PUBLIC FINANCES

PSBR

2.01 The outturn for the public sector borrowing requirement (PSBR) for 1995-96 was 32.2 billion pounds, 3 billion pounds higher than forecast in the Budget in November. The PSBR is forecast to be 27 billion pounds in 1996-97 and 23 billion pounds in 1997-98, which is rather higher in each year than the Budget projections. Nevertheless the level of borrowing forecast for 1997-98 is only around half of that in 1993-94, when the PSBR exceeded 45 billion pounds.

Assumptions

2.02 The forecast assumes that Control Total spending in 1996-97 and 1997-98 is in line with the plans announced in the Budget, with a full spend of the Reserve. Privatisation proceeds are assumed to be 4 1/2 billion pounds in 1996-97 and 2 billion pounds in 1997-98.

2.03 On the receipts side the forecast is based on the usual assumption that income tax allowances are indexed and excise duties are revalorised in future Budgets (except tobacco duty and fuel duties, where the Government has made clear its policy to increase duty rates in real terms). Decisions about the actual level of tax rates and allowances in 1997-98 will be taken in the Budget in November. The forecast also assumes that a gilt strips market begins in April 1997; this has the effect of reducing tax receipts in 1997-98 by around 1/2 billion pounds, as a result of later payment of tax. (The Budget forecast made no specific assumption about a start date for a gilt strips market.)

PSBR ratio

2.04 The PSBR outturn for 1995-96 represents 4 1/2 per cent of GDP, a reduction of 3/4 percentage points from 1994-95. The PSBR is forecast to be reduced further to 3 1/2 per cent of GDP in 1996-97 and 3 per cent of GDP in 1997-98. This compares with a peak PSBR/GDP ratio of 7 per cent in 1993-94. Higher tax receipts and lower spending, relative to GDP, make approximately equal contributions to the reduction in the PSBR/GDP ratio over this four year period.

Receipts

2.05 General government receipts in 1995-96 increased by 8 per cent, which was significantly larger than the rise in money GDP. However the Budget in November made a net reduction in taxation, and growth in receipts for 1996-97, at 4 1/4 per cent, is expected to be a bit below that of money GDP. Rather faster growth in receipts - around 6 1/4 per cent - is forecast for 1997-98.

2.06 The ratio of general government receipts to GDP for 1995-96 is now estimated at 38 per cent. This represents an increase of around 2 per cent of GDP from 1993-94. This rise reflects the tax increases in the two 1993 Budgets. Nevertheless it is a rather smaller rise than was anticipated in November 1993. The tax measures announced in the March and November 1993 Budgets were expected to increase receipts by around 2 1/4 per cent of GDP over the following two years. With economic recovery also contributing, the November 1993 Budget projections anticipated a 3 percentage point rise in the receipts to GDP ratio by 1995-96. In the event the rise in this ratio has turned out to be a full percentage point lower.

2.07 VAT provides much of the explanation of the lower than expected rise in receipts. VAT receipts increased by only 3 per cent in 1995-96, as compared with a 4 3/4 per cent rise in consumer spending (at current prices). Over the three years since 1992-93, whereas consumer spending has risen by 16 per cent, VAT receipts have only increased by 15 per cent in total. Yet real spending growth has been a steady 2-3 per cent per annum over that period, circumstances which in the past have led, if anything, to some increase in the ratio of VAT to consumer spending. On top of this, the net effect of Budget measures on VAT - in particular, the extension of VAT to fuel and power at a reduced rate - was expected to raise receipts by 1 billion pounds. So the failure of VAT receipts even to keep pace with spending over the past three years is surprising.

2.08 There is no clear explanation of this weak VAT receipts growth. The obvious place to look for an explanation is in the mix of spending between VATable and non-VATable goods and services, but this does not appear to explain very much of it. It is possible that earlier administrative changes to VAT, such as real increases in the registration threshold and changes to the bad debt relief provisions, have had a rather larger impact on receipts than was originally estimated. It is also possible that companies are simply becoming more efficient in managing their VAT liabilities.

2.09 Therefore the forecast assumes only a modest rise in VAT relative to consumer spending, at a time when the forecast acceleration in real consumption growth, to 4 3/4 per cent in 1997, might be expected to lead to some pick up in the proportion of consumer spending that is VATable. On top of this, the administrative change to the payments on accounts scheme announced in the last Budget should result in a once for all boost to 1996-97 receipts of around 1/2 billion pounds.

2.10 Income tax receipts have increased by 20 per cent over the past three years, only slightly above the growth in money GDP. Thus tax yield has risen only marginally from 9.4 per cent of GDP in 1992-93 to 9.6 per cent of GDP in 1995-96. That period saw the implementation of tax changes in the two 1993 Budgets worth around 0.7 per cent of GDP, but also the full year impact of the 20p lower rate band introduced in 1992, and the increasing cost of special reliefs introduced to encourage saving and employee participation. Relatively low growth in the wages and salaries bill and structural changes in the labour market also help explain what has been quite weak growth in income tax. With income tax reductions in the November Budget worth over 3 billion pounds in 1996-97, and the start of a gilts strips market producing a cash flow loss of 1/2 billion pounds in 1997-98, a fall in income tax receipts relative to GDP is forecast.

2.11 In contrast, corporation tax receipts have been buoyant over the past two years, with an increase of over 20 per cent in 1995-96 following one of 30 per cent in the previous year. As a per cent of GDP, corporation tax receipts have risen from 2.3 per cent in 1993-94 to 3.3 per cent in 1995-96. This reflects the quite rapid profits growth seen in the early stages of the current economic recovery - changes to the corporation tax regime since 1993 have been relatively small in terms of yield. Rather slower profits growth in 1995 and 1996 is expected to lead to somewhat slower growth in corporation tax receipts in 1996-97 and 1997-98, with the yield of corporation tax, relative to GDP, stabilising.

Expenditure

2.12 The 1995-96 outturn for Control Total spending is estimated at 255.6 billion pounds, which is 3/4 billion pounds lower than the original plans announced in the November 1994 Budget. This is the third year in succession in which the Control Total plans have been underspent. The 1995-96 outturn represents a real terms increase in spending of 1/2 per cent. The 1995 Budget plans provide for Control Total spending of 260.2 billion pounds in 1996-97 and 268.2 billion pounds in 1997-98. On the latest forecast of the GDP deflator this implies a real terms fall in Control Total spending of 1/2 per cent in 1996-97, followed by an increase of 1 per cent in 1997-98.

2.13 The Government's objective to reduce public expenditure as a share of national income over time is expressed in terms of GGE(X) - general government expenditure excluding privatisation proceeds and lottery- financed spending, and net of interest and dividend receipts. GGE(X) has been growing rather faster than the Control Total as a result of a rise in debt interest spending, reflecting relatively high borrowing in recent years. Nevertheless growth in GGE(X) has been below of that money GDP, and the ratio of GGE(X) to GDP fell to 42 1/4 per cent in 1995-96, down from a peak of 43 1/2 per cent in 1992-93. Although GGE(X) is expected to continue to grow faster than the Control Total over the next two years, the projected growth rates are well below that of GDP, and the spending to GDP ratio is projected to fall quite sharply to 40 1/2 per cent in 1997-98.

Comparison with Budget forecast

2.14 The PSBR outturn for 1995-96 was 3 billion pounds higher than forecast in the Budget last November. Receipts were 3 billion pounds lower. Privatisation proceeds were 1/2 billion pounds lower than forecast but offsetting this was lower public corporations market borrowing.

2.15 Lower general government receipts are explained by shortfalls on the Budget forecast for each of the three main taxes - income tax, corporation tax and VAT - which together were down on forecast by nearly 3 billion pounds. In total the shortfall on the Budget forecast for taxes is around 0.4 per cent of GDP, but because money GDP is also lower than projected in the Budget, the receipts to GDP ratio is only down by 0.2 per cent on the Budget projection.

2.16 In terms of individual taxes, the largest shortfall on forecast is for corporation tax (1.1 billion pounds). This cannot be attributed to lower money GDP; the shortfall is entirely on mainstream corporation tax, levied on previous years' profits. It seems to be largely a consequence of an earlier misreading of the underlying level of receipts in 1994-95. Emerging evidence now shows that the introduction of pay-and-file for corporation tax payments in 1994-95 had a significant impact in bringing forward the payment profile; this may have boosted receipts in that year by 1/2 billion pounds or more. The Budget forecast did not take proper account of this.

2.17 A VAT shortfall of 0.9 billion pounds appears to reflect a case of continuing weakness of VAT relative to consumer spending, rather than of lower than expected spending - growth of the latter has turned out close to the Budget forecast. There was also an income tax shortfall of 0.8 billion pounds, some of which can be attributed to a timing effect; PAYE receipts in March 1996 were around 0.5 billion pounds lower than normal, but this was made good in April.

2.18 Many of the factors which have reduced receipts relative to forecast for 1995-96 carry forward to 1996-97 and subsequent years. On top of this, the growth of money GDP for 1996-97 is now forecast to be 1/2 per cent lower than in the Budget projections - partly from lower real growth and partly from a lower price level. The key tax bases - personal incomes, company profits, consumer spending - are all lower in nominal terms, which helps explain why a receipts shortfall of 3 billion pounds in 1995-96 becomes a shortfall of 4 1/2 billion pounds in 1996-97. The shortfall on cash receipts increases further in 1997-98 as a result of a somewhat larger downward revision to corporation tax, reflecting lower profits growth in 1996. At 5 1/2 billion pounds, the downward revision from the Budget to 1997-98 receipts is worth about per cent of GDP. But lower money GDP means that, in ratio terms, the reductions on the Budget forecast are only around 1/4 percentage points in each year.

2.19 The Control Totals for 1996-97 and 1997-98 are unchanged from the Budget by assumption, but spending outside the Control Total is a bit higher. For cyclical social security, the 1995-96 outturn was 1/2 billion pounds up on the Budget forecast, largely representing a different apportionment of spending between Control Total and non-Control Total. This knocks through into a higher level of cyclical social security spending in 1996-97 and 1997-98. Debt interest is also up on the Budget forecast for 1997-98, a result of the higher borrowing requirements now forecast.

2.20 In cash terms the upward revisions to spending from the Budget forecast increase GGE(X) by some 1 1/2 billion pounds by 1997-98, less than 1/4 per cent of GDP. But the lower level of money GDP now forecast means that in ratio terms the revisions are rather larger. The latest forecast for the GGE(X)/GDP ratio in 1997-98 is over 1/2 percentage point up on the Budget.

Other measures of the fiscal stance

2.21 The public sector's current deficit is now forecast to fall from an estimated 24 billion pounds in 1995-96 to 15 1/2 billion pounds, 2 per cent of GDP, in 1997-98. This represents a rather higher deficit than in the Budget forecast.

2.22 The general government financial deficit (GGFD) is forecast at 29 1/2 billion pounds - 4 per cent of GDP - in 1996-97, falling to just below the 3 per cent reference level for the European Union excessive deficits procedure for 1997-98. The UK's debt/GDP ratio is already below, and expected to stay below, the debt reference level.

2.23 The stock of net public sector debt is estimated to have stood at 323 billion pounds - 44 1/2 per cent of GDP - at end-March 1996. The latest forecasts of the PSBR imply a further rise in net public sector debt to a peak of 46 1/2 per cent of GDP at end-March 1998. The European Union excessive deficits procedure uses a different measure of debt, gross general government debt, and also measures the denominator in a slightly different way when calculating the debt/GDP ratio. On the EU measure, the ratio is forecast to reach a peak of 56 per cent at end-March 1998.