19 October 2007
The new chancellor's first Pre-Budget Report forecast a temporary dip in revenue and slowed the growth in spending. Both of these pose risks for the government's grand plans for public services
Alistair Darling's first Pre-Budget Report revealed that he believes revenues will be lower than previously expected over the next three years, but that most of this weakness will be temporary. On the spending side, the chancellor announced that government departments — which have been used to annual after-inflation spending rises of 4.9% — are set to get an increase of just 2.1% a year over the next three years.
There are risks to both of these projections. Receipts might not bounce back as strongly as the chancellor expects and the spending plans might prove incompatible with the government's aspirations for providing world-class public services and slashing the number of children living in poverty.
One striking similarity between Darling's PBR and Gordon Brown's recent Budgets is that they have all contained an upwards revision to borrowing. Figure 1 shows successive forecasts for government borrowing (excluding that used to finance investment), which is known as the 'current budget'. Each projection since Budget 2002 has projected a larger deficit than previously expected in the near term and a delay in the return to surplus. The latest government projection suggests that, even though the economy is currently thought to be in a relatively healthy position, there will not be a surplus on the current budget until 2009/10.
The most recent downwards revision is attributed to a combination of turmoil in the financial markets and a weaker outlook for wages. These have reduced projected receipts next year by £6.5bn. However, the Treasury believes that £5bn of this will be temporary and therefore dealt with only the remaining £1.5bn in the PBR, through the net increase in tax and reductions in the earnings-related component of state pensions. The Treasury might be correct in this prediction, but there is a clear risk that the short-term deterioration will turn out to be more than £6.5bn or, more importantly, that the long-term deterioration will exceed £1.5bn.
There are also considerable risks on the spending side. Part of the reduction in borrowing over the coming years is to be brought about by cuts in public spending as a share of national income. While the rhetoric might have suggested that Darling was doing much for health, education, transport, housing and child poverty, there was much less for all these areas than in the past.
Health spending in 2010/11 is set to be more than £2bn below the level that Sir Derek Wanless's 2002 report envisaged would be needed to progress towards a world-class health system.
Growth in spending on both education and transport is set to be much lower than in recent years. Spending on housing — supposedly a priority for the new Brown government — is set to grow by just 1.8% a year after inflation, which is considerably less than the 4.3% a year it has received over the past nine years. The chancellor did find an extra £600m to take 100,000 children out of poverty. But estimates from colleagues at the IFS suggest that this would still leave the government 700,000 short of its 2010/11 target, for child poverty to be half the level it was in 1998/99.
The settlement for local government in England is also much tighter than in recent years, with a budget increase of just 0.8% per year after inflation for the next three years. By contrast, grants from central government have grown by an average of 3.3% per year after inflation over the past decade, while Band D council tax rates have risen by an average of 4.2% per year. And yet the government has said that it wants Band D council tax increases to be held below 5% per year, which would equate to 2.3% a year after economy-wide inflation.
In this area, the government might find — as it has done in the past — that pressures on local government services will necessitate either an increase in the settlement for local councils or additional support for certain groups of council taxpayers, such as pensioners.
So there are several dangers ahead for Darling. He might get lucky and be able to top up his spending plans if receipts bounce back even more strongly than he currently expects. But if not, he could be faced with the difficult choice of either announcing further tax-raising measures or scaling back the government's aspirations for improving public services and reducing child poverty.
Carl Emmerson and Gemma Tetlow are, respectively, deputy director and senior research economist at the Institute for Fiscal Studies
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