7 83.7 88.2 88.7 0.4 0.4 0.0 58.4 57.5 56.2 4.7 3.5 0.0 83.7 85.9 80.2 2.7 1.8 0.7 103.1 103.9 98.7 10.0 9.1 5.8 135.4 144.7 158.7 8.7 7.3 4.4 83.8 87.7 89.4 General government net borrowing excludes APF flows Source: OBR, IMF, World Economic Outlook , October 2012 169 Economic and fiscal outlook 5 Performance against the Government's fiscal targets Introduction 5.1 This chapter: sets out the Government's medium-term fiscal targets (from paragraph 5.2); examines whether the Government has a better than 50 per cent chance of meeting them, given our central forecast (from paragraph 5.5); and assesses how robust this judgement is to the uncertainties inherent in any fiscal forecast, by looking at: past forecast errors; sensitivity to key parameters of the forecast; and alternative economic scenarios (from paragraph 5.11). The fiscal mandate and the supplementary target 5.2 In the June 2010 Budget, the Government set itself two medium-term fiscal targets for the current Parliament: the fiscal mandate and a supplementary target. The OBR is required to judge whether the Government has a greater then 50 per cent probability of hitting these targets under existing policy. 5.3 The Charter for Budget Responsibility defines the fiscal mandate as "a forwardlooking target to achieve cyclically-adjusted current balance by the end of the rolling, five-year forecast period". This means that total public sector receipts need to at least equal total public sector spending (minus spending on net investment) in five years time, after adjusting for the impact of any remaining spare capacity in the economy. For the purposes of this forecast, as in our last forecast at the time of the Autumn Statement, the five-year horizon ends in 201718. For our autumn 2013 EFO, the horizon will roll forward to 2018-19. 5.4 The Charter says that the supplementary target requires "public sector net debt as a percentage of GDP to be falling at a fixed date of 2015-16, ensuring the public finances are restored to a sustainable path." The target refers to public sector net debt (PSND) excluding the temporary effects of financial interventions. 171 Economic and fiscal outlook Performance against the Government's fiscal targets The implications of our central forecast 5.5 Table 5.1 shows our central forecasts for the cyclically-adjusted current budget (CACB) and PSND in each year to 2017-18, as set out in Chapter 4. These are median forecasts, which means that we believe it is equally likely that the eventual outturns will come in above them as below them. Table 5.1: Performance against the Government's fiscal targets Per cent of GDP Forecast Outturn 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Cyclically-adjusted current budget December forecast March forecast excluding Budget measures1 March forecast -4.3 -3.6 -2.2 -1.4 -0.8 0.4 0.9 -4.2 -4.0 -2.9 -1.6 -1.2 -0.2 0.5 -4.2 -4.0 -2.8 -1.7 -1.2 0.1 0.8 -1.3 -0.1 0.8 Cyclically-adjusted current budget excluding Royal December forecast -4.3 March forecast excluding Budget -4.2 measures1 -4.2 March forecast Public sector net debt Mail, APF, B&B and NRAM -4.3 -3.1 -2.1 December forecast March forecast excluding Budget measures1 March forecast 1 -4.5 -3.7 -2.4 -1.7 -0.6 0.4 -4.5 -3.6 -2.5 -1.7 -0.3 0.6 66.4 74.7 76.8 79.0 79.9 79.2 77.3 71.8 75.9 79.2 82.4 84.6 85.2 84.5 71.8 75.9 79.2 82.6 85.1 85.6 84.8 80.2 82.0 81.9 80.5 83.8 86.8 87.9 87.5 84.0 87.2 88.3 87.8 1 Public sector net debt excluding Royal Mail, APF, B&B and NRAM December forecast 66.4 72.5 77.1 March forecast excluding Budget 66.8 73.7 79.5 measures1 66.8 73.7 79.5 March forecast 1 These remove the direct effects. No account is taken of indirect effects, including the impact on debt interest payments. 5.6 Table 5.1 shows that in the absence of Budget measures our central forecast would show the CACB in surplus by 0.5 per cent of GDP in 2017-18 and in deficit by 0.2 per cent of GDP in 2016-17. Budget measures improve the balance by a quarter of a per cent of GDP in both years. This is sufficient to put the CACB back into surplus in 2016-17 and to achieve a surplus in 2017-18 that is only fractionally smaller than that we forecast in December. So there remains a greater than 50 per cent chance of the Government achieving balance on this measure in 2017-18 and as a result we judge it to be on course to achieve the mandate. Economic and fiscal outlook 172 Performance against the Government's fiscal targets 5.7 Excluding the Chancellor's decision to transfer the cash balances held in the Asset Purchase Facility (APF) to the Exchequer on an ongoing basis - as well as the impact of the reclassification of Bradford & Bingley plc (B&B) and Northern Rock (Asset Management) (NRAM) into central government - the surplus in 201718 would be 0.6 per cent of GDP. 5.8 Table 5.2 decomposes the changes in our forecasts of CACB since December. It shows that: although much of the downward revision to our GDP forecasts since December is assumed to be cyclical and temporary, some is assumed to be structural and persistent. Our assessment of the current output gap and future trend growth reduces the level of potential output by 0.3 per cent of GDP by 2017-18, worsening the CACB by 0.2 per cent of GDP; transfers from the APF to the Exchequer have a small additional positive impact on the CACB in 2017-18, following the ONS's definitive announcement on how these will be treated; measures announced in the Budget improve the CACB by 0.2 per cent of GDP in 2017-18; and other forecasting changes reduce the CACB by 0.3 per cent of GDP from 2015-16. This relates to our latest assessment of the CACB in 2012-13, which knocks through to later years and a smaller decline in current spending as a share of GDP beyond the current Spending Review period. Table 5.2: Changes to the cyclically-adjusted current budget since December Per cent of GDP 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 December forecast March forecast Change of which: Judgement on potential output APF transfers Budget measures Other forecasting changes 5.9 2017-18 -4.3 -4.2 0.1 -3.6 -4.0 -0.5 -2.2 -2.8 -0.6 -1.4 -1.7 -0.4 -0.8 -1.2 -0.4 0.4 0.1 -0.3 0.9 0.8 -0.2 0.0 0.0 0.0 0.1 -0.1 -0.3 0.0 -0.1 -0.2 0.0 0.1 -0.5 -0.2 0.0 -0.1 -0.1 -0.2 0.0 0.0 -0.3 -0.2 0.0 0.3 -0.3 -0.2 0.1 0.2 -0.3 The supplementary target requires PSND to fall as a share of GDP between 2014-15 and 2015-16, and this target year remains fixed. As Table 5.3 shows, our December forecast showed PSND rising by 1 per cent of GDP in that year. We now expect PSND to rise by 2.4 per cent of GDP in 2015-16 and by another 173 Economic and fiscal outlook Performance against the Government's fiscal targets 0.5 per cent of GDP in 2016-17. In December, we forecast that PSND would fall as a share of GDP in 2016-17, although excluding the APF transfers and B&B and NRAM reclassifications it would have been broadly flat. It should be emphasised that these are small changes in the context of the uncertainty around the forecast of PSND at these time horizons. 5.10 Table 5.3 shows a decomposition of changes in the profile of net debt as a share of GDP since December. This shows: lower forecasts for nominal GDP growth reduce the denominator we use to calculate PSND as a share of GDP and increase the change in PSND from year to year by 0.2 per cent of GDP each year from 2014-15; net borrowing is higher in each year of the forecast horizon, largely as a consequence of the weaker economic outlook. As borrowing now falls more gradually, debt rises more quickly as a share of GDP than in December; and other changes mean that net debt rises by an additional 0.5 per cent of GDP in both 2015-16 and 2016-17. This mainly reflects our judgement that the Debt Management Office will issue gilts at a lower premium relative to their nominal value than we assumed in December. Table 5.3: Decomposition of changes in the profile of net debt since December Change in PSND on a year earlier (per cent of GDP) December forecast March forecast Change of which: Nominal GDP Changes in net borrowing Other 2013-14 2.1 3.3 1.2 2014-15 2.2 3.5 1.3 2015-16 1.0 2.4 1.5 2016-17 -0.8 0.5 1.3 2017-18 -1.9 -0.8 1.1 0.3 0.5 0.3 0.2 0.6 0.6 0.2 0.8 0.5 0.2 0.5 0.5 0.2 0.5 0.4 Recognising uncertainty 5.11 Past experience and common sense suggest that there are significant upside and downside risks to our central forecasts for the public finances. These reflect uncertainty both about the outlook for the economy and about the level of receipts and spending in any given state of the economy. Economic and fiscal outlook 174 Performance against the Government's fiscal targets 5.12 Given these uncertainties, it is important to stress-test our judgements that the Government is on course to meet the mandate in 2017-18, but is no longer on course to meet the supplementary target in 2015-16. We do this in three ways: by looking at the lessons from past forecast errors; by seeing how our central forecast would change if we altered some of the key judgements that underpin it; and by looking at alternative economic scenarios. Past performance 5.13 One relatively simple way to illustrate the uncertainty around our central forecast is to draw lessons from the accuracy of previous official public finance forecasts. This can be illustrated using fan charts like those we presented for GDP growth in Chapter 3 and public sector net borrowing (PSNB) in Chapter 4. These fan charts do not represent our assessment of specific risks to the central forecast. Instead they show the outcomes that someone might anticipate if they believed, rightly or wrongly, that errors in the past offered a reasonable guide to errors in the future. 5.14 In this spirit, Chart 5.1 shows the probability distribution around our central forecast for the CACB, based on past official forecasting errors (which are usually dominated by errors in the fiscal forecast rather than the underlying economic forecast). The solid black line shows the median forecast, with the successive pairs of lighter shaded areas around it representing 20 per cent probability bands. This implies that, based on current policy, there would be an 80 per cent probability of the outturn lying within the shaded bands. 175 Economic and fiscal outlook Performance against the Government's fiscal targets Chart 5.1: Cyclically-adjusted current budget fan chart 4 3 2 Per cent of GDP 1 0 -1 -2 -3 -4 -5 -6 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Source: OBR March central forecast 5.15 We can see from the chart that, given past forecasting performance, the margin between the Government meeting and missing its fiscal mandate is small relative to the uncertainty that surrounds the public finance forecast over that time horizon. A direct reading of the chart would imply that the Government currently has a roughly 70 per cent probability of achieving a surplus on the CACB in 2017-18 and thereby meeting the mandate. The probability of achieving a cyclically-adjusted surplus in earlier years is lower at just over 50 per cent for 2016-17 and around 25 per cent for 2015-16. 5.16 Unfortunately, one cannot estimate the probability of achieving the supplementary target, given that we do not have a joint distribution that would allow us to apply the same technique. That said our central median forecast shows PSND rising as a percentage of GDP in 2015-16. Sensitivity analysis 5.17 It is very difficult to produce a full subjective probability distribution for the Government's target fiscal variables because they are affected by a huge variety of economic and non-economic determinants. However, to recognise the uncertainty in our forecast we can go further than using the lessons of past forecasting errors, by quantifying roughly how sensitive our central forecast is to certain key economic parameters. Economic and fiscal outlook 176 Performance against the Government's fiscal targets 5.18 In thinking about the evolution of the public finances over the medium term, there are several parameters that have a particularly important bearing on the forecast. In this section we focus on four: the level of potential output, captured by the size of the output gap; the speed with which the output gap closes (i.e. the pace of the recovery); the interest rates that the Government has to pay on its debt; and possible errors on our cyclical adjustment coefficients. 5.19 Our central forecast is based on a judgement that the economy was running around 2.7 per cent below potential in the final quarter of 2012, that the output gap will widen through 2013, and that there will be above-trend GDP growth from 2015. 5.20 Our assumptions and forecasts for the level of economic potential and headline growth imply that the negative output gap will close in 2021-22. But neither the level of potential, nor the pace of recovery, are possible to estimate with confidence, not least because the former is not a variable that we can observe directly in the economic data. So what if the medium-term level of potential was higher or lower than our central estimate, and what if the output gap closed earlier or later than our central estimates? 5.21 Tables 5.4 and 5.5 present illustrative estimates of the impact on: the level of the cyclically-adjusted current budget in 2017-18; and the change in PSND between 2014-15 and 2015-16. 5.22 For practical reasons, we have not undertaken complete forecast runs for each variant, but have instead used ready-reckoners and simplifying assumptions to generate illustrative estimates. We assume that a lower or higher level of potential is reflected in our starting output gap, rather than errors in forecasting trend growth rates further forward. 5.23 The cyclical adjustment ready-reckoner assumes that a 1 per cent change in GDP will result in a 0.7 per cent of GDP change in PSNB and the current budget after two years. The actual change in the public finances would depend on many other factors, including the composition of growth, inflation and labour market response. While we recognise the limitations of this top-down approach, applying these ready-reckoners yields the results shown in the tables below. 177 Economic and fiscal outlook Performance against the Government's fiscal targets Table 5.4: Cyclically-adjusted current budget in 2017-18 Output gap closes Per cent of GDP Output gap in 2012 Q4 2017-18 -0.7 -1.7 -2.7 -3.7 -4.7 2019-20 2021-22 2023-24 2025-26 -0.7 0.1 0.8 1.5 2.3 -0.7 0.0 0.8 1.5 2.2 -0.7 0.0 0.8 1.5 2.2 -0.7 0.0 0.7 1.5 2.2 -0.7 0.0 0.7 1.4 2.1 Table 5.5: Change in PSND between 2014-15 and 2015-16 Output gap closes Per cent of GDP Output gap in 2012 Q4 2017-18 -0.7 -1.7 -2.7 -3.7 -4.7 2019-20 2021-22 2023-24 2025-26 2.3 1.6 1.1 0.4 0.0 2.8 2.4 2.0 1.7 1.3 3.0 2.7 2.4 2.1 1.8 3.3 3.0 2.8 2.5 2.3 3.4 3.2 3.0 2.8 2.6 5.24 Table 5.4 shows that the level of potential output has a strong effect on the size of the cyclically-adjusted current budget balance in 2017-18. The lower potential output is, and therefore the smaller the output gap, the larger the proportion of the deficit that is structural (and therefore impervious to economic recovery) and the less margin the Government has against its fiscal mandate. Conversely if potential is higher, less of the deficit is structural and the Government has more margin against its mandate. 5.25 Closing the output gap at a different pace will typically result in a change in cyclical borrowing, but have little effect on the structural balance. For example, closing the output gap more slowly will result in a lower growth path, leading to more cyclical borrowing but a broadly similar level of structural borrowing. 5.26 Roughly speaking, the output gap would have to be about 1 per cent of potential output narrower than our central estimate (or rather the level of potential output would need to be 1 per cent lower in 2017-18 than in our central forecast) to make it more likely than not that the mandate would be missed. As we saw in Chapter 3, projections of potential output vary considerably, and this is well within the margins of uncertainty. 5.27 Table 5.5 shows that the Government would continue to miss its supplementary target unless the output gap was materially wider than in our central forecast and closed significantly quicker. The former would imply less structural borrowing, whereas the latter would suggest less cyclical borrowing. Economic and fiscal outlook 178 Performance against the Government's fiscal targets 5.28 A third potential source of departure from our central forecast is variation in the interest rates that the Government has to pay on future borrowing and some existing debt. As set out in Chapter 4 our central forecast assumes that gilt rates for future borrowing move in line with market expectations. But what if the central forecast of gilt rates were to suffer a shock? We examine the implications of a negative shock of 50 basis points, making debt cheaper, and increases of 50, 100, 150 and 200 basis points, making debt more expensive. We assume the shock occurs in 2013-14 and does not affect any other part of the forecast, including exchange rates and shorter-term interest rates. Table 5.6 shows the level of the CACB in 2017-18 and the change in PSND between 2014-15 and 2015-16 under these variants, constructed using a ready-reckoner. Table 5.6: Fiscal target variables under different gilt rate assumptions Per cent of GDP Change in gilt rate (bps) -50 0 50 100 150 200 Cyclically-adjusted current budget balance in 2017-18 1.0 0.8 0.5 0.2 0.0 -0.2 Change in public sector net debt between 2014-15 and 2015-16 2.3 2.4 2.6 2.7 2.8 2.9 5.29 Table 5.6 shows that these illustrative shocks to gilt rates have a relatively small impact on the chances of meeting the mandate and supplementary target. This is because an increase in rates only applies to new debt issuance, and the UK has a relatively long average debt maturity for conventional gilts, and because new issuance is projected to fall as borrowing declines. Therefore over a short horizon, such as our five-year forecasting period, the impact of a shock to the average nominal rate on gilts is relatively small. 5.30 Gilt rates will also affect transfers between the Exchequer and the APF as gilts are sold. If gilt rates were higher, prices would be lower and therefore capital losses greater. But as gilts are assumed to be sold from the second quarter of 2016, a gilt rate shock would not affect our assessment of the supplementary target through this channel and have only a small effect on the CACB in 2017-18, as transfers to the APF are classified as capital spending. 5.31 All else equal, a sustained shock of 150-200 basis points would make it more likely than not that the Government would miss both its fiscal targets. However if short-term interest rates moved in line with gilt rates, there would also be a direct offsetting impact on the public finances through an increase in interest receipts and tax on corporate and household savings. In the November 2011 EFO we showed that potentially this could offset around 60 per cent of the direct impact on debt interest payments, though this would depend on the precise change in interest rates at different maturities. 179 Economic and fiscal outlook Performance against the Government's fiscal targets 5.32 Our last sensitivity analysis concerns the uncertainty around our cyclical adjustment coefficients. Cyclical adjustment attempts to remove the effect of the economic cycle from forecasts of the public finances. This is achieved by adjusting a given fiscal aggregate, such as PSNB, for the size of the output gap in the current and previous years, using cyclical adjustment coefficients.1 We set out our approach to cyclical adjustment in the 2012 working paper Cyclically adjusting the public finances and apply coefficients of 0.2 for the previous year's output gap, and 0.5 for the current year's gap.2 5.33 The coefficients are derived by analysing the past relationship between the output gap and the fiscal position. They are highly uncertain for a number of reasons: the output gap is not directly observable, so there is no historical 'fact' from which to estimate the coefficients; the number of observations on which to base coefficient estimates is limited; the fiscal position is affected by events that do not necessarily move in line with the cycle, such as one-off fiscal policy adjustments and movements in commodity and asset prices; and insofar as the current economic cycle differs from the average cycle, the relationship between the public finances and the output gap over the course of that cycle will not be captured in the coefficients. 5.34 Given these uncertainties, it is useful to consider how sensitive our central forecast is to variations in the coefficients. If the coefficient on the current year's output gap was 0.4, rather than our estimate of 0.5, the CACB would be 0.2 per cent of GDP lower in 2017-18. If the coefficient on the previous year's output gap was also 0.1 rather than 0.2, the CACB would be 0.5 per cent of GDP lower in 201718. Equally, higher coefficients would result in a smaller deficit or larger surplus on the current budget and lower net borrowing, on a cyclically-adjusted basis. 5.35 This analysis should be seen in the context of the uncertainty surrounding the size of the coefficients. The European Central Bank (ECB) assumes a coefficient of 0.65 and the OECD a lower figure of 0.45. Compared with our estimates, the lower ECB and OECD coefficients would imply reductions in the cyclicallyadjusted current budget in 2017-18 of 0.23 and 0.65 per cent of GDP 1 For example, the cyclically-adjusted current budget is calculated as: CACBt = CBt - ?(OGt-1) - ?(OGt), where OG is the output gap in a given fiscal year and are cyclical adjustment coefficients, and the current budget is expressed as a percentage of GDP. 2 Helgadottir et al, 2012, Working Paper No. 4: Cyclically adjusting the public finances. Economic and fiscal outlook 180 Performance against the Government's fiscal targets respectively.3 Using these coefficients the fiscal mandate would still be met, but with less margin for error than in our central forecast. Scenario analysis 5.36 The variants discussed above focus on a narrow set of factors and therefore only offer a partial assessment of potential uncertainty. In this section we set out the fiscal implications of two broader illustrative alternative economic scenarios, designed to test how dependent our conclusions are on key judgements that are subject to debate in the forecasting community. We stress that these scenarios are not intended to capture all possible ways in which the economy might deviate from the central forecast and we do not attempt to attach particular probabilities to their occurrence. 5.37 One current topic of debate is the future path of the exchange rate. In our central forecast, exchange rates, after the first quarter of 2013, are assumed to follow a path implied by the uncovered interest parity condition (UIP). The UIP suggests a relationship between differences in interest rates between countries and exchange rate movements and currently implies that the sterling exchange rate edges marginally lower during our forecast. Given the sharp falls in sterling during January and February and the UK's large current account deficit some commentators have questioned whether there could be a larger fall in sterling.4 5.38 The most recent depreciation between 2007 and 2009 generated only a modest improvement in exports, while higher import prices fed into higher inflation, reducing real consumption. Past depreciations - such as that of the early 1990s - appear to have had a greater positive impact on GDP growth. It may be that the greater uncertainty and tighter financial conditions over the last five years deterred companies from devoting resources to export markets. Whether a future depreciation would generate a substantial boost to net trade or more closely resemble the 2007 to 2009 depreciation is uncertain. It would depend on: the degree to which exporters extend their market share, rather than pricing to market, selling the same quantity of goods at higher sterling prices; and 3 These estimated effects assume that the ECB and OECD coefficients apply to the current year's output gap, so the coefficient on the previous year's output gap is zero. 4 For example, MPC member Martin Weale suggests that "unless we continue to enjoy capital gains, this points to a marked increase in United Kingdom net external debt at the current exchange rate. The likely outcome of this would be a lower real exchange rate." Martin Weale, The Balance of payments, February 2013. 181 Economic and fiscal outlook Performance against the Government's fiscal targets the extent and speed of pass-through of higher import prices into consumer inflation. 5.39 Here we examine two alternative scenarios following a 15 per cent depreciation in the sterling exchange rate relative to our central forecast in 2013, which persists in the medium term. The size of the depreciation, when added to the fall in sterling in the first quarter of 2013, would be around half-way between the scale of the last two large depreciations in sterling. 5.40 In the first scenario, export volumes rise so that UK exporters' market share increases by a similar amount to the increase after the early 1990s depreciation. In the second scenario, the export response is more muted, and their market share remains flat, rather than falling as in our central forecast. But the pass through into consumer prices is more pronounced and persistent. Other key assumptions and the implications are: the Bank looks through the initial rise in consumer prices. Higher inflation reduces consumer spending power, leading to lower real consumption in both scenarios. We assume nominal consumption is broadly unaffected; higher inflation increases debt interest costs and overall spending in the later years, which is linked to the general inflation in the economy. This impact is larger in scenario two, where there is greater and more prolonged pass through of import prices to consumer prices; demand for imports falls due to higher import prices and lower real consumption, but this is somewhat offset by greater demand for imported materials by exporters; nominal GDP growth is higher than in our central forecast, as the nominal value of exports increases. The export share of expenditure therefore rises relative to the consumer share. As consumption is relatively more tax rich, this implies a small structural hit to the public finances, more discernible in scenario one which prompts a larger rebalancing; scenario one also prompts a stronger rebound in real GDP growth, as export volumes rise to a greater extent, leading to less spare capacity than in our central forecast. Conversely in scenario two a temporary boost in exports is outweighed by weaker consumption, as a more prolonged rise in prices continues to bear down on incomes. Under that scenario, the degree of spare capacity at the end of the forecast horizon is largely unchanged; and Economic and fiscal outlook 182 Performance against the Government's fiscal targets under either scenario the supplementary target continues to be missed, as net debt rises as a share of GDP in 2015-16 by a similar amount as in our central forecast. In scenario one there is less cyclical borrowing, but slightly more structural borrowing due to the less tax-rich composition of GDP. So the margin by which the fiscal mandate is met in 2017-18 is therefore slightly smaller. In scenario two the mandate is met with the same margin for error as in our central forecast. 5.41 Table 5.7 summarises the economic assumptions we have made, as well as the fiscal consequences of these alternative scenarios. It shows that under either scenario, the fiscal mandate would continue to be met and the supplementary target would continue to be breached. Table 5.7: Key economic and fiscal aggregates under alternative scenarios 2012-13 Central forecast Economic assumptions GDP (percentage change) CPI inflation (Q3) ILO unemployment (% rate) Output gap Fiscal impact (per cent of GDP) Public sector net borrowing Cyclically-adjusted current budget Public sector net debt Depreciation scenario one Economic assumptions GDP (percentage change) CPI inflation (Q3) ILO unemployment (% rate) Output gap Fiscal impact (per cent of GDP) Public sector net borrowing Cyclically-adjusted current budget Public sector net debt Depreciation scenario two Economic assumptions GDP (percentage change) CPI inflation (Q3) ILO unemployment (% rate) Output gap Fiscal impact (per cent of GDP) Public sector net borrowing Cyclically-adjusted current budget Public sector net debt 2013-14 2014-15 2015-16 2016-17 2017-18 0.2 2.4 7.9 -2.9 0.8 2.9 8.0 -3.7 2.0 2.3 8.0 -3.6 2.4 2.1 7.8 -3.3 2.7 2.0 7.3 -2.7 2.8 2.0 6.8 -2.1 5.6 -4.0 75.9 6.8 -2.8 79.2 5.9 -1.7 82.6 5.0 -1.2 85.1 3.4 0.1 85.6 2.2 0.8 84.8 0.2 2.4 7.9 -2.9 1.1 3.0 7.9 -3.5 2.1 3.3 7.9 -3.2 2.5 2.6 7.6 -2.8 2.9 2.2 7.0 -2.1 3.0 2.1 6.4 -1.4 5.6 -4.0 75.9 6.6 -2.8 79.0 5.7 -1.7 82.3 4.8 -1.3 84.6 3.1 -0.1 85.0 1.9 0.5 83.7 0.2 2.4 7.9 -2.9 1.0 3.0 7.9 -3.5 1.9 3.4 8.0 -3.5 2.3 2.9 7.8 -3.3 2.6 2.6 7.4 -2.8 2.8 2.4 6.8 -2.3 5.6 -4.0 75.9 6.6 -2.7 79.0 5.7 -1.7 82.4 5.0 -1.2 84.9 3.4 0.1 85.4 2.2 0.8 84.5 183 Economic and fiscal outlook A Budget 2013 policy measures A.1 The Economic and fiscal outlook incorporates the Government's costings of policy decisions announced in Budget 2013 or since the Autumn Statement. The OBR has certified all of the costings of tax and AME measures as being reasonable central estimates. This Annex reproduces HM Treasury's table of policy decisions. Chapter 4 of this report and the OBR's annex in the Treasury's Budget 2013 policy costings document sets out further details. 185 Economic and fiscal outlook Budget 2013 policy measures Table A.1: HM Treasury table of Budget 2013 policy decisions Head Previously announced (smaller measures) 1 Carbon Reduction Commitment: exclude schools 2 Government response to OTS review of share schemes 3 Carbon price floor: Northern Ireland exemption ?million 2013-14 2014-15 2015-16 2016-17 2017-18 Tax 0 0 -65 -65 -65 Tax -40 -45 -50 -55 -55 Tax -20 -25 -40 -45 -45 Tax -30 -40 -40 -40 -45 Tax +25 0 0 +5 +5 6 Annual charge and SDLT 15% rate: reliefs for commercial businesses Capital Gains Tax on disposals of high value residential property: extension to UK non-natural persons Universal Credit: exempt from income tax Tax 0 0 -35 -35 -30 7 Debt Cap: tightening of rules Tax +50 +60 +50 +35 +30 8 Building Societies: capital instruments Tax +20 +20 +20 +20 +30 9 Employee shareholder status: CGT changes Tax 0 0 * +5 +30 10 Enterprise Management Incentive: qualification for CGT entrepreneurs' relief 11 Lorry road user levy and offsetting VED reduction 12 Income tax: transfer of assets abroad Tax -10 -15 -20 -25 -25 Tax 0 +25 +25 +25 +25 Tax 0 0 -10 -10 -10 13 Cap on reliefs: exemption for EIS share loss relief and overlap relief Tax 0 -20 -10 -10 -10 14 Carbon price floor: non rate changes Tax +5 +5 +5 +5 +5 15 Disincorporation relief Tax -10 -5 -5 -5 -5 -10 -5 0 4 5 16 Vehicle Excise Duty: PIP disability exemption Tax -10 -10 Spend +5 +5 18 Contracting out NICs: public sector employers Tax 0 0 0 +3,325 +3,285 19 Contracting out NICs: public sector employees Tax 0 0 0 +1,365 +1,350 20 Contracting out NICs: private sector employers Tax 0 0 0 +570 +565 21 Contracting out NICs: private sector employees 22 Inheritance tax: threshold freeze for 3 years from 2015-16 Other Mid Term Review: 23 Social Care funding reform: introduce Dilnot cap from 2016-17 24 Childcare additional funding2 Growth and Enterprise 25 National Insurance: ?2,000 Employment Allowance 26 Corporation tax: reduce main rate to 20% from 2015-16 27 Capital Spending: maintain 2014-15 level Tax Tax 0 0 0 0 0 +20 +235 +80 +235 +170 Spend 0 0 Spend 0 0 Tax 0 -1,255 -1,370 -1,595 -1,725 Tax 0 -5 -400 -785 -865 Spend 0 0 -125 -145 -150 -160 17 Pension Credit pass through Previously announced (Mid Term Review) Single Tier: introduce from 2016-17: 28 Affordable housing Spend 0 29 Right to Buy changes Spend -5 +45 Tax 0 -145 30 Stamp duty: abolish schedule 19 charge Economic and fiscal outlook 186 Budget 2013 policy measures 31 Abolishing stamp duty on AIM and other junior Tax shares 32 Seed Enterprise Investment Scheme: extend Tax CGT holiday to 2013-14 33 Employee shareholder status: income tax Tax 34 R&D Tax Credits: increase Above the Line credit Spend to 10% 35 Employee ownership: additional support Spend 36 Industrial Strategy 37 Growth vouchers 38 Tax relief: health interventions 39 Health interventions 40 Bank Levy (including offsetting CT changes) Spend Spend +5 -170 -170 -170 -175 0 -5 0 0 0 0 -20 -15 -80 -45 -65 -75 0 -50 -125 -10 -160 -25 -10 -10 -10 Tax 0 -10 Spend 0 +10 Tax 0 +195 +250 +245 +250 Tax 0 -1,075 -1,045 -1,060 -1,210 Tax 0 +100 +80 +50 0 Tax Tax -480 -170 -810 -215 -835 -210 -870 -205 -900 -205 Personal Tax 41 Personal allowance: increase by an additional ?560 to ?10,000 in 2014-15 42 Pensions tax relief: individual protection Duties 43 Fuel Duty: cancel September 2013 increase 44 Alcohol: 1p off pint of beer and abolish escalator in 2014-15 Avoidance and Debt 45 Tax repatriation from Jersey, Guernsey, and Isle of Man 46 Offshore employment intermediaries 47 Partnerships 48 Corporation Tax: losses 49 Loans from close companies to participators 50 IHT: limiting deduction of liabilities 51 General Anti-Abuse Rule: non revenue protection 52 Stamp Duty Land Tax: subsales 53 Debt: improving coding out 54 Avoidance schemes: enhanced information powers 55 Penalties in avoidance cases Motoring and Environment 56 Capital allowances: Ultra Low Emission Vehicles 57 Company car tax: ULEVs Tax +395 +80 +1,025 +240 +1,395 +325 +1,075 +235 +1,020 +170 Tax Tax Tax Tax Tax Tax 0 0 +260 0 +5 0 +80 +125 +305 +65 +20 +60 +85 +365 +270 +75 +15 +50 +85 +300 +205 +70 +15 +40 +90 +285 +190 +60 +15 +85 Tax Tax Tax +45 0 0 +35 0 +5 +30 +45 +35 +25 +40 +35 +25 +45 +35 Tax 0 +55 +60 +5 +10 Tax 0 0 -5 -25 -35 Tax 0 0 -10 -15 -15 58 VED: freeze rates for HGVs in 2013-14 59 Aggregates levy: freeze in 2013-14 Tax Tax -10 -10 -10 -15 -10 -15 -10 -15 -10 -15 60 Capital allowances: energy and water efficient technologies 61 Capital allowances: energy saving plant & machinery in Northern Ireland Tax +5 +15 +25 +30 +20 Tax 0 +5 +5 +10 +10 Changes to spending forecasts 62 Spending total adjustment 63 Official Development Assistance: adjusting to meet 0.7% GNI target Spend Spend +1,325 +135 +1,085 +165 64 Special Reserve Spend +300 0 Budget 2013 policy measures 65 Equitable life TOTAL POLICY DECISIONS Total spending policy decisions Total tax policy decisions Total tax policy decisions excluding impact on Government departments Financial transactions3: Help to Buy extension Build to Rent extension Spend 0 +1,315 +1,605 -290 -290 -45 -1,650 +1,055 -2,705 -2,705 -2,850 0 -2,850 -2,850 +1,740 0 +1,740 -1,585 +1,305 0 +1,305 -1,980 -1,150 -150 -1,430 -445 -1,550 -360 0 0 0 0 Published by TSO (The Stationery Office) and available from: Online www.tsoshop.co.uk Mail, telephone, fax and email TSO PO Box 29, Norwich, NR3 1GN Telephone orders/General enquiries 0870 600 5522 Order through the Parliamentary Hotline Lo-Call 0845 7 023474 Fax orders: 0870 600 5533 E-mail: customer.services@tso.co.uk Textphone: 0870 240 3701 The Houses of Parliament Shop 12 Bridge Street, Parliament Square, London SW1A 2JX Telephone orders/ General enquiries: 020 7219 3890 Fax orders: 020 7219 3866 Email: shop@parliament.uk Internet: http://www.shop.parliament.uk TSO@Blackwell and other 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