OBR report: now for the even worse news

13 Jul 11
Tony Travers

The Office for Budget Responsibility has presented a sobering view of the pressures facing governments in the decades ahead

The Office for Budget Responsibility’s Fiscal sustainability report, published today, is a pessimistic warning that the United Kingdom faces a long period of public spending constraint – or the need for a significant increase in the country’s tax yield.  The report is full of fascinating statistics, notably about the possible future we face.  For example, the population of the UK is shown as rising to a ‘central projection' of 75 million by 2060, with the possibility of over 87 million.

There will be a sharp drop in the relative size of the working age population, and a related rise in the need to spend on health for the elderly.  While none of these numbers is wholly unexpected, seeing them laid out baldly in an independent analysis of the country’s future is a salutary experience.  Even when/if economic growth returns to its long-term average rate, the pressure on public spending programmes will continue.  It will be as if the current austerity affecting public expenditure has to be extended to 2020, then 2030 and beyond.  While the downward pressure seen in 2011-12 to 2015-16 will become less severe, the long-term need to reduce state spending per head will remain.

Table 3.4 shows NHS, education, state pensions, pensioner benefits and other spending as a proportion of GDP in 2011-12, 2015-16 and then trending forward to 2060-61.  Health spending is shown as dropping from 8.4 per cent of GDP this year to 7.2 per cent in 2015-16, while schools expenditure falls from 6.3 per cent to 5.0 in the same period.  If these falls occur, the government’s recently published Public Spending Statistical Analyses report for 2011 suggests that by 2015-16, health spending as a share of GDP will have returned to the levels seen in 2007-08, while education will be back to 2002-03 levels.     Table 4.1 of PESA shows overall public expenditure as a proportion of GDP falling from 47.6 per cent in 2009-10 to 41 per cent in 2014-15 – a reduction equivalent to 6.6 per cent of GDP within five years.  Nothing like this has happened since Mrs Thatcher’s heyday, and rarely before in modern history.

In the period after 2015-16, demographics and other factors are shown driving health spending to 9.8 per cent of GDP, while the cost of state pensions rises from 5.5 per cent of GDP in 2015-16 to 7.9 per cent in 2060-61.  Public service pensions, intriguingly, fall from 2.0 per cent of the economy in 2015-16 to 1.4 per cent in 2060-61.  Perhaps the government should be putting its efforts into to cutting state pensions ahead of the struggle with the unions over public service pensions.

There is an ominous figure in Table 1.13 of PESA, derived from last year’s Spending Review.  ‘CLG Local government’ spending is shown falling sharply in 2012-13, then rising modestly in 2013-14.  Presumably the government wants to ensure that the reforms introduced by the ‘resource review’ take place in a year when there is a let-up in the pressure on council budgets.  But in 2014-15, ‘CLG - local government’ spending drops by about five per cent.  By then, councils should be in the era of business rate retention and immune from this kind of central intervention to cut resources.  Perhaps the Treasury knows something we don’t.

The OBR states: 'Under our central projections, the government would need to increase taxes and/or cut spending permanently by a little over 3 per cent of GDP (£45 billion in today’s terms) from 2016-17 onwards to satisfy the inter-temporal budget constraint through an immediate and permanent adjustment”.  This means that if the government wanted to eliminate its debt entirely, a 3 per cent tax increase/ spending cut would be required.  More modestly, the OBR says: 'the government would need to implement a permanent tax increase or spending cut of 1.5 per cent of GDP (£22 billion in today’s terms) in 2016-17 to get debt back to 40 per cent and 0.8 per cent of GDP (£12 billion in today’s terms) to get it back to 70 per cent'.   The range of adjustment seems likely, therefore to be in the range £22 to £45 billion – on top of all the spending constraints and cuts now envisaged.  This is where the additional pressures will come.

Separately, the government has today issued draft Whole of Government Accounts, as a first step to registering all of the government’s future liabilities in the longer-term.  The costs of pensions, PFI charges and other demands on the government’s books have been assessed.  This exercise, alongside the OBR’s report, give us a picture of the challenges of balancing revenue and income in the longer term.  It is hard to object to the transparency of such an exercise, at least so long as it reassures (rather than causes worry to) the international foreign exchange markets.

One word of caution is probably necessary in relation to such futurology.  Imagine if, in 1961, the government had published a ‘fiscal sustainability report’ for the years 1961 to 2011.  Public spending as a share of GDP was around 35 per cent at that time.  Subsequently, it has risen to a level of perhaps 41 to 42 per cent in the medium term, and to almost 48 per cent on a couple of occasions.  No one would have imagined in 1961 that public expenditure might step upwards by six or seven percent of GDP on a permanent basis.  Nor would early-1960s experts have forecast that defence would decline precipitously as a national priority while the NHS and benefits would rise substantially above their earlier long-term figures. Things change.

Nevertheless, Robert Chote and his OBR colleagues deserve credit for a sobering view of the pressures facing governments in the decades ahead.  The present government has embarked on a range of public service reforms.  Tony Blair attempted to do the same.  It now seems inevitable future governments will feel the need to find radical ways of lessening the impact of rising demands for public expenditure.  The NHS, schools and social benefits will not be immune – they cannot be, simply on account of their scale.  Given that the near future follows a vast existential challenge to the world’s banking and finance system, it appears likely that half a century of tax and spending constraint lies ahead.





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