Institute for Fiscal Studies | Observations In these frequent observations, we look at aspects of topical issues related to our research programme. To sign up to receive email alerts when new observations are posted, please email Bonnie Brimstone. http://www.ifs.org.uk Thu, 18 Dec 2014 02:38:14 +0000 <![CDATA[Coping with the cap?]]> In 2013 the government introduced a cap on the amount that some working-age families can receive in benefits. Today the Department for Work and Pensions (DWP) published quantitative analysis of the direct impacts of the cap and of how the affected people might have responded. We peer-reviewed this work and offered advice on the methods used, and in this observation we draw out some of the key findings. (A previous observation gave an overview of the benefits cap and commented on the potential rationale – or otherwise – for such a policy.)

The cap, which works by reducing housing benefit awards, was set at £500 per week (except for childless single people, for whom it is £350), and those receiving Working Tax Credit and some claiming disability benefits are exempt. These choices mean that the cap does not affect many people and that the overall fiscal consequences are small. About 27,000 families (less than 1% of working-age families receiving housing benefit) were being capped once the policy was fully rolled out in late 2013, with their benefit income reduced by a total of about £100 million per year. Essentially all the families who receive enough benefit income for the cap to be binding have a large number of children or high rents (and often both).

However, the relatively small number of affected families can lose substantial amounts. Half of those capped in November 2013 lost at least £46 per week as a result. Some recipients lost much more than this, so the mean loss among those capped was much higher still, at £70 per week. Given these large impacts on those affected, it is important to understand how they are responding.

Identifying causal impacts of policies on behaviour is rarely easy, but DWP’s analysis allows us to draw some conclusions about the likely effects. The Figure below illustrates perhaps the most striking evidence. It plots the amount of weekly benefit income (before any cap is applied) against the probability of claiming working tax credit (WTC) a year later, for four groups (`cohorts’) of benefit recipients: those receiving benefits in May of 2010, 2011, 2012 and 2013 (excluding those exempt from the cap, and excluding the single childless who are subject to a different cap level). The May 2012 cohort is the first that we might expect to see changing its behaviour in light of the cap: from May 2012, claimants who looked like they were set to be affected were sent a letter notifying them of this and were offered support through Jobcentre Plus. The cap was then rolled out from April 2013.

The May 2012 and 2013 cohorts were more likely to flow onto WTC than the earlier cohorts at all benefit levels shown – including for recipients below the cap level, which suggests that some of this difference is due to a wider recovery in the economy after 2011 rather than the cap. Crucially though, the divergence between cohorts begins to widen at just around the £500 point at which the cap binds. The divergence grows consistently as one moves to the very highest levels of benefit entitlement, i.e. to those who were hit hardest by the cap. (Note that there are very few claimants at these very high levels of entitlement.)

Figure: Movements onto Working Tax Credit after one year by benefit income (before capping)

 

Notes: £500 benefit cap introduced in 2013. Excludes single adults without dependent children, for whom a lower cap level applies (£350 rather than £500 per week). Figures are four-point moving averages.

Source: Chart 8.2 of DWP report “Benefit Cap: Analysis of outcomes of capped claimants”, available here.

DWP conducted some more formal econometric analysis of the kinds of patterns documented in the Figure. On average, claimants with benefit income exceeding the impending cap level in the May 2012 cohort – who received warning of the cap and support in dealing with it - were 1.5 percentage points more likely to flow onto WTC within a year than their counterparts just below (within £50 per week of) the cap. This is over and above any gap that would be expected simply because of observed differences in the characteristics of these two groups, such as the number of children that they have. The difference grew to 4.7 percentage points for the May 2013 cohort, after implementation of the cap. These differences did not exist for the earlier May 2010 and May 2011 cohorts (indeed prior to the cap those with higher levels of benefit income were slightly less likely subsequently to move onto WTC). This suggests that these differences provide a reasonable sense of the likely effect of the cap on movements onto WTC.

It is worth bearing in mind the caveat that starting a WTC claim is not the same thing as moving into paid work. Some people may move into work but not work enough hours to be entitled to WTC or not take up the WTC to which they become entitled. On the other hand, some might start a WTC claim when they were in work all along, perhaps because claiming this entitlement is a relatively easy way of exempting oneself from the benefit cap. To the extent that additional moves onto WTC are an accurate indicator of moves into work, these estimates suggest that around 2,000 families who were claiming benefits in May 2013 had someone move into paid work twelve months later in response to the cap. (Note: this estimate is for this cohort, rather than an overall estimate of total additional moves to WTC.)

We might also expect some claimants to move house in response, as many affected claimants are above the cap because they have high rents and hence have a large housing benefit claim. There is evidence of this, but (at least so far) only for the small number of claimants who lost particularly large amounts of benefit income as a result of the cap. For those with benefit entitlement at least £200 above the cap level, 14% of the May 2010 cohort moved within the next year; this had risen to 20% for the May 2013 cohort once the cap was in place. For benefit claimants just under the cap level, the proportion moving house within a year stayed constant at 11% for each of the May 2010, 2011, 2012 and 2013 cohorts.

This evidence helps us to learn about the behaviour of a group of benefit claimants who we previously knew little about. At its Autumn conference, the Conservative Party suggested lowering the benefits cap by approximately a further £60 per week (to about £440 per week). On the basis of the analysis published today, it would be reasonable to expect this to result in some of the affected claimants moving into work, but few moving house – the maximum possible loss of benefit income, from this additional hypothetical cut, would be £60 per week, and the current cap seems to have increased house moves only among those who lost substantially more than that.

Nevertheless, there is still much we do not know. There are various other possible responses to this reform, including cutting back on spending, running down savings (or building up debts) or getting help from family or friends. Analysis of benefits data cannot tell us about this (although DWP have also conducted surveys of, and in-depth interviews with, those subject to the cap and these provide some information on other potential responses). What the quantitative analysis does tell us is that the large majority of affected claimants responded neither by moving into work nor by moving house. For this majority, it remains an open question as to how they adjusted to what were, in many cases, very large reductions in their income.

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http://www.ifs.org.uk/publications/7482 Mon, 15 Dec 2014 00:00:00 +0000
<![CDATA[The government’s proposed new postgraduate loan scheme: will the RAB charge really be zero?]]> In the Autumn Statement last week, the Chancellor announced a new government-backed loan scheme for postgraduates. Loans of up to £10,000 are to be made available for under-30s studying full-time or part-time for taught masters courses from 2016/17. The government expects 92,000 people to be eligible for the loans in the first year they are available, and intends the long-run cost of the scheme to be zero, meaning that the full value of loans will be repaid, on average. While full details of the loan system have yet to be announced – and will be subject to consultation – the documentation accompanying the Autumn Statement highlighted one way in which the scheme could operate. This observation assesses the example loan scheme put forward and raises some issues that should be considered during the consultation.

The loan system announced by the Chancellor should help individuals who may otherwise be prevented from continuing into postgraduate study because they are credit constrained. If the value of the loans issued were not repaid in full, then it would also represent a government subsidy for postgraduate education, just as there is in the undergraduate student loan system. (Previous IFS research estimated that the government can only expect to recoup 57% of the value of undergraduate student loans, representing a considerable government subsidy.) However, the Autumn Statement made clear that the government intends the loans issued to postgraduates to be repaid in full, on average, suggesting that it does not wish to subsidise loans for postgraduate study.

In the illustrative scheme put forward in the Autumn Statement loans of up to £10,000 will be made available to those under the age of 30 studying for taught masters courses. English students studying in the UK and EU students studying in England would be eligible. The loans will be subject to a real interest rate of 3% (i.e. interest will be charged at RPI plus 3%) and will be repaid at a rate of 9% of income above a lower-income threshold of £21,000, which would be frozen in nominal terms for 5 years. We assume that all other features of the repayment system follow that of the undergraduate loan system, i.e. that individuals incur an interest rate of RPI plus 3% while they are studying; that the lower earnings threshold is uprated by average earnings growth after the five year period; and that postgraduate debt will be written off after 30 years.

Our estimates of the future repayments that would be made under such a scheme are outlined in Figure 1. These estimates are calculated for English-domiciled students using repayments made on the basis of lifetime earnings rather than income and assume that repayments are made in line with the repayment schedule (with no under- or over-payments). We estimate that the government could expect to recoup 100% of the value of these loans in the long-run (i.e. that the so-called RAB charge – the long-run cost to the government of issuing student loans – is effectively zero).

This differs from estimates of the long-run cost of the undergraduate loan system – which we estimate will cost the government 43p for every £1 loaned out – for three reasons. First, and most importantly, postgraduates will borrow considerably less: the maximum postgraduate loan will be £10,000, while the average undergraduate loan is around £44,000. Second, according to recent estimates, postgraduates earn around £200,000 more over their lifetimes, meaning they repay more quickly. Third, the illustrative loan scheme suggests that they would be charged higher interest rates on their loans than most undergraduates. 

 

Figure 1: Net Present Value (NPV) of postgraduate loan repayments made and RAB charge, by distribution of postgraduate lifetime earnings distribution (2016 prices)

Figure 1 also shows how repayments vary across the distribution of lifetime earnings amongst postgraduates. It shows that in all but the first decile of lifetime earnings, loans are close to being repaid in full, on average. Indeed, less than 15% of postgraduates do not repay the full value of their loan, and repayments are, on average, highest in the third decile of lifetime earnings. This relative lack of progressivity is a consequence of the positive real interest rate charged and the fact that repayments are lower than the interest accrued at relatively low earnings. Individuals higher up the earnings distribution also repay more quickly, on average, with those with the highest lifetime earnings repaying in full within seven years of graduating.

There are a number of assumptions that underlie these estimated figures, all of which introduce risk to the government that the long-run cost of issuing loans to postgraduates may turn out to be different from zero. Two important assumptions for the total cost of undergraduate loans were the long-run real earnings growth rate and the population of borrowers. However, for postgraduates these assumptions are less important, as the loan is relatively small in comparison.

For example, while changing our assumption about long-run real earnings growth from 1.1% to -1% increased the RAB charge from 43% to 52% for the undergraduate loan scheme, for postgraduates it increases only slightly, from -0.9% to 1.3%. Similarly, even if we were to assume that only the lowest earning 56% of postgraduates take out loans (this is the take-up rate assumed by the Autumn Statement), the RAB charge would still be very small: around 3%. This lack of sensitivity arises mostly because the value of the loans issued is relatively small compared to the undergraduate scheme, but is also partly driven by the features of the illustrative loan scheme. If, for example, the interest rate charged were to increase with income, then the burden of repayment would fall more heavily on higher earners, but the RAB charge would also become more sensitive to changes in the population of borrowers. This represents an important trade-off that should be considered when designing the repayments system.

One assumption to which our findings are sensitive is that of repayment compliance. In 2012/13, 13.5% of new postgraduate students in the UK were EU domiciled. If the same proportion of EU students took out loans, but the government were unable to collect any repayments from these students, we estimate that the RAB charge would increase to 12.6%. This is another important consideration for the policy consultation.

An additional concern with the introduction of the government’s illustrative example is the high marginal tax rate that individuals would face under the new system. Since repayments on the postgraduate loan would be made “concurrently” with undergraduate repayments, individuals earning between the lower loan repayment threshold (of £21,000 in 2016 prices) and the higher income tax-rate threshold would face marginal tax and employee NICs rates of 50%, while those earning above the higher rate tax threshold would face marginal rates of 60%. This could potentially affect the labour supply decisions of young postgraduates and hence may have wider consequences for growth and productivity.  

It would also introduce a further complication to the tax schedule faced by postgraduates: while the repayment threshold for undergraduate loans looks set to be uprated in line with average earnings growth, the Autumn Statement documentation suggests that the repayment threshold for postgraduate loans would be frozen in nominal terms for five years (we have assumed that it would rise at the same rate as the undergraduate threshold thereafter). This would create an increasingly large range over which repayments would be due on any outstanding postgraduate loan but not on any outstanding undergraduate loan. Of course, this is just an illustrative example, and the government will consult before outlining the specifics of the policy, but it will be important to consider such features.

Ultimately, the success of the policy will be determined by the responses of both students and universities. Are credit constraints a primary driver of individuals’ decisions not to stay on for postgraduate study, and if so is the new scheme sufficient to alleviate these constraints? The response of universities is also uncertain. While the proposed postgraduate loan scheme does not link loans to fees in the same way as it does at undergraduate level, institutions with high market power might still respond to the increased availability of credit by raising prices, which would reduce the effectiveness of the policy in making the upfront costs of postgraduate study cheaper. Thus, while the introduction of a loan scheme is broadly welcome, the devil will, as always, be in the detail.

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http://www.ifs.org.uk/publications/7472 Tue, 09 Dec 2014 00:00:00 +0000
<![CDATA[Household incomes set to start growing again, but slowly and unequally]]> In work funded by the Office of the First Minister and Deputy First Minister in Northern Ireland, the IFS today published an update of our previous income projections for Northern Ireland and for the UK as a whole. This observation draws out what this research tells us about the likely path of household incomes in the UK in the next few years.

Throughout this observation, we focus on changes in incomes relative to inflation as measured by the CPI. Official government statistics still used the flawed RPI measure of inflation; figures using this measure are shown in the briefing note.

Unsurprisingly, the recent recession had a significant impact on household incomes. Median (middle) income fell by 5% relative to CPI between 2008–09 and 2011–12, before growing slightly in 2012–13, the latest year for which official statistics are available. Our projections show that median income is likely to have fallen again relative to CPI in 2013–14, but might now be growing (slowly) in real terms. This means that we expect median household income in 2015–16 to be roughly where it was in 2010–11 (after adjusting for CPI inflation), though still about 3% below its 2007–08 level.

These trends in median income tell us nothing about what is going on at higher or lower income levels. During the recession, income inequality fell as state benefits broadly retained their real value due to price indexation, while workers’ earnings failed to keep pace with CPI inflation. Tax rises affecting better-off households also played a role in reducing inequality. However, this does assume that all households face the average inflation rate - previous IFS research has shown that lower-income households were experiencing higher rates of inflation than richer households over this period. In addition, our projections show that this pattern of income changes is likely to be reversing now: cuts to working-age benefits were accelerated in 2013–14 and will continue to accumulate until at least 2015–16, while earnings growth starts to recover and middle- and higher-income households benefit most from large increases in the income tax personal allowance. As we show in our report, the fact that the incomes of low-income households are projected to fall between 2012–13 and 2015–16, both relative to CPI inflation and median income, means that we would expect both absolute and relative poverty measures to increase over this period.

It is important to note that our projections rely on forecasts for the macroeconomy produced by the Office for Budget Responsibility. A new set of these forecasts will be produced alongside the Autumn Statement next week. Changes to these forecasts – for example, if earnings growth is once again downgraded, or inflation is lower – will have an impact on our projections. We will therefore be updating our projections as part of our election analysis next year.

Figure 1. Real income growth by percentile point: 2007–08 to 2015–16

Figure 1. income growth

Note: Figures adjusted for CPI inflation.

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http://www.ifs.org.uk/publications/7454 Mon, 24 Nov 2014 00:00:00 +0000
<![CDATA[Does GP Practice Size Matter? The relationship between GP practice size and the quality of health care]]> This week the Care Quality Commission (CQC) published comparable information on all GP surgeries in England for the first time, with the aim of identifying which practices should be prioritised for newly introduced inspections.  Understanding whether and why some GP practices fail to provide quality care is important given the vital role that GPs play within the NHS. In recent years, there have been substantial changes to the organisation of GP practices, with a shift away from single-handed practices towards practices with six or more full time equivalent GPs. This observation summarises the findings of an IFS report published today, which describes these trends in detail and examines the relationship between practice size and a variety of practice outcomes and behaviours.

Trends in the organisation of GP practices

Between 2004 and 2010, the total number of full-time equivalent (FTE) GPs in England grew by 15%, rising from 32,263 to 37,173 FTE GPs. Over the same period, the registered population grew by just 5%.  As a result, the number of FTE GPs per individual increased by 10%.

Meanwhile, the number of GP practices fell.  In 2004, 9,016 practices were registered.  By 2010, this had decreased to 8,832.  These trends together reflect in a shift towards a smaller number of GP practices which on average employ a larger number of GPs.  In 2004, there were 3.6 FTE GPs per practice.  This rose to 4.2 in 2010. In particular, there has been a marked decrease in the number of single-handed GPs, while practices with six or more FTE GPs have become more common. 

In the figure below, we divide practices into four categories:

  • single-handed (one or fewer FTE GPs per practice)
  • small-medium (more than one and up to three FTE GPs)
  • medium-large (more than three and up to six FTE GPs)
  • large (more than six FTE GPs)

The share of small-medium practices and medium-large practices stayed flat between 2004 and 2010, while the percentage of single-handed GPs fell (from 22% to 15%) and the share of large practices grew (from 16% to 23%).

Figure: Share of GP practices, by FTE GPs (all practices)

Note: Includes all GP practices with at least one registered GP in the year in question.

Source: Kelly and Stoye (2014), Figure 2.2

Practice size, behaviour and patient outcomes

Overall there is a small, positive relationship between the size of GP practices and the score that they achieve under the Quality and Outcomes Framework (QOF). QOF scores (introduced in 2004), partially determine payments to practices and are used to provide an overall measure of the clinical quality of a GP practice. We find that single-handed practices achieved the lowest average scores, while large practices achieved the highest.  These findings remain even after controlling for differences in the characteristics of the populations and areas that small and large practices serve.  However, there is variation across the different domains captured by QOF.  Interestingly, single-handed practices achieved the highest average scores for patient experience but lower scores in the other domains.  This means that patients appear to be more satisfied with the care received in small practices, despite objective measures suggesting that they receive worse clinical standards of care.

We also find some evidence that single-handed GPs are more likely than GPs in larger practices to have high emergency admission rates among their patients for conditions that would potentially have been avoidable. There are a number of conditions (known as ambulatory care sensitive or ACS, conditions) for which emergency hospital admissions are potentially preventable if the patient receives timely and effective primary care. These include acute conditions (such as ear, nose and throat and urinary tract infections), chronic conditions (such as diabetes and asthma) and vaccine preventable conditions (such as influenza).  Smaller practices are found to be significantly more likely to be among the 20 per cent of practices with the highest emergency admissions rates for ACS conditions, and this relationship holds even when taking account of other patient and practice characteristics.  This relationship is particularly strong in the case of chronic conditions, with single-handed GP practices 4% more likely to appear in this category relative to large practices.  This perhaps suggests that practices with fewer GPs are less able to spend significant periods of time managing long-term conditions.

We also find that smaller practices behave differently from larger ones in how they refer patients on for secondary care. Single-handed and small-medium practices are, other things being equal, less likely to refer their patients for secondary care than GPs in larger practices are.  For example, single-handed practices are 12% more likely to appear in the 20 per cent of practices with the lowest referral rates (once adjusting for the demographic composition of their patients).These practices are also less likely to refer patients to independent sector providers. This may indicate a lower willingness or ability of GPs in smaller practices to offer a full range of treatment options to patients.

It is important to note however that there is significant variation across practices of the same size, and some smaller practices provide extremely good quality care. There are also many factors that could affect the outcomes examined in our report, and which may differ between small and large practices.  As a result, the relationships between GP practice size and GP behaviour are not necessarily causal.  For example, if small practices typically treat patients with worse health on average, the findings related to higher than expected emergency admissions in small practices could simply reflect underlying health differences rather than any impacts of practice size.  Other GP characteristics may also vary across different practice sizes in some unobservable way. 

These findings overall suggest that smaller practice sizes typically deliver worse health outcomes for patients, particularly in single-handed practices.  Although we cannot say for sure that the small number of GPs is the sole cause of this relationship, it is likely to be an important factor.  It is important for policymakers to be aware of this, and understand it better so as to address it.

 

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http://www.ifs.org.uk/publications/7450 Thu, 20 Nov 2014 00:00:00 +0000
<![CDATA[What is happening to spending on social security?]]> Over the course of this parliament, the government have made changes to benefits and tax credits that, at the time they were announced, were expected to reduce spending in 2014–15 by £19 billion relative to a world of no policy change. In fact, real spending (after adjusting for CPI inflation) will be only £2.5 billion lower in 2014–15 than it was in 2010–11. This observation explains why.

If we adjust for prices using the CPI, the move from RPI to CPI for uprating benefits (expected to save over £4 billion in 2014–15) did not bring about a cut in spending over time – rather it meant benefits were no longer expected to increase in real terms. So we’re left with around £15 billion of cuts to explain, compared to an actual fall in real terms spending of around £2.5 billion.

Over a third of the remaining £12.5 billion gap is down to higher spending on pensioner benefits. Combined spending on state pensions, pension credit, and universal pensioner benefits such as the winter fuel payment will be £5 billion higher in 2014–15 than in 2010–11. All of that increase is explained by the rising cost of state pensions. To some extent this reflects an ageing population, with the number getting the state pension up 400,000 over the period. But it is mostly the result of higher spending per pensioner, with each recipient getting nearly £500 a year more on average. This was, for the most part, planned – as each new cohort of pensioners retire, they benefit from past decisions giving them more generous entitlements than previous generations.

Once we strip out pensioner benefits, we’re left with around £7.5 billion of extra spending to explain. In order to help with that task, Table 1 shows real terms spending on major working-age benefits in 2010–11 and 2014–15, alongside announced cuts (excluding the move from RPI to CPI indexation).

Table 1. Changes in spending and announced cuts for some major working-age benefits

Notes: Spending figures adjusted for CPI inflation. Spending on employment and support allowance not shown as cuts announced by previous government. Disability living allowance figures include personal independence payment. Cut to JSA is from 1% uprating and is approximate.

Source: Department for Work and Pensions benefit expenditure tables, Office for Budget Responsibility policy measures database.

The first thing to draw from the table is that there is actually more than £7.5 billion of extra spending to explain, once you take account of the fact that spending on JSA has fallen by around £1.3 billion as a result of lower unemployment.

Housing benefit explains £3 billion of the extra spending. Despite announced cuts of over £2 billion, real terms housing benefit spending will be nearly £1 billion higher in 2014­–15 than 2010–11. This was unanticipated – the OBR’s welfare trends report shows expected spending in 2014–15 has risen by nearly £3 billion since their June 2010 forecast. As they explain, the private rented sector has grown faster than expected, private rents have grown faster than expected, and earnings have grown more slowly than expected – all of which increase housing benefit spending. That slower-than-expected earnings growth also increases tax credit spending. Government cuts to tax credits total £4.6 billion, but spending in 2014–15 is expected to be down less than £3 billion on its 2010–11 level.

It’s not all about macroeconomic conditions though. The difference between the £1.2 billion cut to DLA spending that was announced and the £1.6 billion increase in spending that is now expected reflects the significant delays to the government’s replacement of DLA with the less generous personal independence payment. And although the introduction of employment and support allowance is not included in the £19 billion of cuts (since it was announced by the previous government), it too has saved much less than expected (for reasons discussed here).

All this has important fiscal consequences. Working-age benefit spending has always been sensitive to the unemployment rate. But the rapid growth of housing benefit and tax credits over the couple of decades (documented in this briefing note published today) means that slow earnings growth now has the potential to push up spending too. Much of the hoped-for savings from the introduction of ESA have failed to materialise, and it is an open question whether the personal independence payment will be any different. Mr Osborne wants further cuts to social security spending to help reduce the deficit. He may end up having to make cuts just to stay on track.

Note: The DWP benefit expenditure tables adjust spending figures for economy-wide inflation (as measured by the GDP deflator) – in those terms spending is expected to be £5 billion higher in 2014–15 than 2010–11.

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http://www.ifs.org.uk/publications/7447 Mon, 17 Nov 2014 00:00:00 +0000
<![CDATA[What is welfare spending?]]> The government has started to send out information on how tax revenue is spent to individuals who pay income tax or National Insurance contributions. It has broken down spending into a number of categories. The biggest of these is "welfare", which represents a quarter of total spending. State pensions also appear as a separate category, accounting for 12% of spending. In this observation we look at what counts as pension and welfare spending, and offer some alternative breakdowns.

Spending on state pensions is straightforward. This is essentially just the annual spend on the basic state pension and earnings-related state pensions from various different schemes.

"Welfare" spending, at 25% of the total, is taken directly from the government's public expenditure statistical analyses. It is the total spending defined as "social protection" in these analyses, less spending on state pensions. Total spending on social protection comes in at £251 billion in 2013-14, which is about 37% of total public spending of £686 billion (before accounting adjustments). Take off £83 billion of spending on state pensions and you get to £168 billion on "welfare" - very nearly a quarter of total spending.

What is included in that "welfare" total?

It includes £28.5 billion on "personal social services". This is a number that in many analyses one would want to report separately from other welfare spending. It includes spending on a range of things, such as looked-after children and long term care for the elderly, the sick and disabled. Unlike other elements of "social protection" it is not a cash transfer payment and in many ways has more in common with spending on health than spending on social security benefits.

Another £20 billion of the spending counted under welfare is pensions to older people other than state pensions. That includes spending on public service pensions – to retired nurses, soldiers and so on[1]. This is not spending that would normally be classed as "welfare". The rest of the pay package of a public sector worker is included as departmental spending within the department of that worker. One could either report such pension payments separately or, like pay, as part of the relevant spending function. The pay of nurses counts as health spending. One could count their pensions in the same way.

That leaves around £120 billion of other welfare spending, which can be broken down in a number of different ways.

Since the government has chosen to report state pension spending separately, one obvious division would be to separate spending on those of working age and those of pension age. In addition to state pensions a further £28 billion is spent on pensioners, of which £15 billion goes on benefits specifically for that group, such as pension credit, attendance allowance and winter fuel payment, while the remaining £13 billion is largely spent on housing benefit and disability living allowance. So of the £205 billion or so spent on tax credits and social security benefits about £111 billion is spent on those over pension age and £94 billion on those of working age.

Figure 1 and Table 1 show this breakdown of the 25% of total spending described as "welfare" by the government, alongside the 12% spent on state pensions. 4% goes on "personal social services", 3% on public service pensions, 4% on other benefits for pensioners, and the remaining 14% on benefits for those of working age.

Figure 1. Breakdown of "welfare" as a share of total spending

Sources: Public Expenditure Statistical Analyses, Department for Work and Pensions benefit expenditure tables.

Table 1. Breakdown of "welfare" as a share of total spending

 

Sources: see Figure 1.

It could of course be argued that this would provide too much detail. But there are five categories reported in the government's breakdown of spending, each representing less than 2% of total spending. If it is worth reporting contributions to the EU budget which represent less than 1% of total spending then there might be a case for providing this additional breakdown of "welfare spending".

There are of course other ways of breaking down spending on social security benefits. The OBR, for example, show spending on the elderly, sick and disabled, families with children, the unemployed and help with housing costs (table 2.1 here) . In our survey of the benefits system we provide a similar split (table 3.1 here), separating out spending according to its function as best we can. There are clearly different judgments one can make here (we include attendance allowance in spending aimed at the sick and disabled, rather than the elderly for example), but it does give a good sense of the overall spending priorities within the system. Table 2 shows this split, including the 12% of total spending going on state pensions, and excluding the 4% spent on personal social services and the 3% reported as going on pensions other than the state pension (both of which the government includes in "welfare").

Table 2. Welfare spending by function

 

Note: categories correspond to the primary recipient of a given benefit, rather than capturing all of the expenditure on each group.

Source: Department for Work and Pensions benefit expenditure tables.

There are different ways of reporting how our taxes are spent, and there is a balance to be struck between the amount of detail presented and clarity of message. Lumping a quarter of total spending into one bucket labelled "welfare" may not strike the most helpful balance, especially when it includes such diverse items as spending on social care, public service pensions, disability benefits, child benefit and unemployment benefits.

Note: The IFS provides detailed breakdowns of tax revenue here, benefit spending here, and other public service spending here.

[1]It is also not the number reported by the OBR when looking at spending on public service pensions (see table 4.24 here). The OBR reports gross spending of £36 billion and "net" spending – i.e. gross spending less contributions received – of £10.5 billion. But for the purposes of this note we stick with the numbers published in PESA.

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http://www.ifs.org.uk/publications/7424 Tue, 04 Nov 2014 00:00:00 +0000
<![CDATA[How far through the consolidation are we?]]> The Prime Minister, in an article in today's Times, said "In this parliament we will have made £100 billion of savings while cutting income tax by £10.5 billion. In the next parliament we plan to make £25 billion of savings while making £7.2 billion of income tax cuts". This repeats a statement made at this year’s Conservative Party conference. The implication is that most of the planned cuts in public spending have been made and that the promised tax cuts in the next parliament are relatively modest by comparison with what has been managed in this parliament.

The problem is that the two numbers for “savings” are inconsistent and should not be compared with one another. Public spending cuts planned for the next parliament are about as severe as those which have been implemented over the past five years. Depending exactly how you make the comparison you could say we will be a bit less or a bit more than half way there by next April. (See for example http://www.ifs.org.uk/budgets/gb2014/gb2014_ch1.pdf and http://www.ifs.org.uk/budgets/gb2014/gb2014_ch2.pdf from this year’s IFS Green Budget).

So what is the £25 billion number? That is quite straightforward. It is the real terms cut in total public spending (excluding debt interest) expected for the years 2016-17 and 2017-18. This is a measure of the reduction in public spending (relative to economy wide inflation) which the government expects will occur over that period.

Note it is not a measure of cuts over the whole parliament: it excludes 2015-16 and 2018-19. It is also not a measure of discretionary changes in spending resulting from policy decisions over, for example, spending on public services or social security. It is a measure of the change in total non-interest spending. It is because some elements of spending, driven for example by an ageing population, have been rising, and will continue to rise, that such tough decisions have had to be taken over spending on public services, social security and taxation.

All that said this is a sensible measure of spending. It measures what is happening to the total amount spent by the government on things other than debt interest. On that basis we think total spending will fall by about £28 billion over the next parliament compared with about £23 billion of spending cuts which will have been implemented by the end of this parliament. We are just under half way there.

Indeed if you look at the period of the consolidation, the scale of the total deficit, the scale of the cyclically adjusted deficit, or the scale of spending reductions relative to pre-crisis expectations you get to broadly the same answer. On some bases we will be a bit more than half way through the cuts come the next election, on others a little bit less. There is no sense in which we will be 80% of the way through (which is what is implied by the statement that £100 billion of savings have been made with £25 billion to go).

So what is the £100 billion number which Prime Minister described as savings made over this parliament?

For a start it includes cuts planned for 2015-16 – i.e. in the next parliament, not this one.

More importantly it is calculated on an entirely different basis. It is a measure of policy activism, of the discretionary cuts implemented over the period from June 2010 to the end of 2015-16. It also takes account of the reduction in debt interest spending arising from a tighter fiscal stance. It is not a measure of the change in total spending. So, for example, it includes the effect of policy changes which have reduced spending on social security and public sector pensions to significantly below what they would have been in the absence of the cuts. It does not take account of the fact that other pressures have increased spending in these areas.

Again this is an entirely sensible way of looking at things. It is gives a good sense of the squeeze that is being applied to public spending. But it is not comparable with a number based on total spending.

The £25 billion number simply measures the change in spending relative to a baseline period, asking "how much less in total are we spending now relative to the baseline period". The £100 billion number measures the impact of discretionary policy change, asking "how much less are we spending compared with a world in which we had made no policy choices (relative to a particular counterfactual)".

There are different ways of looking at what is happening to public spending. They have different merits and are useful in their own right. To say that there have been "savings" of £100 billion over this parliament is a useful and interesting statement if one is clear about what it means (and takes account of the fact that it includes savings planned for 2015-16). It is also interesting and useful to say that £25 billion of "savings" are planned over the next parliament (or at least for the years 2016-17 and 2017-18). But it is not useful to use those two numbers together to suggest that the vast majority of the planned cuts have happened. They haven't.

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http://www.ifs.org.uk/publications/7422 Thu, 30 Oct 2014 00:00:00 +0000
<![CDATA[Employment and retirement – explaining recent trends]]> Employment rates of men and women in their 50s and 60s have been growing for nearly two decades – a trend that was only briefly halted during the recent recession. Employment rates for men age 65-69 are at their highest levels since 1974 and continue to grow while employment rates for older women are at record levels. There are reasons to expect that this growth will continue as changes in private pensions and state benefits increase incentives to remain in work longer. For women this upward trend reflects the continuation of a long-term trend since at least the late 1960s. In contrast, recent growth in employment among older men follows a period of dramatic decline between the late 1960s and mid-1990s. In two new publications released today, researchers from the IFS set out levels of employment among older men and women in England in 2012–13, and survey explanations for why these have increased so substantially since the mid-1990s.

Figure 1: Employment rates of older men, 1968–2013

Source: Family Expenditure Survey (1968–1982), Labour Force Survey (1983–2013). Figure 2.1 in Retirement in the 21st Century

Figure 2: Employment rates of older women, 1968–2013

Source: Family Expenditure Survey (1968–1982), Labour Force Survey (1983–2013). Figure 2.6 in Retirement in the 21st Century

Employment in 2012-13

In 2013, 87% of men and 77% of women aged 50 in England were in paid employment or self-employment. Labour force participation declines sharply with age, with the largest declines occurring around the State Pension Age, which in 2013 was between the ages of 61 and 62 for women, and 65 for men. After age 61, employment rates of women were below 50%; for men, employment rates were below 50% from age 64 onwards. A small minority continue working into their 70s, and even at the age of 74 nearly one-in-ten men and one-in-twenty women were doing some form of paid work.

Older people are much more likely to be working part time. This pattern applies to both men and women: more than half of men still in work in their late 60s are working part time, while for women this rises to more than 80%. Self-employment also increases significantly with age, accounting for 44% of men and 20% of women who are working ages 65-69. Recent ONS research has shown that the number of over-65s who are self-employed has doubled in the past five years to nearly half a million.

Health is an important determinant of work status and older people on average have worse health than younger people. For those in the worst health, employment is already low at age 50, while those who are in poor health but still in work in their early 50s tend to leave work more quickly than their healthier counterparts. However, even among those aged 70–74, six-in-ten men and seven-in-ten women report that their health does not limit the kind or amount of work they could do – suggesting that, while health may be a very important factor for some people, it is not a limiting factor for labour force participation for most people, even in their early seventies.

Employment since the mid-1990s

As Figures 1 and 2 demonstrate, women have seen rising employment since the late 1960s, while male employment plummeted between the 1960s and 1990s before increasing since then. Although our research has focused on explaining the more recent rise in employment (particularly among men), this is best understood in a longer term context: some explanations for more recent trends point to a reversal or amelioration of downward pressures seen in the 1970s and 1980s, while others point to genuinely new forces acting on labour force participation of older people.

Between the late 1960s and mid-1990s a number of factors affecting both the demand for and supply of older workers put downward pressures on the labour force participation of older people. On the demand side, the recession of the early 1980s, the decline of traditional manufacturing industries and a general shift in employer demand against low skilled employees all had a disproportionately large effect on older men. On the supply side, increases in the coverage and generosity of private pensions and the widespread availability of early retirement packages made retirement a more attractive option for many., A large increase in the fraction of older people claiming disability benefits, which is more readily explained by economic conditions than changes in health, suggests that for some these benefits acted as an alternative route to retirement. Although some of these pressures also affected women, these downwards pressures were more than compensated for by rising labour market attachment of successive cohorts.

Employment rates among older men started rising in the mid-1990s, while employment among women over 50 increased at a faster rate than in the previous decades. On the demand side, strong economic growth from 1995 to 2007 will have contributed to rising demand for all workers (including older workers), while the continued trend towards services may have increased employment opportunities appropriate to older workers. On the supply side, this period saw a drying up of the generous early retirement packages previously offered by many employers, while reforms to the disability benefits system in 1995 and the mid-2000s reduced the on-flow and increased the off-flow from these benefits, respectively. On the other hand, pension coverage was broadly stable among those approaching the State Pension Age, while overall wealth increased (driven in large part by rapidly rising house prices), factors which (if anything) we would have expected to reduce labour supply. Continued improvements in health are likely to have increased employment further, though this cannot explain the reversal in male employment in the mid-1990s as health was also improving in the earlier period.

Some new factors may also have been at play. A range of policy changes are likely to have increased both demand for and supply of older workers, including legislation allowing people to draw their pension while continuing to work for the same employer, anti-age discrimination legislation, and increases in the female SPA.

Looking forward, many of the forces that have contributed to rising employment among older people over the last two decades are likely to persist. On the demand side, employment among older workers has fared remarkably well in the recent recession compared to previous recessions, and the trend towards more flexible, service sector jobs is likely to continue. On the supply side, there is unlikely to be any relaxation of access to disability benefits, while the full impact of the shift from defined benefit (that is, salary-related) pensions to (typically less generous) defined contribution pensions, which have less sharp financial incentives to leave work, is yet to be felt and could well lead to later retirement.

 

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http://www.ifs.org.uk/publications/7413 Thu, 23 Oct 2014 00:00:00 +0000
<![CDATA[The rise and demise of the National Scholarship Programme: implications for university students]]> There has been heated debate over the increase in tuition fees to £9,000 a year for many students that occurred in 2012. But another major change to the support for disadvantaged students was introduced at the same time: not only were universities required to provide details of their proposed financial support schemes and access programmes before they were allowed to charge fees above £6,000, but also the government introduced a National Scholarship Programme (NSP), designed to offer additional financial support to students via their universities. In new work funded by the Nuffield Foundation and the ESRC, IFS researchers provide an in-depth analysis of the financial support that universities have been offering their students since 2012, what role the NSP played in this provision and what are the likely consequences now that the government has announced that the NSP will, from 2015, no longer provide support for undergraduate students.

The National Scholarship Programme: introduction and demise

Before 2012, universities had to offer a bursary of at least 10% of the (then £3,375) tuition fee to every student from a household with income of less than £25,000 per year. Students received this money in addition to any grant or maintenance loan they were entitled to from central government.

In 2012, a National Scholarship Programme was introduced with the promise of £50m government funding in 2012, £100m in 2013 and £150m in 2014. Universities had to at least match the government allocated funding in order to receive it. While NSP funding can only go to students from households earning below £25,000, students from this group are no longer guaranteed an award, as they were under the previous system of bursaries.

In late 2013, the government unexpectedly cut NSP funding in 2014 from £150m to £50m and from 2015 will provide no further funding. For the 2014 intake, universities are obliged to maintain their previously-planned match funding, thus providing at least three times as much funding as provided by government. This observation looks at what financial support has been available from universities for low-income students each year since 2012, how this varies across different groups of institutions, and how levels of support are likely to change, and for whom, now that the NSP has been abolished.

Financial support for students: 2012 to 2014

Overall, we estimate that students starting university in 2014 will receive, on average, £635 per year in financial support direct from universities. Of this, £100 was in the form of fee waivers and £535 in the form of cash support (such as discounts for accommodation). Those with lower parental incomes (of less than £25,000 per year) will get rather more than this overall average – about £1,466 per year (of which 16% – around £240 – is in the form of fee waivers). This represents a small drop from the £1,604 that was available, on average, to poorer students in the 2013 intake – most likely as a result of the unexpected reduction in NSP funding from the government. This is shown in the figure below.

Figure: Average financial support per year by cohort

 

Research-intensive universities (such as members of the Russell Group) tend to have more generous financial support schemes than less research-intensive ones (such as members of the Million+ or University Alliance groups). For example, we estimate that students going to Russell Group universities in 2014 will, on average, receive around £1,250 per year from their university, of which around £130 is a fee waiver, while those in Million+ universities will receive around £320 per year, of which £100 is in the form of a fee waiver. Amongst those whose parental household income is no more than £25,000 per year, the respective average amounts of support are around £2,860 in the Russell Group and £720 in Million+ institutions.

As well as supporting students from poorer backgrounds, universities are also increasingly using financial support as a means of attracting high-achieving students, particularly since the relaxation of student number controls: for example, when student number controls were removed for students scoring at least ABB in 2013 (down from AAB the previous year), 18 out of the 23 universities that had AAB scholarships in 2012 changed their eligibility threshold to ABB. On average, we estimate that students with ABB or above who enrol in 2014 will receive around £1,060 financial support per year, compared with £386 for those without at least ABB.

The current system of university bursaries and fee waivers is unnecessarily complex and opaque. In around one-third of the 90 large universities we looked at, there is no transparent scheme that guarantees low-income students any financial support. The schemes also vary hugely across universities, with the most generous packages available at Russell Group institutions. It is also worth noting that a not insignificant proportion of the support available comes in the form of fee waivers, which – for many students – are of little benefit, since they are unlikely to pay off their student loans within the 30-year repayment period, with or without the fee waiver.

What is likely to happen to financial support for students in future?

With the abolition of the National Scholarship Programme from 2015, the level and distribution of direct university financial support are likely to change again. NSP spending constitutes a small part of total financial support in research-intensive universities, but a very large part for other universities. For example, we estimate that the government funding of NSP constitutes more than 20% of all financial support for low-income students at Million+ universities for the 2014 intake, while nearly 70% is the match funding that universities are obliged to provide under the NSP (according to their commitments before the unexpected cut to NSP government funding). By contrast, the respective proportions for the Russell Group are around 5% and 13%. As the NSP is to be abolished from 2015 onwards, the ability and obligation of less research-intensive universities to provide financial support will be diminished. The most likely outcome is therefore that financial support will become even more focused on highly-qualified entrants who study at research-intensive universities.

Early indications from OFFA access agreements for 2015/16 suggest that highly-selective institutions are planning to redirect money from bursaries/fee-waivers to more long-term outreach work such as summer schools and mentoring, while universities with more diverse student bodies are planning to redirect money towards helping disadvantaged students engage with their studies and settle into university life, rather than on old-style bursaries.

It therefore looks likely that bursaries for disadvantaged students will fall across all types of institutions. This may mean that disadvantaged students are worse off in the short run. However, the overall impact of these changes will depend on whether focusing on outreach activities and/or engagement activities once in university is more effective at improving access and retention for disadvantaged students in the long run.

Note:

This briefing note and accompanying observation are based on an earlier paper on the National Scholarship Programme and Bursaries http://www.ifs.org.uk/publications/6429, part of a project funded by the Nuffield Foundation. Our most recent analysis, taking into account the 2013 and 2014 Office for Fair Access (OFFA) agreements was funded by the ESRC.

 The Nuffield Foundation is an endowed charitable trust that aims to improve social well-being in the widest sense. It funds research and innovation in education and social policy and also works to build capacity in education, science and social science research. The Nuffield Foundation has part-funded this project, but the views expressed are those of the authors and not necessarily those of the Foundation. More information is available at http://www.nuffieldfoundation.org

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http://www.ifs.org.uk/publications/7410 Wed, 22 Oct 2014 00:00:00 +0000
<![CDATA[Will the welfare cap fit?]]> This morning the Office for Budget Responsibility (OBR) published its first Welfare Trends Report. At the request of the Chancellor George Osborne this is to be a new annual report looking at the trends in, and drivers of, spending on benefits. This important frequent review of spending on the individual components of the social security and tax credit budget is a welcome addition to the OBR’s remit. Sensibly, rather than just covering spending covered by the new welfare cap, the OBR has chosen to cover the total cost of social security and tax credits, including state pensions.

Today’s welfare trends report sets out revisions made to forecast spending on different benefits over different forecast vintages. Between March 2011 and March 2014 forecast spending in 2015–16 on housing benefit has been revised up by £2.5 billion (11%, as shown in Chart 4.4), as both the expected number of renters and the level of rents relative to earnings exceeded the OBR’s forecast. Over the same period forecast spending on incapacity benefits in 2015–16 has been revised up by £3.5 billion (34%, as shown in Chart 4.5) as the numbers expected to be receiving these benefits has increased, claimants of incapacity benefit have been transferred to employment and support allowance (ESA) slightly more slowly than anticipated, and a greater proportion of those transferred have been deemed to eligible for ESA (and for the more generous rates of ESA).

In future revisions of this type might lead to policy action being required if a breach in the Chancellor’s new welfare cap is to be avoided. The cap applies to “welfare in scope” spending: that is the total cost of social security and tax credits, excluding spending on the state pension, jobseeker’s allowance (JSA) and housing benefit for those receiving JSA. In the March 2014 Budget the Chancellor set this cap at the same level as the OBR’s forecast for spending on welfare in scope for the years from 2015–16 through to 2018–19. This means that in 2015–16 the cap is set at £119.5 billion (out of total social security and tax credit spending of £218.8 billion) rising to £126.7 billion in 2018–19.

Further details of the possible rationale behind the cap, and the way it operates, can be found in Chapter 2 of the February 2014 IFS Green Budget. Broadly, the way that the cap operates is that in every Autumn Statement the OBR will assess compliance with the cap. It will be deemed to be breached if policy action has caused forecast spending to exceed the cap, or if forecasting changes have caused forecast spending to exceed the cap by more than 2%. If breached, the intention is that the Chancellor will either take policy action to bring spending back within the cap or will obtain Parliamentary approval to increase the cap. Evidence from recent years (specifically Budget 2012) shows that forecast spending on welfare in scope can be revised up by more than 2% and therefore this 2% margin for error is not so large as to make the cap irrelevant (see slide 26 here)

The logic behind the 2% buffer is that it allows a tighter cap to apply to increases in welfare spending brought about by policy changes without the risk of relatively small fluctuations in forecast spending frequently leading to breaches of the cap. In some cases defining what counts as a policy change might not be straightforward. A newly announced increase in a benefit rate is a policy change, while a higher than expected birth rate that pushes up child benefit spending is a forecasting change. But what about an operational decision to delay or slow the rollout of a reform expected to reduce spending? The OBR’s judgements over such factors in future could make the difference between the cap being met and the cap being breached: but at least these judgments will be made by the OBR and not by the Chancellor.

The OBR also identify the likely causes of any breach of the welfare cap in future years. One such risk is higher-than-expected September CPI inflation, which would lead to higher spending on most benefits within the cap. Roughly speaking, a permanent 1% increase in the price level from September 2015 would boost forecast welfare in scope spending by 1% and at a stroke use up half of the 2% buffer. However if the Conservatives form the next Government this risk to spending could be significantly reduced. The Chancellor pledged in his recent conference speech to freeze most working age benefits in 2016–17 and 2017–18, which would transfer the risk of higher-than-expected inflation from the welfare budget to the recipients of those benefits in those years. The other main risk described in the OBR’s report is operational risk. For example, the OBR’s forecasts are now based on the (already delayed) transition from disability living allowance (DLA) to personal independence payments (PIP) reducing claimant numbers by one quarter and spending by £2.8 billion in 2017–18 (or by 17% of what it would have been). Finally, there will inevitably be other forecasting errors – largely due to things that could not be anticipated. Such errors could also lead to forecast welfare spending being increased (or reduced), potentially making the difference between the cap being met and the cap being breached.

Today’s OBR report is welcome. And the welfare cap could, in principle, help governments avoid undesirable increases in spending. But neither the welfare trends report nor the welfare cap are a guarantee of better policy making. If cuts are deemed to be the right response to higher projected welfare spending then those cuts should be well argued and well designed, rather than simply those that are the quickest or politically easiest to achieve.

IFS public finance observations are generously supported by the Economic and Social Research Council (ESRC).

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http://www.ifs.org.uk/publications/7401 Thu, 16 Oct 2014 00:00:00 +0000
<![CDATA[How do the parties' fiscal targets compare?]]> With the general election now just eight months away the political parties are starting to set out what they would aim to achieve in government. In this observation, we describe what each of the three main UK parties have said about their fiscal targets and discuss how these differ from current coalition government policy and from each other. Meeting the Conservatives’ target could result in debt falling more quickly than would be the case under the rules proposed by Labour or the Liberal Democrats. But doing so would require tax rises or significantly greater cuts in public spending than Labour and the Liberal Democrats would require to meet their rules – on top of those that are already planned up to 2015–16.

What are the government’s current plans?

The current government has committed to meeting two fiscal targets:

  • The fiscal mandate states that the cyclically-adjusted current budget should be forecast to be in balance or surplus at the end of a rolling five-year forecast horizon.
  • The supplementary target requires that public sector net debt should fall as a share of national income between 2014–15 and 2015–16.

While borrowing over this parliament is on course to be substantially greater than the Office for Budget Responsibility (OBR) forecast back in June 2010 the additional spending cuts pencilled in for the next parliament are sufficient for the latest official forecasts to suggest that the fiscal mandate is being met. Indeed, it is being met by some margin, with a surplus of 1.5% of national income (or £26 billion in today’s terms) forecast for 2018–19, which is currently the last year of the forecast horizon.

However, the latest OBR forecast suggests that the supplementary target is on course to be missed. Although borrowing is forecast to fall over the coming years, the OBR still expects public spending to exceed public revenues by a significant margin in the next few years and so the stock of public debt will continue to grow more quickly than the economy. As a result, the OBR forecasts that debt will rise from 77.3% of national income in 2014–15 to 78.7% in 2015–16, before falling slightly to 78.3% in 2016–17.

Table: Latest OBR forecasts for borrowing and debt

 

2013–14

 

2014–15

 

2015–16

 

2016–17

 

2017–18

 

2018–19

As % GDP

 

 

 

 

 

 

 

 

 

 

 

Current budget deficit

4.9

 

3.9

 

2.7

 

0.9

 

–0.5

 

–1.5

Cyclically-adjusted current budget deficit

3.6

 

2.9

 

1.9

 

0.4

 

–0.7

 

–1.5

Public sector net borrowing

6.5

 

5.5

 

4.2

 

2.4

 

0.8

 

–0.2

Public sector net debt

76.3

 

77.3

 

78.7

 

78.3

 

76.5

 

74.2

Source: Outturns for the current budget deficit, borrowing and debt in 2013–14 are taken from the ONS’ statistical bulletin Public Sector Finances, July 2014. Forecasts for borrowing and debt as a % of GDP are taken from Tables 4.39 and 4.43 of the OBR’s March 2014 Economic and Fiscal Outlook.

What are the Conservatives’ objectives?

What have they said?

At the Conservative party conference in September 2013, George Osborne set out his party’s objective of achieving an overall budget surplus. Specifically, he committed that “provided the recovery is sustained, our goal is to achieve that surplus in the next Parliament.”

So far, the Conservative party have made no specific commitments on the path for debt, aside from those signed up to (but currently on course to be missed) by the current coalition government. However, since future debt depends on future levels of borrowing, the commitment to achieve an overall budget surplus will imply something about the future path of debt – exactly what it implies will depend on how quickly they reach a surplus and how large a surplus they achieve.

How does this compare to current government policy?

The major difference between what the Conservative party would aim to achieve and the coalition’s fiscal mandate is that the Conservative party want to achieve an overall budget surplus – rather than just a surplus on the current budget. In other words, the Conservatives want to ensure that government revenues are sufficient to pay not only for current spending but also for investment spending.

The latest OBR forecast suggests that current government policy is consistent with the Conservatives’ objective of achieving an overall surplus in 2018–19, albeit with a small margin of error. Specifically, the March 2014 OBR forecast was for public sector net investment in 2018–19 to be 1.4% of national income, and therefore for public sector net borrowing to be –0.2% of national income (i.e. in surplus).

However, the latest forecasts for the public finances imply further deep cuts to public service spending, which have not yet been set out in any detail. To achieve the currently forecast levels of borrowing, without any further tax increases or cuts to welfare spending, the government would need to cut spending by government departments by a further 10.6% in real terms (or £37.6 billion) between 2015–16 and 2018–19. This is on top of the £8.7 billion cut that has already been set out for 2015–16.

What are Labour’s objectives?

What have they said?

In January 2014, Ed Balls set out Labour’s objectives for the fiscal position. As he said then, Labour’s objective is to “deliver a surplus on the current budget and falling national debt in the next Parliament”.

How does this compare to current government policy?

Labour’s first target relates to the current budget balance. The main difference between Labour’s target and the fiscal mandate is that Labour have committed to delivering a balance or surplus on the current budget at some point in the next parliament, whereas the fiscal mandate instead requires that the cyclically-adjusted current budget must always be forecast to be in balance or surplus after five years. A second difference between Labour’s target and the fiscal mandate is that the former targets the headline current budget balance, whereas the latter relates to the cyclically-adjusted measure.

Labour have not been precise about exactly when they would seek to deliver a surplus, or how large a surplus they would aim for. Ed Balls said that “How fast we can go will depend on the state of the economy and the public finances we inherit.”

The OBR’s latest forecasts suggest that, on current plans, the current budget will reach a surplus (of 0.5% of national income) in 2017–18, increasing to 1.5% of national income in 2018–19. Unless Labour seek to deliver as large a surplus as this (or larger), their target potentially implies a looser fiscal position than current policy – that is, they may be able to cut taxes or increase spending relative to current policy by 1.5% of national income in 2018–19. For example, if Labour chose to achieve exactly a current budget balance in 2018–19 and allocated all the extra borrowing to easing the planned cuts to departmental spending (rather than to tax cuts or increases in benefit spending), then the cumulative cut required to departmental spending would be reduced from £37.6 billion to £9.3 billion (or 2.6%) between 2015–16 and 2018–19.

The OBR’s latest forecasts also suggest that Labour could operate somewhat looser fiscal policy than current government policy and still achieve their target of debt falling within the next parliament, since the latest forecasts are for debt to fall from 2016–17 onwards.

What would the Liberal Democrats do?

What have they said?

The Liberal Democrats have stated that they will seek to balance the cyclically-adjusted current budget from 2017–18 onwards and to “significantly reduce national debt as a percentage of GDP, year on year, when growth is positive, so that it reaches sustainable levels around the middle of the next decade.”

How does this compare to current government policy?

The Liberal Democrats’ first target (to achieve a cyclically-adjusted current budget balance from 2017–18) relates to the same measure of borrowing as the fiscal mandate. It differs from the targets discussed by Labour and the Conservatives in that they plan to target a measure of borrowing that explicitly attempts to abstract from temporary strength or weakness in the economy. On the other hand, both the Conservatives and Labour have alluded to similar allowances for the economic cycle when discussing their targets, as they have suggested that whether and exactly when their targets would be achieved would be dependent on the state of the economy. The latest OBR forecasts suggest that the output gap will close in 2018–19, meaning that cyclically-adjusted measures of borrowing are almost exactly the same as headline measures of borrowing in that year (as shown in the Figure). As a result, achieving the Liberal Democrat target for a cyclically adjusted current budget balance implies almost exactly the same thing in that year as achieving Labour’s target of a headline current budget balance.

Current government policy is, according to the OBR’s latest forecast, consistent with achieving a cyclically-adjusted current budget surplus of 0.7% of national income in 2017–18 and 1.5% in 2018–19. Therefore, similar to Labour, the Liberal Democrats’ commitment could be consistent with running looser fiscal policy than the government is currently planning. For example, if the Liberal Democrats chose to achieve exactly a cyclically-adjusted current budget balance in 2018–19 and allocated all the extra borrowing to easing the planned cuts to departmental spending (rather than to tax cuts or increases in benefit spending), then the cumulative cut required to departmental spending would be reduced from £37.6 billion to £8.6 billion (or 2.4%) between 2015–16 and 2018–19.

The Liberal Democrats’ target for debt is consistent with the latest OBR forecast on the basis of current government policy, as outlined above.

Summary

The parties’ fiscal targets differ from one another and from the current government’s objectives and plans in two main ways. First, the exact measure of “borrowing” that is targeted differs. Second, the timescale over which a surplus must be achieved varies – for example, the current government’s fiscal mandate is explicitly forward looking with a rolling five-year target, while each of the three parties’ proposed new targets for borrowing seem to relate to a fixed date – that is, all of them refer to achieving the objective during the next Parliament. There are strong arguments in favour of forward-looking, rather than fixed date, targets and all the parties would be well advised to consider rephrasing their objectives in this way.

The Figure below illustrates how the different measures of borrowing being targeted differ from one another. The Conservatives and Labour have not yet been specific about when exactly they would seek to achieve budget balance. The latest OBR forecasts only run to 2018–19 but there would be one further full financial year in the next parliament, assuming it begins in 2015–16 and runs its full 5-year course.

The targets chosen by Labour and the Liberal Democrats would, in principle, allow them to have a higher level of spending and/or lower level of taxation than the Conservatives would require to meet their target for borrowing. However, for both Labour and the Liberal Democrats this would, of course, come at the cost of debt declining less quickly as a share of national income than implied by either current government projections or the Conservatives’ fiscal target.

For all the main UK parties, based on the latest official forecasts for the economy and public finances, achieving their fiscal targets will require further tax increases, or cuts to welfare spending or public services in the next parliament. None of the parties have yet provided the electorate with full details of these tough choices.

Figure: Comparing the parties’ fiscal targets

Comparing the parties' fiscal targets

Glossary

Current budget deficit

The difference between current spending and total (i.e. current) receipts.

Current receipts

Government revenues, including from taxes, National Insurance contributions, surpluses made by public corporations, and interest and dividends received from the private sector.

Current spending

Government spending excluding investment spending.

Cyclically-adjusted current budget deficit

The current budget deficit adjusted for temporary rises/falls that are associated with a temporarily weak/strong economy. As with cyclically adjusted public sector net borrowing, this measure gives a better indication of the underlying health of the public finances than the headline measure.

Cyclically-adjusted public sector net borrowing

PSNB adjusted to take account of the current position in the economic cycle. This measure provides a more accurate picture of the underlying health of the public finances, as it strips out borrowing associated with temporary economic fluctuations. For example, in a downturn borrowing is likely to increase (e.g. as unemployment benefit spending rises), but should fall again as the economy recovers. The cyclically-adjusted measure of borrowing attempts to remove the temporary effects of a downturn/boom, and therefore indicates how much of borrowing is ‘permanent’ and reflects long-run weakness or strength in the public finances. During downturns, cyclically-adjusted PSNB will be lower than headline PSNB, while during booms the reverse will be true.

Fiscal mandate

One of the government’s two targets for the fiscal position, as set out in the Charter for Budget Responsibility. The current fiscal mandate states that the cyclically-adjusted current budget must be forecast to be in balance or surplus by the end of a rolling, five-year forecast horizon.

Primary balance

The difference between total receipts and spending, excluding spending on debt interest payments.

Public sector net borrowing (PSNB)

The difference between total public spending and total revenues. For this measure the ‘public sector’ is defined as including all public corporations, including the banks that were taken into public ownership during the financial crisis.

Public sector net borrowing excluding banks (PSNB ex)

This measure of borrowing is the difference between total public spending and total revenues, defining the ‘public sector’ as excluding publicly owned banks. This measure provides a better indication of the underlying health of the public finances than PSNB and is the measure most commonly referred to in public debate.

Public sector net debt (PSND)

The public sector’s financial liabilities, less its liquid financial assets; in the words, the stock of what the government owes to the private sector, less the value of assets that it could easily and quickly sell if it wanted to. This measure covers all debt and liquid assets held by the public sector, where the ‘public sector’ is defined as including all public corporations, including the banks that were taken into public ownership during the financial crisis.

Public sector net debt excluding banks (PSND ex)

This measure of debt is similar to PSND but is calculated based on a definition of the ‘public sector’ that excludes publicly owned banks: in other words, the liabilities of these banks (and their liquid assets) are ignored for the purposes of calculating PSND ex.

Public sector net investment (PSNI)

Government spending on investment, less depreciation of the capital stock. This can be thought of as the amount the government is adding to its capital stock – that is, after taking account of the wear and tear on existing assets.

Supplementary target

One of the government’s two targets for the fiscal position set out in the Charter for Budget Responsibility. The supplementary target requires that public sector net debt should fall as a share of national income between 2014–15 and 2015–16.

 

Ends.

_____________________________

 

‘Balancing the Books – tax and spending choices in the next Parliament’ (IFS/CIOT Party Conference fringe events)

IFS and CIOT are once again holding debates at the Labour, Conservative and Liberal Democrat party conferences. Paul Johnson, IFS director, will present at each and refreshments will be available. You do not need to register to attend.

17:45 – 19:00 Tuesday 23 September (followed by a drinks reception), Manchester Town Hall (outside secure zone), Labour party conference

Speakers: Bill Dodwell (CIOT), Paul Johnson (IFS) and Chris Leslie (Shadow Chief Secretary to the Treasury)

17:30 – 18:45 Tuesday 30 September, Jury’s Inn Birmingham (outside secure zone), Conservative party conference

Speakers: David Gauke (Financial Secretary to the Treasury), Paul Johnson (IFS) and Patrick Stevens (CIOT)

18:15 – 19:15 Tuesday 7 October, Dochart 1 SECC (secure zone), Liberal Democrat party conference

Speakers: Anne Fairpo (CIOT), Paul Johnson (IFS) and Ian Swales (Co-Chair, Liberal Democrat Backbench Treasury Committee)

 

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http://www.ifs.org.uk/publications/7373 Fri, 19 Sep 2014 00:00:00 +0000
<![CDATA[The Scottish NHS - more financially secure outside the UK?]]> The future of the welfare state, and particularly of the NHS, has taken centre stage in the Scottish independence debate in recent days. Scotland’s Deputy First Minister Nicola Sturgeon has said that a 'Yes' to independence would free the Scottish NHS from an agenda of privatisation and public spending cuts. On the contrary, say the 'No' campaign: an independent Scotland’s precarious government finances would mean a need for 'austerity plus' that would put NHS funding at risk. Gordon Brown has said he wants to 'Nail the NHS lie' of the 'Yes' campaign.

Given this political rhetoric, there is a clear need for some impartial analysis. So, in this observation we try to set out some of the facts on both recent changes in NHS spending in England and Scotland, and the prospects for the future whether Scotland is in or out of the Union.

First some facts about what we know has happened in recent years:

1. Health is already a devolved matter – that is health policy and funding is the responsibility of the Scottish Government. This means the Scottish NHS does not have to make more use of private sector providers just because the English NHS is (and indeed, it hasn’t been). And the Scottish government decides how much money to allocate to the Scottish NHS from the overall block grant it receives from Westminster. To a significant extent then, the future of the Scottish NHS is already in Scottish hands.

2. Between 2009-10 and 2015-16 spending on the NHS in England will, on currently announced plans, have risen by about 4% in real terms despite an overall fall of 13% in English departmental spending.

3. Over the same period the vagaries of the Barnett formula mean that Scotland will have had to cut overall public service spending by less – by about 8% rather than 13%. But the Scottish government has chosen to protect the NHS in Scotland slightly less than it has been protected in England. Spending on the NHS in Scotland has fallen by 1%.

4. Analysis we published last year shows this is not a new pattern. Between 2002–03 and 2009–10 – years of plenty for public services rather than cuts – real-terms health spending per person grew by 29% in Scotland compared with a 43% increase across the UK as a whole. This was despite overall public service spending per person growing by a very similar amount in Scotland (26%) and the UK as a whole (28%).

So it seems that historically, at least, Scottish Governments in Holyrood have placed less priority on funding the NHS in Scotland (and more on funding other services) than governments in Westminster have for England.

 Table 1: Overall and health budgets (£s billions, 2013–14 prices), England and Scotland

 

2009–10 spend

Planned 2015–16 spend

% change

UK Government

 

 

 

Overall “English” departments

275.3

239.4

-13.0%

Health

106.2

110.9

+4.4%

 

 

 

 

Scotland

 

 

 

Overall Scottish government

33.0

30.2

-8.4%

Health

11.8

11.6

-1.2%

Notes: 'English' Departments are defined as those where the bulk of that department’s work is devolved to the Scottish Government. English departmental spend includes Departmental Expenditure Limits (DEL) only, with the exception of the Department for Communities and Local Government where an adjustment has been made to account for the localisation of council tax benefit and business rates. Scotland spend includes the Scotland DEL (i.e. the block grant) and business rates revenues. Business rates revenues are added to the Scottish DEL to ensure greater comparability with figures for “English” departments (business rates revenues are counted as part of English DEL but as a separate item for Scotland). Ignoring Scottish Business rates revenues, Scotland’s block grant on its own is set to fall by about 10.5% in real terms.  

That is the past though. What about the future?

1. If Scotland remains part of the UK, the Scottish Government is likely to face continued cuts to its block grant until 2018–19 as the UK government continues with its efforts to eliminate the budget deficit (although again, the Barnett formula will mean those cuts are smaller for Scotland than for England). Further cuts in overall budgets will make it harder for both the Scottish and UK governments to continue to protect NHS spending – the cuts to other unprotected areas would need to be very large. But without such protection, managing the rising demand for and costs of health care would likely be difficult indeed.

2. A devolved Scottish Government could use the powers it will acquire under the Scotland Act to increase taxes to give it more money to spend. If it were to increase the Scottish rate of income tax by 1%, for instance, it would raise around £400 - £450 million a year. This would be enough to boost health spending by around 4%.

3. Independence would give the Scottish government more freedom to set spending and tax policies. It would also, in principle, have more freedom to borrow. That freedom would be constrained by the size of the debt it would likely inherit and the willingness of markets to lend. On most plausible scenarios it is hard to see how an independent Scotland could “end austerity” in the short run. In work published this summer we showed how, on the basis of the independent OBR’s oil forecasts, an independent Scotland would likely still have a deficit of 2.9% of GDP (borrowing of about £800 per person in today’s terms) by 2018-19 even if it followed current UK government tax and spending plans – plans that are forecast to lead to the UK as a whole actually having a small budget surplus by the same year. In this case an independent Scotland would need to implement bigger spending cuts (or more tax rises) than the UK as a whole or try to borrow more. This means it would likely be harder rather than easier to protect the NHS.

The Scottish Government is more optimistic about oil revenues than the OBR – hoping for £7 billion in 2016–17, instead of the £3 billion forecast by the OBR. It says this will allow it avoid further cuts to public spending after 2016–17, which could mean more money for the NHS, among other things. But in fact even with oil revenues at £7 billion a year, the Scottish government’s budget position would still be if anything slightly weaker than that forecast for the UK as a whole. If these more optimistic forecasts prove correct an independent Scotland would still need to borrow more or tax more than the rest of the UK if it wanted to increase spending on the NHS while protecting other services. It already has the power to tax more or divert resources from other spending areas. A new country inheriting a substantial debt might not find relying on additional borrowing either easy or conducive to longer run fiscal stability.

And of course, while oil revenues could turn out to be higher than forecast (as the Scottish government hope) they could also turn out to be lower than forecast.

In the short term, then, it is hard to see how independence could allow Scotland to spend more on the NHS than would be possible within a Union where it will have significant tax raising powers and considerable say over spending priorities. Previous IFS work on the longer-term outlook for an independent Scotland’s finances suggests that under a wide range of scenarios, a combination of the eventual fall in oil revenues and an ageing population could make for a tougher fiscal outlook for Scotland than the rest of the UK and hence less room for additional spending on things like the NHS. Faster economic growth in an independent Scotland would help square all these circles and allow more spending. It is possible that might happen and the Scottish Government says independence would give it the tools to do that. But such faster growth is not certain, by any means.

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http://www.ifs.org.uk/publications/7366 Thu, 11 Sep 2014 00:00:00 +0000
<![CDATA[Product reformulation effective in reducing dietary salt intake]]> In 2003 the UK Government set a target of reducing the average salt intake of adults to 6g per day. To help achieve this it adopted a two pronged salt reduction strategy, encouraging voluntary product reformulation by the food industry and simultaneously running a consumer awareness campaign that highlighted the negative health risks associated with high salt intake.

Recent analysis by IFS researchers, published as an IFS Working Paper, finds that between 2005 and 2011 there was a 5.1% reduction in the average salt content (grams per 100g) of British households’ grocery purchases. It also shows that the actions of firms were crucial in driving the decline in the salt content of grocery purchases. The decline was entirely due to the reformulation of food products by manufacturers to reduce their salt content; households actually switched slightly towards saltier food products.

These findings point towards the potential effectiveness of encouraging product reformulation in reducing the intake of other nutrients that might be consumed in excess, such as sugar and saturated fat. This strategy has the potential to change the diets of individuals who might be resistant to changing their behaviour. Despite the recent marked decline in salt intake, in 2010, according to the Health Survey for England, 60% of people were still consuming more salt than the government’s targeted population salt intake of 6g per adult per day, and the average salt intake was 7.9g per person per day. Therefore the government still has a long way to go to reach its goal.

The research uses data from the Kantar Worldpanel on the food grocery purchases made for consumption inside the home by a representative sample of British households from 2005 to 2011. The sample includes 15,000 to 25,000 households at any point in time. We decompose the 5.1% reduction in the average salt content of households’ grocery baskets into the proportion that was due to:

1. Households switching between food products, for example, switching from salted to unsalted butter, or from crisps to apples

2. Product reformulation by firms to reduce the salt content of food products

We find that the decline in average salt content of grocery purchases was entirely due to product reformulation by firms. The effect of consumer switching was to slightly increase the average salt content of the shopping basket between 2005 and 2011. If consumers had not switched to saltier products, then the average salt content of grocery purchases would have fallen by 6.5% (compared to the 5.1% that actually occurred).

We split the overall effect of product reformulation on the salt content of grocery purchases into the contribution made by six broad food groups. Figure 1 shows that reformulation of products in the processed food and grains groups were principally responsible for the decline in the average salt content of households’ shopping baskets. This was primarily due to reformulation of bread, condiments, breakfast cereals, biscuits, pastry and pies.

Figure 1. Effect of product reformulation, by food group

Source: Calculated from Kantar Worldpanel 2005-2011 data.

The impact of reformulation was larger for households in lower socioeconomic groups, in part because these households, on average, buy a larger share of their groceries as processed food. However, households in the lowest two socioeconomic groups (groups D&E) switched more strongly, on average, towards saltier food products compared with households from higher socioeconomic groups, partly offsetting the greater benefit they received from product reformulation.

These results highlight one of the advantages of targeting product reformulation compared with a public information campaign; reformulation has the potential to affect all consumers, while the provision of information is likely to affect different groups of households to varying degrees (if at all). In particular, reformulation is an effective way of changing the diets of individuals who may be unable or unwilling to process the information provided to them. It may also be that these are the individuals that policymakers are most interested in targeting - households from lower socioeconomic groups bought more salt per person per day, on average, over 2005-2011.

Our results suggest that the UK government’s salt reduction programme (combining an information campaign with voluntary product reformulation) has been at least partially successful in reducing the average salt content of households’ grocery baskets. Product reformulation has been entirely responsible for this decline. There is little evidence that the information campaign had any impact, although it is possible that in the absence of the information campaign individuals may have switched more strongly to salty foods. It is also possible that product reformulation itself could have driven some households to switch towards saltier products, because they like the taste of salt. Nevertheless, these findings point to the potential for product reformulation to help the government to achieve its aim of reducing average intake of other nutrients such as sugar.

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http://www.ifs.org.uk/publications/7330 Thu, 14 Aug 2014 00:00:00 +0000
<![CDATA[Household incomes stabilised in 2012–13]]> The Department for Work and Pensions (DWP) has today published its annual statistics on the distribution of household income in the UK. The latest data cover years up to and including 2012–13. On 15th July, IFS researchers will publish a detailed report, funded by the Joseph Rowntree Foundation, on what these data tell us about living standards, poverty and inequality in the UK, putting this in the context of the recent recession and post-recession period as a whole, and the longer-term. This observation briefly highlights some of the key findings from DWP’s report.

Average incomes

Average incomes were relatively stable in 2012–13, in comparison with the sharp falls recorded between 2009–10 and 2011–12. Official statistics recorded no change at the median (middle) and a small and statistically insignificant fall at the mean, after accounting for inflation.

The official figures still show median and mean incomes in 2012-13 6% and 9% below their 2009–10 peaks respectively. The large post-recession falls in incomes followed a period of slow income growth that began in the early 2000s, far pre-dating the recession. The net result is that the official measure shows both measures of average income no higher in 2012–13 than in 2001–02.

However, these headline statistics compare real-terms living standards over time using an inflation measure based on the retail prices index (RPI). This is generally agreed to overstate inflation, and has been stripped of its “National Statistics” status. Because it overstates inflation it will overstate real income falls and understate real income rises. An Annex in the DWP report shows that figures using the Office for National Statistics’ improved RPIJ measure of inflation paint a slightly less sobering picture. According to those figures, real median income actually grew slightly, by 1%, between 2011–12 and 2012–13 (though this is not statistically significant). On this basis, the level of real median income in 2012–13 was around the same level as it was in 2005–06 (rather than 2001–02 according to RPI) and 4% lower than its 2009–10 peak (rather than 6% according to the RPI).

Income inequality

Income inequality barely changed between 2011–12 and 2012–13. However, inequality was substantially lower in 2012–13 than it was before the recession (measuring incomes before deducting housing costs). This is largely because between 2007–08 and 2011–12 the pay of workers grew much less quickly than prices, while benefit entitlements tended to grow roughly in line with prices. Benefits account for a relatively large share of household income towards the bottom, whereas earnings account for a relatively large share further up. After almost two decades in which inequality had changed little, this was enough to return inequality to its lowest level since 1996–97. We would, however, expect to see recent falls in inequality start to unwind in future releases of data for 2013–14 and beyond, as real earnings stop falling while cuts to working-age social security entitlements accelerate.

The DWP also present an alternative set of figures which measure incomes after housing costs have been deducted. Recorded falls in inequality were smaller on this measure. This is to be expected, because mortgage interest rates have fallen substantially and it tends to be higher-income households which have large mortgages.

Income poverty

In 2012–13, 10.6 million individuals (17%) had a household income below the official absolute poverty line (e.g. below £272 per week for a childless couple, net of taxes and inclusive of benefits), measuring incomes before deducting housing costs. This was about 200,000 individuals fewer than the previous year, and a poverty rate no higher than before the recession. However, when incomes are measured after deducting housing costs, the number below the poverty line (e.g. below £235 per week for a childless couple) rose by about 600,000 in 2012–13 to 14.6 million (23%). This is about 2.0 million (2ppts) higher than in 2007–08. The difference is explained by the fact that housing costs have fallen by less for those around the poverty line than for the population as a whole – only the after-housing-costs measure accounts for this.

Using a relative measure of poverty, which instead uses a poverty line of 60% of median income, the figures show significant falls between 2007–08 and 2012–13. This reflects the fact that the incomes of low-income households were hit less hard (proportionately, as well as in cash terms) over that period than the incomes of middle-income households, and again this is explained by rapidly falling earnings and relatively stable benefits. Measuring incomes before deducting housing costs, relative poverty fell by 1.3 million (3ppts) between 2007–08 and 2012–13, to 9.7 million (15%). Measuring incomes after deducting housing costs, relative poverty fell by 400,000 (1ppt) to 13.2 million (21%).

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http://www.ifs.org.uk/publications/7259 Tue, 01 Jul 2014 00:00:00 +0000
<![CDATA[Students’ GCSE performance plays a key role in explaining HE participation choices and outcomes]]> With exam season in full swing and discussions about the future of GCSEs and A-levels continuing, new research from the Institute for Fiscal Studies, published today by the Department for Education, investigates the role played by secondary schools – and the subjects and qualifications for which pupils study while they are there – in explaining whether students go to university and how well they do once there.

The report uses rich administrative data linking all secondary school pupils in England to the university records of those who attend somewhere in the UK. This data tells us which schools pupils attend and provides us with very detailed measures of attainment at the end of secondary school, including the qualifications and subjects each pupil studies and the grades they receive. This is linked to information on whether students go to university and if so where. It also follows them through university, allowing us to see whether they drop-out within two years, complete their degree within five years and graduate with a first or a 2.1 conditional on completing their degree.

We find substantial differences in the likelihood of going to university on the basis of secondary school characteristics. For example, 62% of pupils in the top quintile of school performance (those with the highest proportions of pupils achieving 5 A*-C grades at GCSE) go to university at age 18 or 19, compared to just 17% of those in the bottom quintile of school performance. The differences are even starker if we focus on those attending “high status” institutions (which we define as Russell Group institutions, plus those with similarly high research quality; 41 institutions in total). Pupils in the top quintile of school performance are 11 times more likely to attend a high status institution than pupils in the bottom quintile group.

Of course it is no surprise that pupils are more likely to go to university if they attend schools where both they and their classmates get good GCSEs and A-level results. Indeed once we account for pupil characteristics and performance at GCSE and A-level, we can explain virtually all of the difference in participation rates between pupils attending different types of schools. And by no means all of this is due to the characteristics of pupils before they reach secondary school, highlighting the importance of secondary school as a time to intervene to increase HE participation rates. Indeed, our work highlights the particular importance of ensuring that pupils from all schools make the right choices over the subjects and qualifications they take at GCSE, and that they maximise their chances of getting good grades at this level.

There is also an important association between school performance and HE outcomes. Pupils who went to the highest performing secondary schools are nearly 7 percentage points less likely to drop out within two years, just over 10 percentage points more likely to complete their degree within five years and nearly 18 percentage points more likely to graduate with a first or a 2.1 than pupils who went to the lowest performing secondary schools.

But once we account for differences in background characteristics and a rich set of measures of attainment at the end of secondary school, the raw relationships reverse: pupils from high performing schools are now more likely to drop out, less likely to complete their degree and less likely to be awarded a first or a 2:1 than similar pupils with similar attainment from low performing schools. This remains true if we compare pupils from different schools who attend the same universities and study the same subjects.

These differences are even starker if we compare pupils from selective and non-selective state and independent schools. For example, when comparing pupils with the same background characteristics and prior attainment, studying at the same universities in the same subjects, those from selective independent schools are 2.6 percentage points more likely to drop out, 6.4 percentage points less likely to complete their degree and 10.3 percentage points less likely to graduate with a first or a 2:1 than pupils from non-selective community schools.

These results provide some evidence that, amongst apparently similar students with similar GCSE and A level results, those from less effective state schools may on average have higher ‘potential’ than those from private, selective  or more effective state schools. Whilst recognising that this is a result that holds on average and of course not for every student, this is something which universities may want to be aware of in setting entry requirements.

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http://www.ifs.org.uk/publications/7236 Fri, 06 Jun 2014 00:00:00 +0000
<![CDATA[Oil: the continuing source of disagreement]]> The debate on Scottish independence has been enlivened today by the publication of two separate reports on the outlook for the public finances of an independent Scotland, one from HM Treasury and one from the Scottish Government. These reports appear to come to quite different conclusions about the likely strength of Scotland’s public finances as an independent country compared to continuing as part of the UK.

The publication from the Scottish Government presents a much more optimistic medium term picture for Scotland than our own previous analysis and that of some other organisations. In 2016–17 the Scottish Government is projecting that total spending in Scotland would exceed revenues by (that is, they would have a net fiscal deficit of) 2.8% of national income – slightly greater than the 2.4% deficit currently forecast by the OBR for the UK as a whole in that year. This is significantly more optimistic than the 5.2% deficit forecast for Scotland that we estimated in our analysis published in early March. It is also more optimistic than the medium-term forecast for Scottish fiscal balance underlying the Treasury’s publication today.

What explains this difference?

There is broad agreement over two key facts. Public spending per capita is significantly higher in Scotland than in the UK as a whole. At the same time onshore tax revenues per capita are similar – in fact a little lower in Scotland.

The main point of disagreement is the different forecasts for revenues from North Sea oil and gas used. Our figures and the Treasury’s figures are based on the Office for Budget Responsibility’s projections. The Scottish Government report instead uses their own – higher – forecasts for North Sea revenues. Their figures assume that Scotland will receive £6.9 billion (or 4.1% of Scottish GDP) in tax revenues from offshore oil and gas production in 2016–17, rather than the £2.9 billion (1.7% of GDP) forecast by the OBR.

The figure below shows a comparison of the estimated net fiscal balance for Scotland and the UK under the Scottish Government’s and the OBR’s projections for North Sea revenues. (The dark bars are the figures contained in the Scottish Government’s report today: somewhat oddly perhaps, the Scottish Government report incorporated the higher oil and gas revenues in their projections for Scotland but not in the comparator figures for the UK fiscal position.)

Notes: The first set of bars indicate the figures contained in Scottish Government (2014), Outlook for Scotland’s Public Finances and the Opportunities for Independence. The names assigned to the three Scottish scenarios also correspond to those used in that publication.

Sources: Authors’ calculations based on: Scottish Government (2014), Oil and Gas Analytical Bulletin: May 2014; Scottish Government (2014), Outlook for Scotland’s Public Finances and the Opportunities for Independence; Office for Budget Responsibility (2014), Economic and Fiscal Outlook: March 2014.

It is difficult to know exactly what offshore oil and gas revenues will be in future. There is genuine uncertainty about exactly how much will be raised from this source over the coming years, as is demonstrated by a comparison of recent official forecasts and subsequent outturns. The chart, therefore, serves to highlight how much more sensitive Scotland’s fiscal position would be to fluctuations in this source of revenues than is the UK as a whole. This would pose its own challenges to the management of the public finances in an independent Scotland – as we and others have discussed elsewhere.

Does this mean that, if oil revenues come in as forecast by the Scottish Government up to 2016–17, the public finances of an independent Scotland would be in a sustainable position beyond that?

Unfortunately the longer-run picture is not that simple. There are two important fiscal challenges that an independent Scotland would have to face in the longer run. First, an ageing population, which would tend to increase public spending (particularly on health care and pensions) and reduce some tax revenues. Second, as reserves of oil and gas are depleted over the long run, offshore revenues are likely to decline. These pressures will tend to increase public spending and reduce revenues, and therefore increase borrowing and debt, in the absence of other offsetting policies.

In other words, even if the Scottish public finances were to look favourable in 2016–17, the long run picture may look very different. These challenges face not only Scotland but the UK as a whole. However, our previous work suggests that the issues (particularly the decline in revenues from offshore production) would be more acute for Scotland. For example, one relatively optimistic scenario considered in our analysis published last November (which implied that Scotland would achieve a net fiscal surplus in 2016–17) suggested that – once demographic pressures and the decline of North Sea oil revenues are factored in – an independent Scotland could require a fiscal tightening around 1% of GDP larger than required by the UK to get debt to a similarly “sustainable” position. The HM Treasury analysis published today sets out a similar type of analysis of the long run position for Scotland’s public finances to that which we conducted last November, with similar conclusions.

So why does the Scottish government’s analysis today suggest a different picture?

Today’s analysis from the Scottish Government illustrates how the long run outlook for Scotland’s debt might look more favourable were productivity growth, employment and population growth to be higher than has been the case for the UK in recent times. The scenarios they illustrate suggest that debt could be on a decreasing, rather than increasing, path every year from 2018–19 onwards. There are two concerns with this analysis.

First, whilst it may turn out to be the case that the Scottish economy does a great deal better after independence than it would as part of the UK, planning on this as a central assumption seems less than cautious.

Second, this analysis makes the important assumption that real public service spending per person does not grow faster if productivity growth turns out to be higher. This implies that public spending as a share of national income declines over time – something that has not been borne out in the UK over the long term. If instead public service spending per person were assumed to grow in line with productivity growth (the assumption made in our analysis and by the OBR when modelling the long run outlook for the UK public finances), the higher productivity growth, employment and population growth simulated by the Scottish Government would have little beneficial impact on the long run Scottish public finance position. The quantity and quality of public services provided would, however, be higher.

This analysis forms part of 'The Future of the UK and Scotland', a research programme funded by the Economic and Social Research Council (ESRC). It brings the best of UK social science to the debate about Scotland’s constitutional future and its implications for the rest of the UK. For further information please visit the programme website.

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http://www.ifs.org.uk/publications/7221 Wed, 28 May 2014 00:00:00 +0000
<![CDATA[Budget 2014 pension reforms: increased flexibility, but for whom?]]> In Budget 2014, George Osborne announced significant changes to the way many will be able to access funds in defined contribution (DC) pensions. These changes will extend to a wider group the flexibilities already available to some. The reforms could have wide-ranging implications for the level and profile of individuals’ retirement incomes, their welfare, demand for different financial products, and demands on publicly funded means-tested support for pensioners.

This observation aims to shed light on how many people might be affected in the next few years and how these people might respond by describing the proportion and characteristics of people currently aged 55 to 74 who are likely to have been affected by the Budget announcements. We draw on data from the English Longitudinal Study of Ageing (ELSA) collected in 2010–11. This observation summarises some of the key messages that are described in more detail in tables and figures published today, which will form part of a presentation by Carl Emmerson at an event hosted by the Strategic Society Centre.

Prior to April 2014, most people with a DC pension faced a strong incentive to buy an annuity with their pension fund by the age of 75 because otherwise they faced a tax charge of 55% on assets withdrawn from the fund. They could alternatively take up to one-quarter of their fund tax-free and purchase an annuity with the remainder of their pot, with the annuity income then being taxed at their marginal income tax rate. Two groups of people had more flexibility than this, however. First, those with only small amounts of money in DC pensions were able to withdraw the whole amount, receiving one-quarter tax-free and facing tax at their marginal rate on the other three-quarters. This applied to up to three pension pots worth no more than £2,000 or to all pension funds if an individual’s total private pension wealth was below £18,000 (provided the pension provider(s) concerned allowed such ‘trivial commutation’). Second, those relatively well-off individuals who could demonstrate that they had at least £20,000 a year of other secure annuitised income could withdraw as much as they wanted from their remaining pension funds and face tax at only their marginal rate (known as flexible drawdown).

What the Budget announced was essentially that the flexibilities available to those with small pots or a high level of annuitised income would be extended to all. From April 2015 onwards, all individuals aged 55 and over will be able to withdraw as much as they want from their DC pension funds and face income tax at their marginal rate, rather than 55%.

How people, and markets, will respond to the changes announced in the Budget will depend, at least in part, on who it is that has been affected: How much DC pension wealth do they have? What other forms of retirement resources do they hold? What are their other characteristics?

A significant fraction of individuals will be entirely unaffected by George Osborne’s announcements – either because they have no money in DC pensions or because they were already eligible for trivial commutation or flexible drawdown. The tables and figures published in our briefing note today describe the number and characteristics of those aged 55 to 74 who are likely to be affected. By focussing on those already aged 55 to 74, our figures give a picture of the potential near-term impact of the reforms. (The number and characteristics of people affected in later cohorts – among whom DC pension membership will be much more widespread – are likely to be different. We do not attempt to characterise them here.) For much of the analysis we focus on those aged 55 to 59 since these individuals are more likely not to have already purchased an annuity.

We estimate that about half of men and two-thirds of women (or six-in-ten of all) aged between 55 and 59 have no money currently held in DC pensions. There are two other smaller groups of individuals who are also likely to be unaffected by the Budget announcements – those whose DC pots are below the trivial commutation thresholds (8%) and those who we estimate will have at least £20,000 of secure income from state pensions, defined benefit (DB) pensions and already annuitised DC pensions (2%). This leaves just under four-in-ten men and just over two-in-ten women (or three-in-ten of all those) aged between 55 and 59 who will experience greater flexibility as a result of the Budget changes.

As the table shows, nearly 60% of those likely to get additional flexibility are men. Those affected are generally in better health, better educated and more likely to own their own house than the average. They also expect to live longer.

The amount of money held in DC pension funds by this group of people varies widely. Half of them have less than £53,000, but one-in-four of them hold more than £116,000 in DC pension funds. However, DC pension wealth is only one component of the household wealth portfolio for this group. There is considerable variation in the importance of DC wealth within the portfolios of those likely to get greater flexibility: for around half of them DC wealth accounts for less than 10% of their total household wealth. For just over half of those likely to be affected, DC wealth is their only form of private pension wealth, but just over a quarter actually hold more wealth in DB pensions than in DC funds. The figure below shows that private pension wealth as a whole makes up on average a third of total household wealth for those who might get greater flexibility.

Overall the group who might get more flexibility has higher average wealth than those unlikely to be affected by the reforms: we estimate that those getting more flexibility have median wealth of £680,000, compared to £550,000 among those unaffected.

These characteristics suggest that those who will get greater flexibility might be relatively well-placed to receive, and to act appropriately upon, information, guidance and advice that they are given over how to manage their own finances. However, the fact that they are in relatively good health and expect to have a greater than average chance of living to older ages may complicate their retirement planning and potentially increase the costs of making an inappropriate decision. One concern that has been raised about this policy is that the greater flexibility will allow people to spend all their funds quickly and then fall back onto taxpayer-funded means-tested benefits. However, the figures presented here suggest that – in the near-term at least – this may not be a significant concern, as the vast majority of those most likely to get the greater flexibility are home owners (and thus unlikely to qualify for housing benefit) and on average have significant other assets in addition to their DC funds. The picture is likely to look different in the longer-term, however, as DC pension coverage becomes much more widespread.

Notes: Sample size = 2,015.
Source: Authors’ calculations using English Longitudinal Study of Ageing, wave 5 (2010–11).

Notes: Sample size = 2,015.
Source: Authors’ calculations using English Longitudinal Study of Ageing, wave 5 (2010–11).

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http://www.ifs.org.uk/publications/7206 Thu, 15 May 2014 00:00:00 +0000
<![CDATA[Tax without design]]> Giving the annual CTA (Chartered Tax Adviser) Address today, Paul Johnson, IFS director, sets out some of the numerous ways in which tax policy in recent years has unnecessarily made the tax system more complicated, less efficient and less transparent.

The coalition government have pursued two tax policies with considerable consistency and at remarkable cost – the increase in the income tax personal allowance to £10,500 and the cut in the headline rate of corporation tax to 20%. Between them these are set to cost getting on for £20 billion a year – a remarkable cost in any parliament, let alone under current fiscal circumstances. But consistency in these two particular policies stands out among the complexity and uncertainty created elsewhere.

Responsibility for much, perhaps most, recent poor tax policy rests with both this government and its predecessor (and often earlier governments too). Gordon Brown, Alistair Darling and George Osborne all made some improvements to the tax system. But poor tax policies where this government and the last are both culpable include:

  • There is a basic rate of income tax of 20%, a higher rate of 40% and a top rate now of 45%. What is less well known is that the last government introduced a rate of 60% on a band of income starting at £100,000. This government has maintained it and effectively increased its range considerably. There is now a 60% rate of income tax on income between £100,000 and £121,000 (where it drops back to 40%). It’s hard to make much sense of that.
  • Several elements of the income tax system no longer adjust with inflation. The point at which the 45p rate becomes payable, and indeed the point at which the 60p rate becomes payable, is fixed in cash terms and has already fallen by more than 12% relative to the Consumer Prices Index since its introduction. More people will gradually be pulled into these higher rates. There is apparently no plan to stop this.
  • This government has accelerated a trend overseen by recent governments which has fundamentally altered the nature of our system of income tax, namely a continued increase in the number of higher rate taxpayers. Numbers have risen from less than 2 million in 1990 to nearly 4 million in 2007 and well over 5 million by 2015. The problem is not necessarily so much the fact of the change – there is a case for, and a case against, such a system – but the fact that this fundamental change to our tax system, which appears to have the support of the three main political parties, has never been announced or properly debated.
  • Governments of all stripes have continually cut income tax whilst increasing National Insurance Contributions (NICs) – a tax on earned income. The only reason for this is that income tax seems to be more salient and therefore increases to NIC rates are politically easier.
  • This government has followed in the pusillanimous steps of its predecessors in failing to carry out any revaluation of properties for council tax in England. Council tax, our main property tax, is assessed on relative property values which will soon be a quarter of a century out of date. This situation is becoming increasingly absurd.
  • The last government and this one raised rates of Stamp Duty Land Tax time and time again. This is one of the worst designed and most damaging of all taxes, yet revenues from it are due to hit £15 billion within just a few years. At the extreme a £1 increase in sale price can now trigger an additional £40,000 tax bill. The tax helps to gum up the entire property market.
  • Having set out a clear direction for the taxation of pensions the last government set in train an absurd complication of the regime. This government has moved in a slightly better direction but has dramatically reduced the generosity of income tax allowances for pension contributions. It has not made any long term direction clear. Once again it, like its predecessor, has ignored the role of NICs. The Labour Party appears set on further complicating the system for those with incomes above £150,000 while the Liberal Democrats want to do this for all higher-rate taxpayers too. Long term stability in pension taxation is crucial. What we have is costly short term meddling and complication.
  • Both this government and the last have continually planned for increases in fuel duties and then decided to delay, and then abandon them. The continued failure even to raise duties in line with inflation adds to a long term loss of revenue and reduced tax on the external costs created by motorists.

But the current government hasn’t just carried on with mistakes made by its predecessor. Among problems of its own creation are:

  • The failure to increase the threshold for paying National Insurance Contributions at the same time as increasing the income tax personal allowance. It is hard to think of a rationale, and none has been offered, for continuing to increase the latter while not increasing the former. More than one million low paid workers now pay NICs but not income tax;
  • The way in which the transferable allowance for married couples and civil partners is being introduced effectively creates an infinite marginal tax rate. Since the full value of the allowance is withdrawn as soon as one partner becomes a higher rate tax payer, it is possible to become more than £200 a year worse off as a result of a £1 pay rise;
  • Huge policy uncertainty has been introduced through continual (at least annual) changes to elements of business rates, corporation tax allowances and carbon taxes.

And of course the last government could fill its own hall of shame with damaging tax policy including:

  • The introduction and then abolition of a 10p starting rate of income tax. The chaos around the abolition is what is remembered. The introduction was the mistake. A new 10p band of income tax achieves nothing that could not be better and more simply achieved by an increase in the personal allowance. Yet despite the lessons one would hope they had learned, the Labour Party now promises the reintroduction of this starting rate.
  • The introduction and then abolition of low rates of Capital Gains Tax (CGT). Again it is the furore around the abolition which is perhaps better remembered but it was the introduction of a 10p rate of CGT which allowed hedge fund managers to claim they were paying lower rates of tax than their cleaners. There is still some way to go to sort out CGT.
  • The introduction and subsequent abolition of a 0% rate of corporation tax for the lowest profit companies. It seemed to surprise the government that this led to a wholly predictable upturn in the number of self employed people deciding to incorporate and hence a loss of revenue to no good purpose.

Sadly the list of examples of poor policy could be greatly extended. And if one were to include the failure to sort out existing problems then, despite some improvements made by both the current government and its predecessor, it could be extended over many pages.

And this all matters. Complexity, uncertainty and inefficiency in a tax system which takes £4 in every £10 generated in the economy costs a huge amount in lower welfare, less economic output and straightforward inequity. Even if we can’t have perfection something close to coherence and consistency would be nice. In the words of former US Treasury Secretary William Simon we should have a tax system which looks “like someone designed it on purpose”. That feels like a low benchmark, but it is one we are a long way from meeting.

 

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http://www.ifs.org.uk/publications/7204 Tue, 13 May 2014 00:00:00 +0000
<![CDATA[House prices: what do the statistics really mean?]]> Different house price indices are giving conflicting messages

House price indices are some of the most closely watched economic indicators in the UK and it can feel as if barely a week goes by without a new set of widely-reported statistics. But what do these numbers really mean and why do they sometimes look very different? In a new IFS briefing note we explore some of the reasons for the differences between these indices and some of the methodological difficulties in constructing house price indices in general.

There are now several well-established house price indices that are published on a monthly basis. All the indices show house prices on a general upward trend, but exactly how fast they are increasing is less clear. The various indices can and do differ significantly from month to month, leading to a confusing picture of what is happening. This matters because commentary on whether the UK, and especially London and the South East, is experiencing a ‘boom’ or even ‘bubble’ in house prices, often rests on a particular house price statistic. Two sets of data illustrate this conundrum.

The first graph shows average house prices portrayed by several well-known indices in early 2014, relative to their previous peak in 2007-08. All but one (Halifax) suggest that London house prices, in nominal terms, had exceeded their previous peak. But the differences between the indices are huge. According to an index produced by LSL Property Services / Acadata (LSL Acad), based on Land Registry data, London house prices are now more than 30% above their 2007-08 peak, whilst the Halifax index suggests they have not quite reached that peak. And when it comes to house prices for the UK as a whole three indices suggest prices are still around 5% or more below their previous peak while two show them 5% above.

Note: Land Registry and LSL Acad cover England and Wales only. All figures compare February 2014 to previous index-specific monthly peak, except London figures for Nationwide and Halifax which compare 2014Q1 to previous quarterly peak.
Source: see Figure 4 in IFS Briefing Note 146.

Over longer periods one might expect the various indices to converge on a common trend. But this turns out not to be the case either. In the graph below, we look at the cumulative increase in house prices according to the various indices since 2003. All the indices show a broadly similar pattern. But they disagree on the extent of growth over the decade: the LSL Acad index shows an increase of over 55%, while the Land Registry index suggests an increase of around 35%. This is a large discrepancy.

Source: see Figure 3 in IFS Briefing Note 146

Why house price indices differ

House price indices are based on sales data, which can be misleading

House price indices are based on the prices of properties actually sold in a given period. However, because not all houses are sold in every period, house prices indices are based on a small sample of the total housing stock.

The major challenge with using sales data to measure house prices is that the mix of houses being sold from month to month can vary significantly. In particular, a simple average of sales prices might vary even if house prices stayed the same. For example, suppose sales volumes in London increase relative to the rest of the country, but the price of all houses stay the same. Because houses in London are typically more expensive than elsewhere, the average value of a house sold will increase, even though prices have in fact remained the same.

Most indices adjust sales data

Most house price indices adjust sales data to account for changes in the mix of houses being sold. The most popular method, used by the ONS, Nationwide and Halifax, is to use sales data to put a price on the various characteristics of a house, such as an additional bedroom, a garden, or the location. The values attached to each characteristic are then combined into the price of a synthetic house (e.g. a two-bed, detached house, with garden, in Reading), whose characteristics are representative of the houses being bought and sold. The LSL Acad index follows a broadly similar methodology.

In part, the indices differ because they make different choices about which characteristics matter, and how to measure their value. In addition, the indices differ in terms of how they combine individual characteristics in order to construct an ‘average’ house price. At one extreme, the Halifax index tracks the price of a house that was typical of transactions in 1983, while at the other end, Nationwide and ONS revise their definition of the average house to reflect transactions over the past two or three years, respectively (the ONS index is ‘chain-linked’ in order to provide a consistent series despite these annual revision to what constitutes the ‘average’ house). While the Halifax index has the advantage of consistency (it measures the price of the same property over time), the Nationwide and ONS may be more relevant, because they measure the price of a property which is typical of recent transactions. This may help explain the relatively fast growth in the ONS and Nationwide indices since 2009, as they reflect the shift in sales volumes towards the more expensive London market.

The Land Registry take a different approach

The Land Registry (LR) index is based on another method, known as repeat sales. The LR measures the increase in the price of each property sold in a given month compared to the price of that same property the last time it was sold. The average increase in prices is essentially the average of these individual increases in price. This approach ensures the index only measures genuine increases in price, without requiring the level of detail described in the methods above (assuming the quality of the property has not changed substantially between sales, in which case an increase in ‘price’ might just reflect an increase in quality). However, it is still affected by changes in the mix of sales: for example, a shift in sale volumes towards properties whose price is increasing rapidly will show up as an increase in the overall rate of price growth, even if in fact each property is growing at the same rate as before. More generally, properties which sell more frequently will be over-represented in this index.

Indices also use different data

Different indices are also based on different data. The LSL Acad index is based on Land Registry data which covers every registered property transaction in England and Wales, while the LR index itself uses just those properties which have been sold at least twice since 1995. The ONS, Nationwide and Halifax indices are based on mortgage data, which by definition excludes cash sales, with the ONS drawing on the largest sample, while Nationwide and Halifax use their own sales data which might be influenced by their lending policies. It is not simply the case that the index with the largest sample is ‘best’, because the indices also differ in their methodologies.

What price is right?

Given the underlying differences in both methodology and data, it is not surprising that the various house price indices provide different estimates of house price changes. It is not clear that any single method is “right” or clearly superior to the others. It probably makes sense to look at what is happening to all the indices in thinking about trends in house prices. The tendency of commentators to pick on each new piece of information in isolation as it is reported is not helpful. Ideally we would have a composite index based on all the various methods of construction. But that would be a huge undertaking. And it would raise considerable methodological difficulties of its own.

Source: see Table 1 in IFS Briefing Note 146

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http://www.ifs.org.uk/publications/7199 Fri, 09 May 2014 00:00:00 +0000
<![CDATA[Cutting the deficit: four years down, five to go?]]> The UK is in the fifth year of what is now planned to be a nine-year fiscal tightening. This fiscal consolidation is forecast to total £178 billion in today’s terms by 2018–19. This is £62 billion larger than was originally planned in the June 2010 Budget. In his first Budget, George Osborne outlined a plan to complete the fiscal consolidation by the end of next financial year (2015–16). However, worse-than-expected economic news over the last few years (coupled with the fact that he is now aiming to achieve a tighter fiscal position) has led to Mr Osborne increasing the size of the planned tax rises and spending cuts. As a result, even though Mr Osborne has implemented virtually all the policies he originally announced, the consolidation is not now expected to be complete until the end of 2018–19.

By the end of this financial year, 55% of the total consolidation is expected to have been implemented. However, within this nearly all the tax increases and cuts to investment spending will have been implemented, while only just under half of the cuts to non-investment, non-welfare spending will have been done. The figure below shows the size and timing of the currently planned fiscal consolidation as a share of national income. This shows the combined effect of tax and spending measures announced and implemented by the previous Labour government and the current coalition government since March 2008.

Figure: Timing and composition of the fiscal consolidation

Timing and composition of the fiscal consolidation

Note: This Figure updates the numbers presented in Figure 1.2 of the 2014 IFS Green Budget to include the policy announcements made in Budget 2014 and some other changes to our methodology. The Green Budget contains details of the methodology and sources used to construct this figure. The data underlying this figure can be downloaded here.

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http://www.ifs.org.uk/publications/7186 Tue, 29 Apr 2014 00:00:00 +0000
<![CDATA[Death to the death tax?]]> Last week the Prime Minister, David Cameron, stated that he would like to increase the inheritance tax (IHT) threshold, reviving memories of the 2010 Conservative Party manifesto pledge to increase the threshold to £1 million. Such a reform would leave IHT affecting few estates and bringing in little revenue, perhaps raising the question of whether it was worth continuing with the tax at all. But equality of opportunity concerns might point to an alternative direction for reform with the replacement of IHT with a tax on lifetime receipts. At the very least IHT is in need of reform.

Currently IHT at death is charged at a rate of 40% on estates’ values in excess of a threshold, while transfers made up to seven years before death are taxed at reduced rates and transfers made seven years or more before death are not normally taxed. Bequests to a spouse or civil partner are exempt from IHT and, since October 2007, any unused allowance is transferred to the surviving spouse. The threshold is currently set at £325,000 which means that married couples can collectively bequeath £650,000 tax-free. Agricultural land, certain business assets and bequests to UK registered charities are also exempt from IHT.

As illustrated in the figure below, receipts from IHT fell sharply following the 2007 reform and the onset of the financial crisis and associated falls in asset prices, and at less than 0.2% of national income (0.6% of all tax revenue) they remain at low to moderate levels by historical standards.

The Office for Budget Responsibility (OBR) forecasts that IHT will have raised £3.5 billion in 2013–14 and that this will increase to £5.8 billion in 2018–19. If the increase materialises, this would bring receipts as a share of national income to a level slightly above the previous peaks in in 2007–08 and 1986–87, as shown in the figure below, and would be the highest level of receipts since at least 1973–74 (not shown). The numbers paying IHT are also forecast to increase sharply from just 2.6% of deaths in 2009–10 to 9.9% of deaths in 2018–19, as shown in the figure.

Inheritance tax receipts and taxpayers

Inheritance tax receipts and taxpayers

Note: Figure shows total receipts and number of estates liable for IHT and (for years before 1986–87) capital transfer tax at death.

Source: Authors’ calculations based on data from HM Revenue and Customs, the OBR and the Office for National Statistics.

In part this predicted growth in receipts and taxpayers is due to the economic recovery and, in particular, a forecast bounce back in house prices. It is also in part caused by government policy. The last Labour government announced that the IHT threshold would be frozen at its 2009–10 level of £325,000 through to 2014–15 and the coalition government has chosen first to continue with this policy and then, in Budget 2013, to extend the planned freeze through to 2017–18. This eight-year freeze represents a cut of 22% or £70,700 relative to inflation as measured by the Consumer Prices Index. Thus while Mr Cameron wants to increase the threshold, the policy of his government is for the threshold to continue falling in real terms even after then next general election.

The last Conservative Party manifesto pledged an increase in the threshold to £1 million. Our calculations using data from HMRC suggest that in 2010–11 an increase in the threshold to £1 million would have cost the exchequer at least £1.8 billion. A £1.8 billion giveaway would have reduced IHT receipts by 70% from £2.6 billion to just £0.8 billion. It would have reduced the numbers paying IHT by three-quarters from 2.8% of deaths to just 0.7% of deaths. Of the total £1.8 billion giveaway £0.8 billion would go to those taken out of IHT as a result of the reform while £1.0 billion would go to those still liable for IHT. Much of the gain would go to those in London and the South-East since, in 2010–11, they paid half of all IHT. Given that IHT receipts are projected to increase sharply over the next few years an increase in the threshold to £1 million in, say, 2018–19 would cost considerably more than £1.8 billion.

Increasing the IHT allowance to £1 million would abolish IHT for all except a very small number of very rich families who do not plan their affairs in a tax-efficient manner (by giving away all except £1 million or £2 million of their assets at least seven years before their death, for example). And those individuals who would still be paying IHT after the reform was introduced would be paying considerably less: a couple whose joint estate was worth more than £2 million at death would attract £540,000 less tax as a result of this reform. This policy would leave IHT as a tax that very few estates were liable to pay and that raised little revenue.

The IFS-led Mirrlees Review, funded by the Nuffield Foundation and the ESRC, noted that IHT is “a somewhat half-hearted tax, with many loopholes and opportunities for avoidance through careful organization of affairs. This leads to charges of unfairness and makes a principled defence of inheritance tax difficult”. (See ch.15 Mirrlees Review) Inheritance tax is not very effective at achieving wealth redistribution. Were the threshold raised to £1 million it would also be much less effective in terms of raising money.

In these circumstances more radical change should surely be considered.

One option would be simply to abolish the tax. That would cost little more than increasing the threshold to £1 million, though the total cost would be £5.8 billion in 2018–19 relative to current policy. It would simplify the tax system and get rid of an ineffective and unpopular tax which can be criticised in any case as a source of double taxation in cases where bequests are financed from earnings that have already been taxed.

There is, however, also a case for moving in a different direction. The main justification for an inheritance tax is on grounds of equality of opportunity. Individuals do not control whether or not they are born to wealthy parents and therefore it might be seen as unfair that some are able to inherit much more than others. This argument points to taxing what each recipient gets, rather than what each donor passes on. It is also hard to see in principle why gifts made during someone’s lifetime should be treated differently from bequests at death, The simplest way to avoid IHT is simply to pass on assets above the threshold well before death – easier for the very wealthy than for the merely quite wealthy whose main bequeathable asset is their home.

The Mirrlees Review therefore argued that, if concern for equality of opportunity justifies taxing transfers to the next generation, a more logical approach than the current one – albeit with practical challenges of its own – would be to tax individuals at progressive rates on the total amount of gifts and inheritances that they receive over their lifetime. Systems broadly along these lines were proposed by the Conservative government in 1972 and by the Liberal Democrats as recently as 2006, and one has been in place in Ireland since 1976. (See ch. 8 Mirrlees Review)

Less radical reforms to IHT could also improve it by reducing the scope to avoid the tax. Such a package of reforms could involve removing or reducing the reliefs given for agricultural land and business assets and extending the reach of the tax to gifts made more than seven years before death (an increase to 15 years is current Liberal Democrat policy (See Liberal Democrat Conference)). But whatever happens IHT should not live on in its current form.

We are grateful to the Nuffield Foundation and to the Economic and Social Research Council (ESRC) for supporting much of the research that underpins this analysis.

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http://www.ifs.org.uk/publications/7164 Fri, 04 Apr 2014 00:00:00 +0000
<![CDATA[No new money, yet more generous support for childcare]]> Last year’s Budget announced several major changes to the way in which the government proposed to support childcare for working families. After considering the responses to the public consultation on these proposals, the Government has today announced more details on its new Tax Free Childcare scheme and the way in which childcare will be supported in Universal Credit.

The Tax-Free Childcare scheme, due to begin in autumn 2015, involves the Government topping up payments for childcare made by parents, in a way that is equivalent to parents’ spending on childcare being free of basic-rate income tax. At the same time, the existing scheme that allows employers to give childcare vouchers free from tax will be stopped for new claimants. The new Tax Free Childcare scheme will not be available to parents who receive tax credits or Universal Credit: they are instead able to receive childcare subsidies through the tax credit or UC system. Today’s announcement means that the planned system will be significantly more generous than initially envisaged, providing support to children up to 12 straight away, will provide a higher level of support, and will provide more generous support for childcare in Universal Credit. Yet the Treasury has not increased its estimate of the total cost, as it has revised down considerably its estimate of how many families will benefit.

Specifically, we learned several things today:

  • Rather than being available initially only to children under 5 and then rolled out gradually to children under 12, the new Tax Free Childcare scheme will be available to children under 12 within its first year. The Government says an additional 0.7 million families will therefore benefit during the first year.
  • Although the rate of subsidy remains at 20%, the maximum government subsidy payable for any one child will now be £2,000 a year, rather than £1,200, which will help those (currently relatively few) parents who spend more than £6,000 a year (just under £120 a week) per child on childcare.
  • To be eligible for Tax Free Childcare, all parents in the family will need to earn at least £50 a week and less than £150,000 a year (with some exceptions where one adult is sick or disabled or on parental leave).
  • All parents on Universal Credit will be entitled to an 85% subsidy on childcare spending. This is more generous compared to the announcement in Budget 2013, when the Government said that those paying income tax would receive an 85% subsidy and other claimants would receive a 70% subsidy. (This will be tapered away from better-off families in the same way as other elements of Universal Credit.)
  • A new Early Years Pupil Premium will provide nurseries, schools and other providers of funded early education with extra money for disadvantaged three- or four-year olds

We also got a bit more information about the way that the Tax-Free Childcare scheme will work in practice and how it will interact with Universal Credit. On balance, today’s announcements suggest that the Government’s priority is to devise a scheme that is simple for parents to understand and access: they will not need to report changes in personal circumstances in real time, but only once a quarter, and they will not need to prove that they are in work, but instead only need to self-certify that they are earning more than £50 a week (with different rules applying to the self-employed). Broadly, this simplification is to be welcomed. But there are risks. In particular, policing the requirement to earn £50 a week will be difficult, as no income tax or NI is payable at (or anywhere near) that level of earnings. There will also be a very large incentive for some second earners to claim that they are earning that much: it could be worth thousands of pounds in childcare subsidy.

In what will clearly be an unwelcome decision for several companies which make money by administering the current employer childcare vouchers system, the Government has decided that the new Tax Free Childcare scheme will be delivered by HMRC in partnership with National Savings and Investments (NS&I), an Executive Agency of HM Treasury. Here, the Government has decided that simplicity to parents and the economies of scale that arise from having just one provider are more important than any benefits that would have arisen from having several companies compete to administer the accounts. It has also announced that parents will not need to pay fees to access the scheme.

Surprisingly, today’s announcements come with no new money. Extending the new Tax Free Childcare scheme to all children under 12 within its first year will cost money compared with a world where it was limited to children under 5, but the Treasury can make this announcement without altering its public spending plans because it has significantly revised down its estimate of how many families are likely to be eligible for the scheme (from 2.5 million to 1.9 million). It is not clear what has led to this dramatic change, and so we cannot judge whether these new estimates are any more plausible than the initial ones, but the fact that the change is so large suggests that the Treasury would benefit from being more open about the way it costs new policies. The increased generosity of support for childcare under Universal Credit will be matched by savings elsewhere in Universal Credit that will be confirmed in the autumn.

These announcements confirm that childcare is likely to be an important political battlefield in the months leading up to the general election. In this context, it is crucial that the Government and the opposition parties are clear about the objectives and evidence underlying their proposals. Today’s announcements indicate that the Government’s main motive is to help parents move into work. As we pointed out in the IFS 2014 Green Budget, we know remarkably little about the impact of the policies to support childcare that have been introduced in England in recent years. And there is no consistent evidence from other countries that childcare support has large effects on parental labour supply. While today’s announcements bring welcome simplifications to the new Tax-Free Childcare scheme, and an increase in generosity that will certainly be welcomed by families on Universal Credit using childcare, and better-off families who spend more than £6,000 a year on childcare, the extent to which it will deliver its intended goals is essentially unknown.

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http://www.ifs.org.uk/publications/7151 Tue, 18 Mar 2014 00:00:00 +0000
<![CDATA[Scotland's fiscal position worsened in 2012–13 as North Sea revenues fell]]> Today, the Scottish Government published the latest version of its annual Government Expenditure and Revenues Scotland (GERS) publication covering 2012–13. The IFS will be publishing a full report on these figures and the last pre-referendum update of our assessment of Scotland’s fiscal position next month. But what are the key findings that jump out of the latest year of data?

For the first time in 5 years GERS suggests that Scotland's net fiscal balance, or budget deficit, was worse than that of the UK as a whole even when allocating North Sea revenues to Scotland on an illustrative geographic basis. Until now these revenues have been enough to more than outweigh the fact that public spending per head is significantly higher in Scotland than in the rest of the UK whilst non oil revenues have been much the same. But not in 2012–13.

Two things appear to have happened that explain a large part of this. First, total UK-wide North Sea revenues were substantially lower than in the recent past (£6.6 billion compared to £11.3 billion in 2011–12, for instance). Second, a smaller proportion of North Sea revenues have been allocated to Scotland in 2012–13 than 2011–12, although there have also been downward revisions to the estimated share in 2011–12’s compared to last year’s publication.

As we have said before it is important to think of oil revenues differently to other revenues because they are so volatile (and likely to run down in the longer term). These figures reaffirm the fact that an independent Scotland, like the rest of the UK, would have a substantial fiscal deficit. But higher spending in Scotland makes that deficit bigger than in the UK as a whole if oil revenues are not high enough to compensate.

The fiscal position

GERS includes two measures of the overall fiscal position. That is, the current budget balance, which is the difference between non-investment spending and revenues, and the net fiscal balance, which is the difference between total spending (including investment) and revenues. Figures are presented excluding North Sea revenues, as well as including population-based and illustrative geographic shares of North Sea revenues. Table 1 shows how each of these measures evolved between 2008-09 and 2012–13.

Table 1: Current and net fiscal balance (% of GDP), UK and Scotland, 2008–09 to 2012–13

 Current and net fiscal balance (% of GDP), UK and Scotland, 2008–09 to 2012–13

Source: Government Expenditure and Revenues Scotland, 2012–13

Excluding North Sea revenues, Scotland’s public finances suffered a very substantial deficit in 2012–13: an 11.2% of GDP current budget deficit; and a 14.0% of GDP net fiscal deficit. However, this represents a slight improvement on 2011–12, when the deficits were 11.6% and 14.7% of GDP, respectively. This improvement in the onshore budget balance is a result of onshore revenues growing more quickly (by 2.7%) than government expenditure (0.5%). Indeed, the modest improvement in the onshore budget in 2012–13 was, if anything, slightly larger than that in the UK as a whole, although the level of the onshore deficits remains much higher in Scotland (for the UK as a whole, the onshore deficits are close to the overall deficits reported in Table 1).

The present Scottish Government has traditionally focused on fiscal measures including an illustrative geographic share of North Sea revenues. This seems reasonable: if Scotland were to become independent then it seems likely that apportionment of the North Sea would be on a geographic basis. Allocating a geographic share of North Sea revenues to Scotland improves its fiscal position substantially, although a large deficit remains: a 5.9% of GDP current budget deficit (versus 11.2% without North Sea revenues), and an 8.3% of GDP net fiscal deficit (versus 14.0%).

However, this represents a deterioration since 2011–12, when the current budget deficit including a geographic share of North Sea revenues was just 3.1% and the net fiscal deficit was 5.8% of GDP. This deteriorating fiscal position reflects an estimated fall in Scotland’s share of North Sea revenues from £10.0 billion in 2011–12 to £5.6 billion in 2012–13, following falls in oil and gas production and increases in production and investment costs (which are deductible from taxable profits). Previously, the Scottish Government had been forecasting North Sea revenues of between £6.7 billion and £7.2 billion in 2012–13.

These falls in North Sea revenues also mean that, whereas including a geographic share of North Sea revenues Scotland’s fiscal position was stronger than that of the UK in every year between 2008–09 and 2011–12 (and substantially better in 2008–09 and 2011–12), in 2012–13 the fiscal position was a little weaker in Scotland than in the UK as a whole. For instance, the net fiscal balance (including investment spending) is estimated to have been 8.3% of GDP in deficit, compared to 7.3% for the UK as a whole.

Of course, the decline in North Sea revenues was not helpful to the UK public finances either. But, because most North Sea revenues are estimated to come from the Scottish portion of the North Sea (84% in 2012–13), and because the Scottish economy and tax-base is much smaller than that of the UK as a whole, a fall in this revenue stream has a much larger proportional impact on Scotland. For instance, the fall in North Sea revenues in 2012–13 was equivalent to around 0.3% of GDP for the UK as a whole, but 3.1% of GDP for Scotland. The latest figures therefore illustrate how sensitive an independent Scotland’s public finances would be to volatility in North Sea revenues. As we have argued before, and the Scottish Government’s independent fiscal commission has recognised, this would require a Scottish government to design fiscal rules that reflect this sensitivity. And, if North Sea revenues continue to fall and remain at low levels, as forecast by the OBR, further fiscal tightening in addition to that planned by the UK government would be required to return Scotland’s public finances to health. Even if North Sea revenues do rebound in the medium-term, as the Scottish Government forecast in its independence White Paper, it might be wiser to bank that money to improve the public finances, and to prepare for the longer-term fiscal challenges of an ageing population and the eventual diminishing of North Sea revenues.

Comparing GERS 2012–13 with the IFS’s previous projections

These latest official figures follow publication, last week, of updated medium-term projections by the IFS. We anticipated that Scotland’s budgetary position would weaken in 2012–13. However, our projection for the net fiscal deficit of 6.8% of GDP was somewhat smaller than the outturn of 8.3% of GDP. What explains these differences?

First, part of the difference can be explained by the fact that the decline in North Sea revenues was accompanied by a decline in the total amount of economic output produced in the North Sea which led to a fall in Scottish GDP. A lower GDP means a given cash deficit represents a larger fraction of GDP. The GERS figures take account of this fall in GDP, but our projections did not (as the focus was on the outlook to 2016–17 and 2018–19 and official GDP forecasts are not available for Scotland).

There are also differences between our spending and tax projections for 2012–13 and the outturns reported in GERS.

Our projections for spending were around £0.3 billion lower and our projections for tax revenues around £1 billion higher than the actual outturns reported in GERS. Around half of the gap for taxes is due to Scotland’s North Sea revenues being lower than we projected. Our projections were based on 94% of UK North Sea revenues being allocated to Scotland on a geographic basis, which was the share reported for 2011–12 in last year’s GERS publication. Today’s publication instead allocates just 84% of North Sea revenues to Scotland (it also has revised the share for 2011–12 down to 88%). These revisions reflect the fact that it is difficult to divide up tax revenues between the different parts of the UK when they are collected on a national basis.

If these higher levels of spending, lower levels of taxes and GDP, and the resulting bigger fiscal deficit were to persist, Scotland’s medium-term fiscal position would be somewhat weaker than our projections last week suggested. This is likely to be unwelcome news. If the government of an independent Scotland wanted to make up this gap, the additional tightening of 1.5% of GDP (8.3% - 6.8%) that would be required equates to around £2.2 billion in today’s terms. This would come on top of the 2.9% of GDP tightening (£4.2 billion) we estimated would be required to match the fiscal tightening planned by the UK government for between 2016–17 and 2018–19. And, if the OBR’s forecasts for overall North Sea revenues turn out to be correct, even then, Scotland would have a net fiscal deficit of around 2.5% of GDP in 2018–19, compared to a forecast of budget balance for the UK as a whole in the same year.

Conclusions

How healthy an independent Scotland’s public finances would be is obviously a key issue for the forthcoming referendum: whether an independent Scotland would need further tax rises and spending cuts, or could ease the austerity, is one factor in whether independence would make Scottish families better or worse off. The GERS figures released today, because they are backwards rather than forwards looking do not provide the answer to this question. But they do remind us of three important things:

  • That the health of an independent Scotland’s public finances would be affected by the strength of North-Sea revenues to a much greater extent than the UK as a whole;
  • That these revenues can be extremely volatile from year-to-year;
  • And that forecasting the public finances is a tricky business.

This means that in planning for independence, the Scottish Government should be cautious in its fiscal assessment, and avoid building its budget on the back of optimistic forecasts for North Sea revenues.

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http://www.ifs.org.uk/publications/7131 Wed, 12 Mar 2014 00:00:00 +0000
<![CDATA[Does offering higher teacher salaries improve pupil attainment?]]> Research from the US and England shows the central importance of teacher effectiveness in determining pupil attainment. Understanding how to attract high quality teachers to the profession and to particular schools is therefore clearly crucial. In new research released today, we examine salary scales and pupil attainment in primary schools in and around London. For these schools, and for the salary differences of just under 5% that we observe, we do not find evidence that higher salary scales for teachers have much impact on pupil attainment. This suggests that if individual schools offered salary differentials on this scale, they would not necessarily attract more effective teachers.

Estimating the impact of teachers’ pay on pupil attainment is complicated as teachers' pay is largely set by national agreements; any variation in salaries tends to reflect the experience of the teacher so it is difficult to separate the impact of teacher pay from teacher experience. In innovative new research, we compare teachers in the same geographical area, with the same levels of experience (on average), who are paid different amounts because of London weighting: teachers in the London area receive higher salaries to compensate them for a higher cost of living (and schools receive extra funding in order to pay for these higher salaries). There are four pay zones in total (inner London, outer London, fringe London and the rest of England and Wales). The current starting salaries for teachers across these zones are shown below, together with the top of the upper pay scale.

Table of current starting salaries

We compare pupil attainment in primary schools close to the fringe boundary, where schools are broadly comparable in pupil composition either side of the boundary. As shown above, the salary scales for teachers just inside the London fringe area are just under 5% or around £1,000 higher than they are for teachers at schools just outside.

We find little evidence that these higher teacher salary scales increase pupil attainment in English and maths at the end of primary school. The difference in pupil attainment between schools on either side of the pay boundary is very close to zero for both English and maths. Furthermore, due to the relative precision of our estimates, we are able to rule out even quantitatively small effects (the largest possible effects covered by a 95% confidence interval would be 0.07 and 0.02 standard deviations in English and maths, respectively).

Our work is of course just one piece of evidence. It is based just on primary schools, and the results could be different for secondary schools. But our results are consistent with other research; work from the US (see here also) has suggested that teachers’ decisions about which school to work in are more sensitive to non-pecuniary aspects of the job (such as the mix of pupils at the school and the school environment) than pecuniary ones. Other work for England exploits collective bargaining for teachers to show that a 10% increase in local ‘outside’ wages for teachers (what teachers could earn outside the profession) reduces student test scores at age 16 by about 2%.This suggests that highly effective teachers may be sensitive to pay differentials when they make their initial career choices or when they choose which area of the country to teach in, but the effect is relatively small. Taken together, our respective estimates suggest that the effect of relatively small changes in pay on pupil attainment is either zero or relatively small, and that this seems to apply both to the effect of local wages and salary differentials across schools.

One further important qualification to emphasise is that we are looking at relatively small changes in pay. This doesn’t tell us much about the effect of bigger changes in pay and in particular doesn’t speak to the question of what would happen over the long run if the relative pay of teachers were to change significantly. For instance, previous research has suggested that long-run changes in relative pay are linked to the average cognitive ability of individuals who choose to become teachers.

Nevertheless, the apparent weakness of the relationship between pay and outcomes may reflect a number of issues.

It may be that, when making appointments, schools find it difficult to distinguish between more and less effective teachers. That might imply a need for better information. Indeed there is a strong case for improving the availability of information about the relationship between particular teachers and the outcomes for the pupils they teach.

Pay differentials may be effective when linked more directly to performance. There is some evidence of a modest positive effect of performance-related pay on pupil attainment, though it appears to matter a lot exactly how such systems are designed.

More generally there is a case for focussing on effective advertising and promotion of teaching. The availability of (cost) effective teacher training routes (which IFS is currently researching) is likely to be important. And there may be scope to increase the quality of applicants to teacher training.

Overall there is a remarkable lack of clear evidence about which combination of measures is likely to be most effective in attracting more high quality teachers into the profession or in attracting the best teachers to particular schools. Our research suggests that modest across-the-board pay rises are not likely to be the main answer, at least in the short run.

It is normal to highlight the need for more research. It is urgently needed in this area. In particular, it is vitally important to put together data that would make such research possible. The Department for Education collects data on pupil performance. It also collects data on teachers. It has consistently, and for a long period, refused to collect the necessary information that would allow these two datasets to be linked. This means that we remain largely ignorant about which are the most and least effective teachers and which policies are most effective in helping attract and retain them.

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http://www.ifs.org.uk/publications/7127 Thu, 06 Mar 2014 00:00:00 +0000
<![CDATA[The next five years look better but tough fiscal choices remain for Scotland]]> The Office for Budget Responsibility’s (OBR) latest forecast for the UK’s public finances – published in December 2013 – presented a significantly better picture for the UK’s fiscal position over the next five years than had been suggested by their previous forecast in March. This was the result both of higher expected economic growth up to 2018–19 and the government’s decision to continue to freeze public spending in real terms for one more year in 2018–19. In a speech this evening to the David Hume Institute, IFS Director Paul Johnson will describe how this new information affects our estimate of the outlook for Scotland’s public finances over the next five years. This observation provides more detail behind that analysis: we set out here how the new forecasts from the OBR affect the medium-term fiscal outlook for Scotland that we and the Scottish government, among others, previously presented.

The OBR now thinks that the economy will perform better over the next few years, meaning that most of the major tax revenues will rise more quickly and public spending (many components of which have already been fixed in cash or real terms for the next five years) will decline more rapidly as a share of gross domestic product (GDP). As a result, the official forecast for public sector net borrowing in the UK up to 2017–18 was revised down significantly. This is shown by the red lines in Figure 1. In the 2013 Autumn Statement, the government also pencilled in one more year of freezing public spending. As Figure 1 shows, this (if it in fact occurs) will strengthen the public finances even further in 2018–19.

Between March and December last year, the OBR’s forecast for public sector net borrowing in the UK in 2018–19 improved from 2.0% of GDP to –0.1% of GDP (i.e. the OBR is now forecasting a surplus). Our estimates suggest that the borrowing projection implied for Scotland has fallen from 4.3% of GDP to 2.5% of GDP; these figures assume that all the spending cuts currently pencilled in by the UK government are also implemented in Scotland. In other words, both the UK and Scotland are now expected to have a stronger fiscal position in 2018–19 than was expected in March last year as a result of an improved economic outlook and the pencilling in of an additional year of spending cuts. However, it is worth noting that the OBR expects the better economic performance over the next five years to have reduced scope for further economic recovery after 2018–19. This means that the long-term fiscal improvement implied by the OBR’s new economic forecasts is somewhat overstated by the differences shown in Figure 1.

Figure 1: Public sector net borrowing projections for the UK and Scotland

Public sector net borrowing projections for the UK and Scotland

Notes: All figures assume that the tax increases and spending cuts currently announced and pencilled in by the coalition government are implemented, including those planned in Scotland for after the date of potential independence. Sources: Figures for ‘Mar 2013’ are from Amior, Crawford and Tetlow (2013). Figures for ‘Dec 2013’ are authors’ calculations using Office for Budget Responsibility (2013), Economic and Fiscal Outlook: December 2013.

Our estimate of Scottish borrowing of 2.5% of GDP in 2018–19 assumes that all the tax increases and spending cuts currently announced and pencilled in by the UK’s coalition government are implemented, including those planned in Scotland for after the date of potential independence. If, instead, the Scottish government did not want to cut non-debt interest public spending as a share of national income after 2016−17, then borrowing in 2018−19 would be 5.4% of GDP (rather than 2.5% of GDP) – this is shown by the dotted blue line in Figure 1. In other words, to reach a position where borrowing was at 2.5% of GDP in 2018-19 the government of a newly independent Scotland would need a fiscal tightening of 2.9% of GDP between 2016-17 and 2018-19.

Oil revenues

There was one source of revenues that the OBR took a more pessimistic view on in December than they had in March: that was revenues from oil and gas production. As the vast majority of these revenues are generated in Scotland, a downgrade to this revenue stream has a much more adverse effect on Scotland’s fiscal balance than it does for the UK as a whole. (Oil and gas revenues for Scotland implied by the two OBR forecasts are shown by the black lines in Figure 2.) As a result, the improvement in the fiscal position for Scotland suggested by the OBR’s December forecast (shown by the blue lines in Figure 1) is not nearly as large as for the UK – indeed, in 2013–14 and 2014–15 our calculations suggest that Scotland would have a weaker fiscal position than was implied by the OBR’s March forecast.

Figure 2: Comparing forecasts for Scottish oil and gas revenues

Comparing forecasts for Scottish oil and gas revenues

Notes: Scottish oil and gas revenues based on the OBR forecasts are calculated assuming that Scotland is allocated 94% of UK revenues. Sources: Office for Budget Responsibility (2013), Economic and Fiscal Outlook: March 2013; Office for Budget Responsibility (2013), Economic and Fiscal Outlook: December 2013. Scottish Government (2013), Oil and Gas Analytical Bulletin: March 2013 (http://www.scotland.gov.uk/Resource/0041/00416072.pdf).

The outlook for Scotland is, however, very sensitive to the tax revenues received from oil and gas production and some forecasters take a very different view from the OBR on the prospects for these revenues over the next few years. In particular, the White Paper published by the Scottish government in November presented figures for Scotland’s fiscal position based on a forecast that Scottish oil and gas revenues would be somewhere between £6.8 billion (described as ‘Scenario 2’ in Figure 2) and £7.9 billion (described as ‘Scenario 4’ in Figure 2) in 2016–17. We estimate that the OBR’s forecast at the time implied revenues for Scotland (allocated on a geographic basis) of just £4.5 billion and that their latest forecast implies revenues of just £3.3 billion in that year.

We estimate that the OBR’s forecasts imply that Scottish borrowing in 2017–18 will be 3.6% of GDP. However, if Scottish oil and gas revenues were to turn out as projected under the Scottish government’s ‘Scenario 2’ or ‘Scenario 4’, borrowing would instead be 1.8% or 1.0% of GDP respectively. These latter figures suggest a better position for Scotland’s public finances, similar to the position for the UK as a whole, which the OBR projects will have borrowing of 1.2% of GDP in 2017–18.

It is worth noting in this context that it looks like the Scottish government’s forecasts for revenues under these scenarios have been too optimistic in 2012–13 and, with the vast majority of payments already having been made for 2013–14, that their forecasts for this year also look to be too optimistic. It remains to be seen whose forecasts might be more accurate going forwards.

Conclusion

The latest OBR forecasts for the UK’s public finances imply a slightly stronger fiscal position for a potentially independent Scotland in the medium-term than their previous forecasts suggested, although with higher borrowing over the next couple of years. This is good news but would require the government of a newly independent Scotland to continue with the spending squeeze currently planned by the UK’s coalition government. The latest OBR forecasts also illustrate the sensitivity of Scottish public finances to oil revenues. Neither the OBR nor the Scottish government can know for sure what will happen to these revenues. What is clear is that fiscal decisions in an independent Scotland would need to be taken in the context of considerable uncertainty over this very important part of the budget – and in the context of long term pressures both on these revenues and arising from an ageing population (as we have highlighted).

This analysis has been produced as part of our ESRC funded work on The Future of the UK and Scotland. This research programme aims to clarify some of the fiscal choices that might face Scotland were it to become independent.

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http://www.ifs.org.uk/publications/7124 Tue, 04 Mar 2014 00:00:00 +0000
<![CDATA[50p tax – strolling across the summit of the Laffer curve?]]> On Satuday 25th January, Ed Balls, the shadow chancellor announced that if elected, a Labour government would return the rate of income tax payable on incomes above £150,000 to 50%. What would the effect of this be? The contention of Ed Balls and Ed Miliband is that it would raise a meaningful sum of money to help reduce the budget deficit and make for a fairer tax system. The contention of their opponents is that it could result in an exodus of talent from the UK, a reduction in entrepreneurial drive, and an increase in tax avoidance and evasion, and may actually reduce the amount of tax paid.

Who is right is important not just for the lucky few who have incomes high enough that they would be directly affected. It matters for everyone because the Exchequer is, perhaps worryingly, reliant on this very small group of individuals for a very large fraction of revenue: the 1% of income tax payers with incomes in excess of £150,000 pay somewhere between 25 and 30% of all income tax. How these people would respond to a change in tax rates can therefore have big implications for overall tax revenues.

Perhaps the best evidence we have at present is that produced by HMRC, and signed off by the Office for Budget Responsibility, in 2012. This suggested that cutting the 50p rate to 45p could reduce revenues by about £3.5 billion in 2015–16 if there was no change in behaviour by affected individuals. However, once one allows for behavioural response, their central estimate was a cost of just £100 million – a very small amount of money. The best available estimate of what reversing the cut would raise is therefore about £100 million too.

However, it is important to bear in mind that there is substantial uncertainty around this central estimate. Calculating the revenue effects allowing for behavioural response requires one to estimate the “taxable income elasticity” – the extent to which taxable income changes when the tax rate changes. HMRC’s central estimate is that this elasticity was 0.45, which is broadly in line with estimates by IFS researchers based on the last time the top rate of income tax changed – in the 1980s – and with estimates from a number of other countries. If instead the true elasticity was 0.35 (which is well within the range of uncertainty), reducing the top rate of tax from 50p to 45p will have cost the exchequer about £700 million, whilst if the true elasticity was 0.55 (again, within the range of uncertainty), it will have actually raised about £600 million. In other words cutting the top rate of tax may have cost the government a bit more than it thought or actually raised a bit. This evidence led the OBR chairman Robert Chote to conclude that, whatever the precise answer, we were “strolling across the summit of the Laffer curve”.

Has anything changed since then? Ed Balls and Ed Miliband have suggested that the most recent HMRC statistics show those paying 50% income tax have paid some £10 billion more over the three years 2010–11 to 2012–13 than was thought back in 2012 when HMRC did their analysis. The statistics in question are estimates and projections of tax liabilities based on the Survey of Personal Income, which is itself based on a sample of tax records. The versions of these tables from 2012 and 2013 do show a difference of around £10 billion in the total amount of tax paid by those paying the 50p rate in the years between 2010¬–11 and 2012–13. Is that an indication that the 50p rate was more successful in raising revenue than HMRC assumed in their analysis?

Looking carefully at the notes that accompany the 2012 tables cited by the Labour Party shows that the figures for 2010–11 to 2012–13 were projected tax payments based on how much tax was paid in 2009–10, before the 50p tax rate was introduced. Had the HMRC’s analysis of taxable income elasticity been based on these original, lower, projections for tax revenues then we might have good reason for questioning their analysis. In fact it was not. In their analysis, HMRC made use of the actual 2010–11 tax returns of people paying by self-assessment (who make up the vast majority of people who were paying the 50p rate of tax). This is pretty much the same data (bar a few late filers and those few 50p rate tax payers not required to fill in a self-assessment form) that then goes into producing the Survey of Personal Income data used in the most recent 2013 tables. These tables show 50p tax payers paid £34.5 billion in income tax in 2010–11 on an income of £86.5 billion (and HMRC’s analysis assumed their income was £87 billion). So in fact there is little additional evidence to suggest that a 50p rate would raise more than was estimated by HMRC back in 2012.

Of course, even if increasing the top rate of income tax raised little or nothing one might still consider it worthwhile if one had a very strong preference for reducing inequality. Some effect has of course already been felt since the recession hit through the combination of the 45p rate itself, a major reduction in pension tax reliefs, and the withdrawal of the personal income tax allowance for those on high incomes. Our analysis of the effect of policy changes since the recession suggests people with incomes over £100,000 have on average seen a bigger percentage hit to their incomes from tax and benefit policies than people in any other part of the income distribution. But the group with incomes over £150,000 a year remains extremely well off relative to the majority.

The uncertainty around HMRC’s estimates mean it is also possible that the 50p rate would be somewhat more effective at raising revenue than their initial analysis suggests. HMRC made their calculations at great speed on the basis of one year’s data that had only just become available. Indeed only around 95% of the data was available at the time they made the calculation. By now they have data for 2011–12 too, and soon they will have data for 2012–13 as well. Given this there is certainly a case for HMRC looking again. IFS researchers also now have access to much of the relevant data and we will also be looking at this issue over the course of the year.

But at the moment, the best evidence we have still suggests that raising the top rate of tax would raise little revenue and make, at best, a marginal contribution to reducing the budget deficit an incoming government would face after the next election.

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http://www.ifs.org.uk/publications/7066 Mon, 27 Jan 2014 00:00:00 +0000
<![CDATA[Hard choices ahead for government cutting public sector employment and pay]]> After the 2013 Budget, the Office for Budget Responsibility (OBR) forecast that general government employment (that is employment by central and local government) would fall by 1 million between 2010–11 and 2017–18. However, with the Chancellor choosing to pencil in further cuts to departmental spending in 2018–19, last week the OBR suggested that a further 130,000 general government jobs would go in 2018–19, bringing the total fall to 1.1 million by 2018–19.

Despite the scale of these cuts, it was not the reductions in government employment that really stood out in the OBR’s latest forecasts. Instead it was the reductions to forecast growth in public sector pay. Public sector pay is now forecast to be 3.6% lower in 2017–18 than expected in June, when our analysis used the OBR’s March forecasts and incorporated an estimate of the effect of the 1% pay award in 2015–16. This change of view in part reflects the fact that earnings growth in the public sector has been weak so far this year, with no growth in pay in the 3rd quarter of 2013 compared with the same quarter a year before. This has led the OBR to reduce its forecast for public sector pay growth in 2013–14 to only 0.5% compared with a forecast of 2.2% in March. It has also reduced its forecast for each year up to 2016–17 compared to the March forecast.

At the Spending Round in June, based on the forecasts then available, we showed that the headline public-private pay gap was likely to return to its pre-recession level by 2015¬¬–16. As can be seen in Figure 1, this was after public pay had grown faster than private pay during the recession. The latest forecasts now suggest an acceleration of the fall in public pay relative to private: the pay differential is predicted to return to its 2007–08 level (and the level seen in 2008–09) this year – two years earlier than previously forecast. Furthermore, OBR projections imply that public sector pay is set to grow less quickly than the private sector in each of the years after 2013–14 too. This implies that by 2018–19, public sector pay is predicted to be 6.4 percentage points lower relative to private sector pay than it was before the crisis in 2007–08.

Notes: Data to 2012–13 estimated using Labour Force Survey data. Forecasts based on authors’ calculations using OBR Economic Fiscal Outlook March 2013 and December 2013. “Forecast June 2013” incorporated an estimate of the 1% pay award in 2015–16 announced in Budget 2013.

The recent trends in average public sector pay relative to private sector pay do not appear to be driven by a change in the composition of the workforces. The green line on Figure 1 shows that after we control for observed differences in individuals’ age, sex, experience and education, following a similar methodology to our previous analysis, the trends in the differential in recent years are little altered. Of course, controlling for the observed differences, the ‘conditional’ differential is lower than the average raw premium, as public sector workers are more likely to be highly educated and in professional or similar roles. More details on this latest analysis are available here.

If, as these projections suggest, public sector pay is set to fall relative to private pay by 8 percentage points between 2012–13 and 2018–19, it seems likely that public pay will fall lower relative to private pay than its level in the early 2000s when parts of the public sector had difficulties recruiting and retaining staff. This has some important implications. First, if the current forecasts are correct and private sector earnings growth continues to be higher than public sector earnings growth, some public sector employers may well find it increasingly difficult to retain and recruit high quality workers. Second, if that leads the government to want to mitigate the squeeze in public sector pay but to keep workforce costs as planned it would have to absorb even more cuts to the size of the workforce, beyond the cuts of more than 1.1 million already planned between 2010–11 and 2018–19.

In making such decisions, both the government and pay-review bodies need to pay great attention to indicators of whether the public sector is facing any difficulties in recruiting and retaining high-quality staff, and decide on settlements in light of any such evidence. While public sector pay relative to private sector pay was forecast to return to its pre crisis level by 2015–16, squeezing public sector pay may have been a relatively easy way to cut departmental spending. Given the current OBR forecasts, the choices ahead for the government now look rather harder.

This analysis has been developed during an ongoing project funded by the Joseph Rowntree Foundation, to whom we are grateful for support. Over the next year, we will seek to publish further analysis of changes to the public workforce and public sector pay.

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http://www.ifs.org.uk/publications/7009 Thu, 12 Dec 2013 00:00:00 +0000
<![CDATA[A give and take Autumn Statement?]]> Now scheduled for December 5, the Autumn Statement is – for the third year in a row – set to be a “fiscal event” as the Chancellor George Osborne provides more detail on the giveaways announced during the party conference season. The data so far this year – including today’s public finance numbers – suggest that we can expect to see a welcome upwards revision to the forecast for economic growth and a downward revision to the forecast for the headline deficit. But any improvement will be small relative to the level of the deficit forecast in the Budget, and the deficit this year will still be very high by historical standards and relative to what was projected at the start of this Parliament and compared to what the Chancellor is ultimately hoping to achieve. So as he prepares for the Autumn Statement, if the Chancellor is planning to make good on the promises of giveaways made during the party conference season he should also be considering ways of raising revenue to pay for them.

The March Budget forecast – produced by the Office for Budget Responsibility (OBR) – was that the UK economy would grow by 0.6% in 2013, which was similar to the 0.9% average of independent forecasts surveyed by the Treasury in the previous month. The latest survey of independent forecasters – published on November 18 – suggests that the average growth rate now forecast for this year is 1.4%, an increase of 0.5 percentage points since the Budget. The Bank of England has also revised up its expectation of growth in 2013 by a similar amount: from 0.9% in February 2013 to 1.4% in November 2013. The outlook for growth in future years has also, on average, been revised upwards too.

The monthly data on the public finances since the Budget suggest that the headline deficit is also set to be better than the OBR’s Budget forecast. Central government receipts would need to grow by 2.8% in 2013–14 for the OBR’s forecast to be correct. The data from the first seven months of this financial year suggest that they have in fact grown by 4.6% compared to the same period last year. Receipts from National Insurance contributions, self-assessment income tax, and stamp duty land tax have grown particularly strongly over the last seven months compared to the OBR’s forecast for the year as a whole and easily outweighs a more than £2 billion shortfall in receipts from the Swiss capital tax arrangement.

Should central government receipts continue to grow at this rate for the remaining five months of this financial year (which of course they might not), and if the OBR’s forecasts for public spending and for other receipts were to prove accurate (which again they might not), then the deficit this year would be £7 billion lower than the Budget forecast. An error of this magnitude would be impressively small – at least compared to the historical record of the Treasury who, on average, made an absolute error in projecting borrowing one year out of around 1% of national income or £16 billion in today’s terms.

Of course even if the deficit forecast for this year is revised down by £7 billion, it would still be £113 billion, which – at 6.9% of national income – would be the fourth largest UK deficit seen between the end of the Second World War and 2008–09. Furthermore, a deficit of £113 billion in 2013–14, while lower than projected in the March Budget, would still be substantially higher than the £60 billion that Mr Osborne projected for this year at the time of his first Budget in June 2010.

When considering the scope for permanent net giveaways in the Autumn Statement, what matters is the extent to which any reduction in borrowing this year feeds into lower expected borrowing in future. The Swiss tax was largely one-off so the shortfall here will not persist, suggesting that underlying revenues could be £9 billion higher than previously forecast. One reason why they might not is that the OBR could judge that faster economic growth this year simply means less spare capacity remains – that is there is now less scope for the economy to grow before inflation pressures return. In this case, its growth forecast for future years ought to be revised down, and any additional strength in revenues this year compared to what was previously forecast might not persist indefinitely. The faster growth in 2013 can explain just under half of the faster growth in revenues this year, which could suggest that only around £4 billion of the £9 billion strengthening in revenues might persist into future years. Of course the OBR could judge that the faster growth this year has not been associated with much, or indeed any, reduction in spare capacity this year. In that case, more of the lower projected deficit this year might be considered to be permanent rather than temporary – giving more scope for permanent giveaways.

No doubt Mr Osborne would like to be able to use any fall in borrowing to justify a significant net giveaway in the Autumn Statement: not least because of the cost of the measures announced at the Liberal Democrat and Conservative Party conferences. In total three significant policies outlined at these party conferences imply a giveaway of around £2 billion a year, including: universal free school meals for those in their first three years at primary school from September 2014 (£600 million a year); a transferable income tax allowance for some married couples from April 2015 (£700 million); and an aspiration to cancel the increase in fuel duties currently planned for September 2014 (£700 million).

So, should Mr Osborne implement all these measures – and possibly more – without any offsetting tax rises or spending cuts? In both Autumn 2011 and Autumn 2012 Mr Osborne reacted to a worsening outlook for the public finances by allowing projected borrowing to rise considerably over this parliament and pencilling in further spending cuts for the next parliament. A symmetric approach to good news would be to plan to borrow less in this parliament and to reduce the amount of austerity planned for the next.

Mr Osborne also announced in conference season a desire to eliminate the total deficit by the end of the next parliament, so as to hasten the reduction in public sector net debt. The OBR’s March 2013 forecast was that the deficit would still be at £42 billion in 2017–18. That is to say, even after the implementation of all the austerity measures already announced up to 2015–16 plus those spending cuts pencilled in for 2016–17 and 2017–18, considerable further austerity (requiring either a further two year freeze in total public spending or a further net tax rise) would still be needed to meet Mr Osborne’s proposed new deficit target. So perhaps any talk of pre-election giveaways should wait.

IFS public finance observations are generously supported by the Economic and Social Research Council (ESRC).

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http://www.ifs.org.uk/publications/6972 Thu, 21 Nov 2013 00:00:00 +0000
<![CDATA[Entry to grammar schools in England for disadvantaged children]]> There are 164 grammar schools in England, which select their pupils on the basis of performance in entry tests in Year 6. These schools educate 4% of the Year 7 pupils in England. They are concentrated in selective local authorities such as Kent, Buckinghamshire, Slough and Trafford, although a third of grammar schools are in non-selective local authorities (including London). Despite their small number, grammar schools attract a significant amount of attention. New research published today by IFS researchers, which was funded by the Sutton Trust, investigates the extent to which children from disadvantaged backgrounds are disproportionately unlikely to attend grammar schools.

Using administrative data on all children in state schools in England, the research investigates whether pupils who are eligible for Free School Meals (FSM) are particularly unlikely to enter a grammar school. FSM eligibility is a good measure of coming from a poor household, as it indicates that a parent is in receipt of a means tested out of work benefit.

Comparing the proportion of children eligible for FSM in grammar schools to the proportion eligible for FSM in the surrounding areas shows that relatively few disadvantaged children go to a grammar school. In selective local authorities, 3% of grammar school entrants were eligible for FSM, compared with 17.5% at other state schools.

Given the selective nature of grammar schools, if pupils eligible for FSM have poor academic performance, they are unlikely to pass a selective entrance test. Unsurprisingly our research found that higher academic performance in Key Stage 2 tests in Year 6 dramatically increases the probability of getting a place at a grammar school. But, as has been shown before, FSM eligible children are far less likely to have high academic performance. According to the latest statistics, about 14% of disadvantaged pupils (mostly those who are or who have ever been eligible for FSM) achieved Level 5 in both English and maths at age 11, compared with around a third of other pupils. As well as having lower attainment at age 11, pupils from poorer families are also more likely to experience other potential disadvantages, such as having English as an additional language, or going to a more challenging primary school.

In areas operating the grammar system, we find that two thirds of children who achieve level 5 in both English and Maths at Key Stage 2 and who are not eligible for free school meals go to a grammar school. This compares with only 40% of similarly high achieving children who are eligible for free school meals. Furthermore, even after allowing for a wider range of factors that may depress pupils’ academic achievement, as well as pupils’ level of prior achievement in Year 6, this difference remains at just over 12 percentage points . Therefore it is not purely low attainment that prevents FSM children from attending grammar school. We found similar patterns in London local authorities and in grammar schools located in local authorities that do not operate a full grammar system.

Eligibility for free school meals only allows us to look at the poorest group of families. To get a handle on whether these socio-economic differences extend further up the income distribution, we compare pupils’ chances of getting into a grammar school according to the level of deprivation in their local area. This shows that 4% of pupils in grammar schools live in the poorest fifth of neighbourhoods, around 21% come from the middle quintile and 34% live in the richest fifth of neighbourhoods. Children living in the richest areas are disproportionately likely to attend a grammar school compared with those living in areas close to the national average, who are in turn more likely to attend grammar schools compared with those living in the poorest areas. The differences do thus seem to extend further up the income distribution.

While pupils from more disadvantaged backgrounds are less likely to attend grammar schools, a further striking result from the research is that large numbers of pupils who enter grammar schools come from primary schools outside the English state education system. Most of these students coming in from outside the state system are likely to have attended private schools. Children attending private schools, who tend to come from more affluent families, make up 13% of Year 7 entrants to grammar schools. In comparison, on average 6% of 10 year olds are enrolled in a private school nationally. Unfortunately we do not have any measures of prior achievement for pupils in private schools, so it is impossible to compare the likelihood of enrolling in a grammar school of state and private school pupils with similar levels of prior achievement.

This evidence indicates that some parents may use private primary schooling to try to increase the probability of their child attending a selective state secondary school. Of course others may purchase individual tutoring for their children to help them prepare for the entrance exams. Surveys of individual grammar schools have suggested that a high proportion of the students in those particular schools had been tutored for the entrance exam, though the extent of tutoring nationally for this purpose is not known. Clearly these are advantages which children from poorer backgrounds are unlikely to benefit from.

What drives the differential in attendance at a grammar school between pupils from different socioeconomic backgrounds? Unfortunately, this research is unable to pin down the exact mechanism for the under-representation of poorer pupils in grammar schools. It may be that children from poorer backgrounds are less likely to apply to a grammar school in the first place, or that those who do sit the exams are less likely to pass the entrance exam, perhaps due to lack of preparation for that kind of test, or a combination of both.

Future research is needed to determine exactly what is driving this grammar school attendance gap between richer and poorer pupils. This is an important research question as if it is the result of low applications then the policy response should focus on encouraging greater numbers of applications. If applications are similar, then the focus should be on the nature of the test and levels of preparation.

Notes:

This paper, Entry into Grammar Schools in England is authored by Jonathan Cribb (IFS), Luke Sibieta (IFS), and Anna Vignoles (Cambridge and IFS).

It was published as part of a larger report, Poor Grammar: Entry into Grammar Schools for disadvantaged pupils in England by Jonathan Cribb, Luke Sibieta, Anna Vignoles, Amy Skipp, Fay Sadro and David Jesson. The report has been funded by the Sutton Trust.

IFS receives significant funding from the ESRC through the ESRC Centre for the Microeconomic Analysis of Public Policy at the Institute for Fiscal Studies.

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http://www.ifs.org.uk/publications/6936 Fri, 08 Nov 2013 00:00:00 +0000
<![CDATA[The crucial role of good evidence in evidence-based policymaking]]> In a time of continuing fiscal austerity, policymakers increasingly want to know ‘what works’ and for whom, in order to target scarce resources on those who will benefit most and to ensure that policy has the desired impact upon those it is designed for. Basing policy decisions on evidence is undoubtedly a good thing – but only if the evidence used is robust, unbiased and methodologically sound.

Of particular concern is whether the introduction of a new policy or a change in an existing policy would cause (i.e. directly lead to) a change in the relevant outcome of interest, or whether the two are simply correlated. What do we mean by this? Two factors are causally related if movement in one factor causes a change in the other. For example, heating water causes water to boil. Two factors are correlated if they move together, but one factor doesn’t cause the other. This occurs when another factor (or multiple factors) influences both. For example, higher ice-cream sales are correlated with lower water levels in reservoirs, but greater ice-cream consumption does not cause water levels to fall; both factors are driven by external weather conditions.

This distinction is crucial when thinking about how to use evidence to inform policymaking. It would be very worrying indeed if a government thought it could increase water levels in reservoirs by taxing ice-cream sales. But it is easy to think of many rather less silly examples, particularly in the social sciences, where the relationships between factors are more complicated, and it is harder to say with any degree of certainty whether one causes the other, or whether the two are simply correlated, both driven by one or more other factors.

New IFS research funded by the Nuffield Foundation on the link between parents’ marital status and relationship stability and child outcomes illustrates these challenges. It shows that married parents are, on average, less likely to separate while their child is young than cohabiting parents. It also shows that children born to married parents have slightly higher cognitive and socio-emotional development, on average, than children born to cohabiting couples; they are also less likely to engage in risky and antisocial behaviours, such as underage smoking, drinking and cannabis use. Does this evidence prove that marriage causes improvements in relationship stability and child development?

The short answer is no.

We know that married parents differ from cohabiting parents in many ways other than their marital status (and in ways which we can be confident were determined before they decided whether or not to get married). For example, they are from different ethnic backgrounds, have typically grown up in more advantaged homes themselves, and are more highly educated. To the extent that these factors influence both the likelihood that a couple marries, and the likelihood that they stay together (or raise a child with higher cognitive or socio-emotional development), we can think of these as the ‘external weather conditions’ in the example above: ignoring them gives a misleading impression of the effect of marital status on relationship stability or child development.

Our research shows unequivocally that accounting for these other characteristics is important: once we compare cohabiting and married parents who ‘look the same’ in all respects other than their marital status (i.e. are from the same ethnic background, have grown up in similar home environments, have similar education levels, and so on), we substantially reduce or even eliminate the link between marital status and relationship stability or child development. This suggests that much of the raw relationship is due to the fact that different types of people choose to get married, rather than that marriage has a large causal effect on relationship stability or child outcomes.

There is an important caveat to our findings, however: we are not always able to eliminate the difference in outcomes between married and cohabiting parents using only characteristics that are fixed (such as ethnicity) or observed in childhood, long before marriage decisions were taken. In some cases, we must rely on the inclusion of characteristics (such as household income and housing tenure) that are observed after a couple’s decision to marry or cohabit, and so have the potential to be affected by marriage. Our judgement – and the view of most other academic research on this topic – is that these effects are likely to be small. But as a result, it is possible that we could be understating any potential positive impact of marriage if characteristics beneficial to child development or relationship stability are strongly influenced by the decision to marry.

Having said this, however, even if a statistically significant association does remain between parents’ marital status and relationship stability or child development, this estimate does not necessarily represent the causal effect of marriage on these outcomes. This is because there are likely to be many factors that influence both the likelihood of getting married and a couple’s relationship stability or their children’s development that are difficult to observe and account for in our analysis, but that were apparent before their decision to marry. Good examples might be a couple’s level of commitment to one another, or their attitudes to childrearing. Without access to richer data including these characteristics (or a source of exogenous variation – an external factor that affects the likelihood of getting married), it is impossible to know whether any significant association would remain after accounting for all of the ways in which married and cohabiting couples differ.

Understanding whether and to what extent factors are causally related or simply correlated is crucial from a policy perspective. Policy decisions should ideally be based on evidence of a causal relationship. This is not always possible, however, in which case it is important to be clear about exactly what we do, and don’t, know.

The work we are publishing today on the link between parents’ marital status and relationship stability and children’s outcomes is a good example of where one has to be very careful about the conclusions one is drawing. There is a strong correlation between parents being married and children who are more successful academically and in other ways. But there is not good evidence of a causal link – though we can’t say for sure that such a link does not exist. Researchers must be careful not to interpret or present statistically significant associations as evidence of causation. In turn, policymakers must be cautious about using such associations as a basis for policymaking.

The Nuffield Foundation has funded this project but the views expressed are those of the authors and not necessarily those of the Foundation – www.nuffieldfoundation.org

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http://www.ifs.org.uk/publications/6909 Fri, 25 Oct 2013 00:00:00 +0000
<![CDATA[EU Commission labels UK Patent Box harmful tax competition]]> The EU Commission has opined that the UK’s Patent Box breaches the code of conduct for business taxation, which aims to prevent countries from operating policies that result in harmful tax competition. The Patent Box provides a 10% rate of corporation tax for the income deemed to be derived from patents. The policy, originally announced by the previous Labour Government, came into effect in April this year. Once fully in place it is estimated by the Office for Budget Responsibility to cost £1.1 billion a year. One aim of the policy is to encourage innovative activities in the UK. The government highlighted that the policy focuses on patents, as opposed to other forms of intellectual property, because they have "a particularly strong link to ongoing high-tech R&D".

In previous work IFS researchers have highlighted some of the concerns surrounding the Patent Box. Notably, the policy is poorly targeted at incentivising research. This is largely because the policy targets the income from a successful idea and not the underlying research activities. Much of the benefit will accrue to large profitable firms that earn the majority of income from patents. The Patent Box may help to ensure that such firms continue to locate activity in the UK. However, the policy does not require that the innovative activity underlying a patent take place in the UK. In addition, the extent to which the policy succeeds in attracting new activity has likely been eroded by the introduction of similar policies in 10 other European countries.

The Code of Conduct group also raises concerns that the Patent Box may not be sufficiently related to the real activities that the policy aims to promote. They have challenged the specific design of the UK regime based on their assessment that it breaches two provisions. First, the Patent Box may grant tax advantages without requiring any real economic activity in the UK. This may arise if, for example, a firm owns the intellectual property in the UK but conducts research and commercialisation in other countries. Second, the rules for determining eligible profits are deemed to depart from internationally accepted principles. In contrast to other countries, the UK Patent Box does not require profits to be associated with individual patents. This potentially allows for a broad scope of income to be included in the provision. In both cases the Code of Conduct group have raised concerns that the UK rules are not sufficiently transparent and may lead to multiple interpretations, some of which allow abuse of the regime.

The code of conduct is not binding, although it has tended to be followed by governments. The Commission's assessment will be discussed by Member States at a meeting of the Code of Conduct Group on 22 October. The UK government will likely argue that the policy does not breach the provisions. If the Commission upholds the claim the UK government will come under pressure to amend the policy.

However, the broader issue is whether Patent Boxes in general result in tax competition that lowers revenues for governments without providing offsetting benefits. The regimes in Belgium, France, Spain and the Netherlands have previously been reviewed and not deemed to represent harmful tax competition. Recent research at IFS describes the range of policies available in the UK and 10 other European countries, including France, Spain and the Benelux countries. Many offer much lower rates than the UK (including 0% in Malta and 2% in Cyprus) and include a broader range of intellectual property. In some respects elements of their design may be preferable to the UK Patent Box. But there are also regimes that are more generous than the UK and more likely to attract income independently of economic activities. While the precise designs of regimes are different, in practice many of their economic effects are likely to be similar. All raise concerns over tax competition. There is now a strong case for the EU Commission to undertake a full review of the policies.

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http://www.ifs.org.uk/publications/6899 Fri, 18 Oct 2013 00:00:00 +0000
<![CDATA[Tax revenue in England, Scotland, Wales and Northern Ireland]]> HM Revenue and Customs (HMRC) yesterday published estimates of the revenue raised by different HMRC taxes in England, Scotland, Wales and Northern Ireland. These taxes cover 80% of total revenue, since they do not include revenue not collected by HMRC, such as council tax, business rates and vehicle excise duty. The results for 2012–13 are summarised in the figure below. This is the first time that most sources of revenue have been broken down to show the amount raised in Wales and Northern Ireland separately and what is particularly striking about these estimates is how much lower taxes per person in these areas are than in England or Scotland.

Government revenue per person across the UK, 2012-13

Government revenue per person across the UK, 2012–13

Note: ‘Capital taxes’ are capital gains tax, inheritance tax and stamp duties on shares and property. The HMRC estimates run from 1999–00 to 2012–13, although for all the main taxes the 2012–13 (and often 2011–12) ‘estimates’ simply assume that the share of revenue is the same as in previous years.

Source: Authors’ calculations using HMRC statistics and 2012 population totals from the Office for National Statistics.

Wales and Northern Ireland

HMRC tax revenue per person in 2012-13, excluding revenue from North Sea oil and gas, is 26% lower in Wales (at £5,400) and 23% lower in Northern Ireland (£5,700) than in UK as a whole (£7,300). This largely arises because Wales and Northern Ireland have less income and wealth than the rest of the UK and correspondingly raise less revenue per person from all the main taxes on earnings, savings and profits: income tax, National Insurance contributions (NICs), corporation tax, capital gains tax, inheritance tax and stamp duties all yield at least 25% less revenue per person in both Wales and Northern Ireland than in the UK as a whole.

Wales also brings in significantly less VAT revenue per person than the UK average. But in Northern Ireland VAT revenues are only slightly lower than in the UK as a whole – because Northern Irish households (or non-household actors that cannot reclaim VAT on their purchases such as VAT-exempt traders and some public sector bodies) spend more of their income on goods and services subject to VAT. And Northern Ireland actually provides 18% (£76 per year) more revenue from fuel duties per person than UK as a whole and a remarkable 79% (£120 per year) more tobacco duty.

Scotland

North Sea oil and gas aside, tax revenue in Scotland (£7,100 per person in 2012–13) looks much more like that in the UK as a whole (£7,300). Scots do pay £290 per year less in income tax on average, partly because incomes in Scotland are more equally distributed, with fewer of the very high-income individuals who provide such a large share of income tax revenue in the UK as a whole. But Scots contribute slightly more in VAT and in alcohol and tobacco taxes.

Unlike for Wales and Northern Ireland, these patterns were largely known already, since the Scottish government already produces estimates of Scottish revenues (the latest being for 2011–12) in Government Expenditure and Revenue Scotland (GERS) . In most respects HMRC have used a similar methodology and produced similar estimates to those in GERS.

In three areas, however, HMRC attributes somewhat lower revenues to Scotland than GERS does: onshore corporation tax (15%, or £0.4 billion, lower), taxes on North Sea production (12%, or £1.3 billion, lower) and stamp duty on shares (40%, or £0.1 billion, lower).

Onshore corporation tax

UK corporation tax applies to profits created from economic activities located in the UK. Where firms operate in more than one part of the UK, it is difficult to know how much of their profits are attributable to activities in each location, and companies are not required to divide up their profits in this way.

Both GERS and HMRC approximate the division of onshore corporation tax revenue based on estimates of the location of profits. GERS uses a regional measure of profits contained in the ONS regional accounts that is predominantly based on the share of wages earned in Scotland. HMRC allocates individual companies’ profits to regions, largely based on the location of their employment, and aggregates this to get the share of profits in each location.

These different methods yield somewhat – albeit not radically – different estimates. Onshore corporation tax revenue in Scotland in 2011–12 is estimated to be £3.0bn (9.0% of UK total) in GERS and £2.5bn (7.7% of UK total) by HMRC. This £400m difference is equivalent to about 1% of all Scottish revenue.

Neither of these estimates is clearly superior to the other, and both may be some way off. Profits are not necessarily generated in proportion to the number of employees, or their wages. Some employees may be more instrumental in generating profits than others; and profits also arise from capital assets – both physical (such as buildings and equipment) and intangible (such as intellectual property and brand value) – the location and contribution of which may differ from the location and wages of employees. Calculating how much of a company’s profits are attributable to economic activity in different locations is conceptually and practically difficult and is the source of many problems in international corporate taxation.

North Sea oil and gas

How North Sea oil and gas revenues would be divided in the event of Scottish independence is uncertain. Both HMRC and GERS show two illustrative possibilities. One divides North Sea revenues according to Scotland’s share of the UK population. Unsurprisingly, on this basis GERS and HMRC both report that Scotland’s share of North Sea revenues in 2011–12 was 8.4%.

The other approach taken is to divide revenues on a geographical basis according to the location of individual oil and gas fields. On this basis GERS estimates Scotland’s share in 2011–12 at 94% (£10.6 billion), while HMRC’s estimate is 83% (£9.3 billion). This disparity is not because they divide fields between England and Scotland differently: both use a boundary that was established in the Scottish Adjacent Waters Boundaries Order 1999. Rather, it derives from differences in their models of how much taxable profit arises from different fields.

Stamp duty on shares

GERS allocates revenue from stamp duty on share transactions to Scotland based on the proportion of share owning UK adults that are resident in Scotland. That is a poor guide to what Scotland’s share of stamp duty revenue would be under independence. The number of people owning shares does not tell us the value of shares traded each year (the tax base). More fundamentally, the location of the shares’ owners is not the relevant consideration for stamp duty, which is paid on transactions of shares in UK registered companies.

HMRC's approach recognises this, allocating stamp duty revenue according to companies’ registered addresses (weighted by share turnover). HMRC’s lower allocation of stamp duty revenue to Scotland – 5.0% (£139 million) rather than the 8.3% (£231 million) recorded in GERS for 2011–12 – is therefore the better guide.

The new HMRC statistics are a welcome additional source of information. In some cases the estimates are only rough approximations to tax receipts in different locations, and further devolution or Scottish independence might change the location of revenues. However, these figures reveal some interesting differences across different parts of the UK.

This work has been funded by the Economic and Social Research Council through its ‘Future of Scotland’ programme.

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http://www.ifs.org.uk/publications/6881 Thu, 03 Oct 2013 00:00:00 +0000
<![CDATA[The new tax break for some married couples]]> Note: The fourth paragraph of this observation was revised on 1st October 2013 to correct errors in the estimates of the numbers of families eligible for this tax cut. These corrections are indicated in the text.

The Prime Minister David Cameron has announced how the Government proposes to recognise some marriages and civil partnerships in the income tax system. From April 2015 it plans to make up to £1,000 of the income tax personal allowance transferable between adults who are married or in a civil partnership, so long as the higher-income adult is a basic-rate taxpayer. We estimate that this would cost the exchequer around £700 million per year. The precise cost will depend on the rate of take-up, as people will presumably have to make an active claim to HMRC to benefit, and the extent to which individuals change their behaviour in order to qualify.

The proposal would work as follows. If an individual were not using all of their income tax personal allowance – because their income was less than the allowance, which is set to be £10,230 per year when the policy is introduced – then they would be able to transfer up to £1,000 of any unused allowance to their spouse. This transferred allowance would lower the spouse’s tax bill by up to £200 a year: the amount of basic rate (20%) income tax that would be paid on £1,000. However, the transferred allowance will not be available to higher rate or additional rate taxpayers – those with taxable incomes exceeding £42,285 in 2015–16.

As the maximum gain is less than £4 per couple per week, effects on incomes and incentives (which we set out below) would be small. The social message sent by the tax break looks more significant than its financial consequences for families, as the Prime Minister has stated himself. But as a structural change to the tax system it may ultimately turn out to be more important. First, it would re-introduce an incentive to marry in the income tax system, just when Married Couples’ Allowance - now available only where one spouse was born before 6 April 1935 - had been almost entirely phased out. The benefits system affects many people’s financial incentives to cohabit (either married or unmarried) rather than live apart, mostly in the form of implicit ‘couple penalties’ (IFS researchers have quantified these here). But only the inheritance and capital gains tax systems currently affect financial incentives to marry, albeit providing big incentives to do so for the relatively wealthy. Second, the transferral of allowances between spouses would re-introduce an element of joint income taxation. This is inescapable if the aim is to assess people based on family characteristics (in this case, to target single-income families) as our benefits system already does, rather than based only on individual characteristics. There is a much wider, principled debate behind all this about the role of joint versus individual assessment.

Who would gain and who would not?

The families that would qualify for the tax break are couples in marriages or civil partnerships where one individual is a basic rate taxpayer and the other does not pay any income tax - that is, 3.4 3.9 million of the 12.4 million (28% 31%) couples in a marriage or civil partnership. This includes 1.2 1.4 million of the 7.8 million families with children. 2.3 2.7 million of the 3.4 3.9 million eligible families have someone in work. The rest are mostly married pensioners. The eligible families tend to be around the middle or lower-middle of the income distribution: most are in the third to sixth income decile groups. As neither two-taxpayer couples nor higher-rate taxpayers would benefit, the cash would go to families with somewhat less high incomes, on average, than under a straightforward increase in the personal allowance that cost the same amount.

Three sorts of couples in a marriage or civil partnership will not be eligible for the tax cut:

  • Couples whose members both have incomes above the personal allowance.
  • Couples containing a higher-rate (40%) or additional-rate (45%) income tax payer.
  • Couples whose members both have incomes below the personal allowance: they would pay no income tax in the absence of the policy, so cannot benefit from any income tax cut.

Clearly then, the policy is not a general recognition of marriage in the income tax system. It is also worth noting the likelihood that take-up will be less than 100% among those eligible, as an active claim to HMRC will presumably be required.

Work incentives

The policy would benefit one-earner married couples but not zero- or two-earner couples, so it would increase the financial incentive to be a one-earner married couple. In particular, it would strengthen the incentive for married couples to have someone in paid work (provided that they would be a basic-rate income taxpayer), since they would pay less tax on their earnings. But married couples containing a basic-rate taxpayer would face a weaker incentive to have the second person in work (assuming that their potential earnings would take them above the personal allowance), because this would result in a reduced allowance for their working partner.

Since the transferred personal allowance would not be available to higher rate taxpayers, workers benefiting from a transferred allowance would have a weaker incentive to increase their taxable income above £42,285 (or a stronger incentive to make more pension contributions or charitable donations, which can be deductible from taxable income, to remain in the basic rate band). Indeed some could be worse off after a pay rise, or better off after a pay cut, because the transferred allowance will be withdrawn in ‘cliff-edge’ fashion – that is, withdrawn in its entirety once income rises above a threshold rather than tapered away gradually over a range of income. Income tax liability would jump by £200 per year when taxable income crossed £42,285, and hence post-tax income would be higher if taxable income were just below this threshold than if it were just above it.

One striking feature of the policy is that it complicates the income tax system. A transferable personal allowance for married couples capped at £1,000 and then withdrawn using a cliff-edge at the higher-rate threshold is not the simplest to understand. It is three years since another cliff-edge at the higher rate threshold was announced at the 2010 Conservative Party conference as a way of effectively means-testing Child Benefit, only to be removed and replaced with a less egregious taper at Budget 2012. The amounts involved here are less than in that case, which perhaps explains the willingness to cliff-edge again rather than implement a taper. Nevertheless, it is difficult to escape the conclusion that an income tax system which makes some people worse off after a pay rise has something wrong with it. Simpler ways to provide more support to working low- and middle- income married couples would include a higher work allowance for married couples in Universal Credit (with, if the government wished, a further restriction to one-earner couples).

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http://www.ifs.org.uk/publications/6869 Mon, 30 Sep 2013 00:00:00 +0000
<![CDATA[When should summer born children start school?]]> Research from the IFS and others consistently finds that, on average, pupils born later in the academic year perform significantly worse in school than those born at the start of the academic year. As well as achieving lower test scores and assessments from teachers, on average, children’s confidence in their academic ability is also affected. Many parents of summer born children are therefore concerned about how well their child performs at school, and some have called for more flexibility in the timing of entry to primary school as an appropriate policy response. (Of course, such a policy may have other goals, aside from reducing differences in educational attainment, but it is this objective that has been cited in the latest debates.)

These concerns seem to have been heeded by the government: the childcare minister, Elizabeth Truss, has recently expressed concern that local authorities are not doing enough to offer parents flexibility over when children can start school, and guidance issued by the Department for Education in July highlights that there is no statutory barrier against delayed entry (where a child starts school a year later with a lower age group, becoming the oldest in the class), as well as the more common deferred entry (where children start school later but join the year group that is correct for their age) .

It is, of course, understandable that parents are concerned about the welfare of their own children. But the government has wider objectives; they must think about how the education system affects all pupils, as well as particular subgroups, and here the decision is not always so clear cut.

We know that, on average, deferred entry is not in the interests of summer-born children. IFS research has compared the performance of children who start school across areas of England which operate different admissions systems. We find that deferred entry to school does not close the gap in educational attainment between those born at the start and end of the academic year. In fact, on average, those born later in the year benefit slightly from starting school at the beginning of the academic year with their older peers, rather than joining them up to a year later. This is because the benefit of additional time in school more than outweighs the disadvantage of starting school slightly younger.

Assessing the impact of delayed entry to school is less straightforward, as this practice is not commonly observed in England. It is possible that it would benefit some of those who become one of the oldest in their class, rather than one of the youngest. This flexibility may have adverse consequences for other children, however: those that do not delay entry will become the youngest in the class and may have peers that are over a year older. This increase in the age-range of pupils may make teaching harder, and may simply shift the problem of lower attainment and self-belief to other children. Moreover, there are still differences in attainment between children born at the start and end of the year in countries in which it is common for children to delay or defer entry to school, and some that follow such policies (e.g. Scotland) are actually thinking about reducing or removing these flexibilities.

More importantly, IFS research has concluded that it is the age at which a child sits a test, rather than the age at which they start school, that is the main determinant of differences in attainment between those born at the start and end of the academic year. This suggests that a policy of providing age-adjusted test scores, so that a child receives feedback about their attainment relative to others their age, rather than others in their class, would help address the educational inequalities we observe. Children’s self-belief may also improve with timely and regular feedback of this kind, although some differences, such as the higher proportion of summer-born pupils identified as having special educational needs, may require additional policy responses. Moreover, unlike other policies designed to reduce these attainment gaps, providing age adjusted test scores benefits all children, as everyone is given appropriate feedback; older children that should receive more support will be identified, and younger children that are doing well for their age will be reassured.

It is important to note that IFS research cannot be used to conclude whether increasing the statutory school starting age from 5 to 6 or 7 (as suggested by a group of educationalists today) would be beneficial for children or help address the inequality between those born at the start or end of the academic year: a policy of this kind has not been trialled in England. Our research suggests, however, that within the confines of the current system, allowing deferred or delayed entry to school is highly unlikely to eliminate the disadvantages faced by summer-born children – as we find that it is age at test, rather than age of starting school, that matters most – and indeed may be detrimental to the school experiences of others.

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http://www.ifs.org.uk/publications/6856 Thu, 12 Sep 2013 00:00:00 +0000
<![CDATA[Further falls in income across the distribution in 2011–12]]> The Department for Work and Pensions (DWP) has published its annual statistics on the distribution of income in the UK. The latest data cover years up to and including 2011–12. IFS researchers published a detailed report, funded by the Joseph Rowntree Foundation (JRF), on what these data tell us about living standards, poverty and inequality in the UK. In this observation, we briefly highlight some of the key findings from DWP’s report.

Average incomes

Average incomes fell for the second successive year in 2011–12. Official statistics recorded a reduction of 3% at the median (middle) and 2% at the mean, after accounting for inflation (measuring incomes before deducting housing costs, BHC). This comes on top of large falls in 2010–11, leaving median and mean income 6% and 7% below their 2009–10 peaks respectively.

These large post-recession falls in average incomes follow a period of slow growth that began in the early 2000s, far pre-dating the recession. The net result is that the official measure shows both mean and median income in 2011–12 no higher than in 2001–02, after adjusting for inflation.

However, it is important to bear in mind that these statistics make real-terms comparisons of incomes over time using an inflation measure based on the retail price index (RPI). The Office for National Statistics (ONS) now acknowledges that RPI inflation overstates the true rate of inflation facing households, and that this problem has got worse since 2010 (see here). The DWP has (sensibly) indicated that it is therefore reviewing the measure of inflation used in its income statistics. This is potentially important. If one were to adjust incomes using the new RPIJ index – which does not suffer from the same technical problems as the standard RPI – then recent trends in real incomes would still look bad, but slightly less so.

According to the RPIJ, real median income fell by 4% between 2009–10 and 2011–12 (compared with 6% according to the RPI) and real mean income by 6% (compared with 7% according to the RPI). On this basis, real median income in 2011–12 had fallen back to the level last seen in 2004–05 and real mean income to the level last seen in 2005–06 (rather than 2001–02 in both cases using the RPI).

Income inequality

The falls in incomes in 2011–12 were of similar (proportionate) magnitude across the income distribution. Income inequality was therefore essentially the same as in the previous year.

But inequality was substantially lower in 2011–12 than it was before the recession. Between 2007–08 and 2010–11, the incomes of lower-income households had held up better than the incomes of higher-income households. This is largely because, over that period, real earnings fell whereas benefit entitlements grew roughly in line with prices.

In work published recently, projections by IFS researchers suggested that the reduction in inequality between 2007–08 and 2011–12 will be temporary, and will have been almost unwound by 2015–16. This is because, if the Office for Budget Responsibility’s (OBR’s) forecasts are correct, most of the falls in real earnings had already occurred by 2011–12, whereas a number of cuts to the working-age welfare budget are being implemented over the current parliament.

Income poverty

In 2011–12, the numbers in absolute poverty (defined as having a household income below 60% of the 2010–11 median, with incomes measured BHC) rose from 9.8 million to 10.8 million – its highest level since 2002–03 – but relative poverty (defined as having a household income below 60% of the contemporary median, with incomes measured BHC) was broadly flat. This is because incomes fell by similar proportionate amounts for all income groups in 2011–12, so low-income households became worse off in absolute terms, but maintained roughly the same position relative to middle-income households.

However, relative poverty was substantially lower in 2011–12 than it was before the recession in 2007–08, having fallen from 11.0 million to 9.8 million to reach its lowest rate (16%) since 1986 (again measured BHC). This reflects the more general reduction in income inequality between 2007–08 and 2010–11 highlighted above. The reductions in relative poverty have been particularly large among pensioners and children. Relative child poverty in 2011–12 is at its lowest level since the mid-1980s, having fallen by about one-quarter since 2007–08; the rate of relative pensioner poverty has fallen by more than one-quarter over the same period, from 23% to 16%.

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http://www.ifs.org.uk/publications/6758 Thu, 13 Jun 2013 00:00:00 +0000
<![CDATA[Labour's record on poverty and inequality]]> Today, the Oxford Review of Economic Policy publishes a special issue on Labour's economic record when in government between 1997 and 2010. As part of this, IFS researchers assess Labour’s record on income inequality and poverty. Here, we show how income inequality changed little but child and pensioner poverty fell significantly. We suggest, though, that these falls in poverty might prove fragile given that they were mostly based on very large increases in spending on benefits and tax credits. We also reflect on the main lessons for today’s policymakers. One such lesson is that how you spend money is more important than how much you spend. Governments need effective means to establish what works and what doesn't, and patience to see whether policies bear fruit in the long-run.

Labour had very clear objectives to reduce poverty amongst families with children and pensioners, and accorded these objectives high priority. Tony Blair made a famous commitment to end child poverty within a generation, and Gordon Brown promised to ‘to end pensioner poverty in our country”. However, it is much less clear that Labour took a strong view on the appropriate level of inequality within the top half of the income distribution, as indicated for example by Peter Mandelson’s famous statement that he was “intensely relaxed about people getting filthy rich as long as they pay their taxes.'

What happened to poverty and inequality under Labour?

If our summary of Labour's distributional objectives is accurate, then outcomes reflected those objectives quite closely. Turning first to poverty, both absolute and relative measures of income poverty fell markedly among children and pensioners - although the scale of the changes did not always match the considerable ambition, as set out explicitly in the case of the government’s child poverty targets.

By contrast, the incomes of poorer working-age adults without dependent children - the major demographic group not emphasised by Labour as a priority - changed very little over the period. As a result they fell behind the rest of the population and relative poverty levels rose. Since childless working-age people started the period with low levels of poverty compared with other demographic groups, one consequence of these trends was that the risks of poverty across the major demographic groups converged under Labour. This is illustrated in the Figure below.

Figure: Relative poverty rates since 1996-97

Figure: Relative poverty rates since 1996-97

Notes: Years refer to financial years. Poverty line is 60% of median income. Incomes measured before deducting housing costs.
Source: Family Resources Survey.

With falls in income poverty, one might expect to have seen a fall in income inequality. Indeed inequality did fall across much of the distribution. Those on relatively low incomes did a little better than those with incomes just above the average. However, those right at the top saw their incomes increase very substantially with the result that, on most measures, overall inequality nudged up slightly.

What drove these changes?

The substantial falls in pensioner and child poverty were largely driven by very significant additional spending on benefits and tax credits. Reforms since 1997-98 resulted in an £18 billion annual increase in spending on benefits for families with children and an £11 billion annual increase on benefits for pensioners by 2010-11 (see here). Our modelling suggests that child and pensioner poverty would either have stayed the same or risen, rather than fall substantially, had there not been these big spending increases. Meanwhile, Labour’s tax and benefit changes had relatively little net impact on the top half of the income distribution, or on low-income adults without dependent children – the group whose poverty rate did not fall. However, there is evidence to suggest that these reforms prevented a larger rise in inequality than actually occurred under Labour.

There were also increases in employment which had a small but detectable effect on income poverty. For example, reductions in the proportion of children living in workless families acted to reduce relative child poverty by about 2 percentage points.

There were many other Labour initiatives that could be considered anti-poverty policies. These include the introduction of the National Minimum Wage, Sure Start, increased financial support for childcare, significant increases in education spending and an expansion of the number of young people going on to higher education. Any payoffs from most of these measures will be long run, rather than immediate. It is of course very difficult to predict precisely what effects they will ultimately have on overall levels of poverty and inequality - and we will never know for sure, as their effects will inevitably happen alongside many other factors which continue to affect the income distribution. The verdict on the effects of Labour’s period in power on poverty and inequality is necessarily incomplete.

Reflections for the future

The fiscal climate is now very different and welfare spending can be cut back just as quickly as it is increased. As most of the currently detectable effects of Labour policy on poverty rates came through benefit increases, Labour’s legacy may prove fragile. Its durability will thus depend crucially on whether wider policies on things like education and childcare do have long-run impacts.

We would draw a few key lessons.

First, a sensible strategy for achieving distributional objectives will probably involve a lot of patience. Tax and benefit policy has quick impacts, but most other plausible policy levers do not. Many policies that might achieve sustainable impacts are likely to bear fruit only over the medium to long term, and certainly beyond the timeframe of a normal electoral cycle.

Second, the uncertainty about the long run effects of Labour’s policies on the income distribution highlights a wider point, which governments of all complexions should take seriously: major changes to things like childcare and education policy should, wherever possible, be implemented in ways which allow their effects to be robustly evaluated. We know much less than we should about policy effectiveness because so much major policy is implemented without proper evaluation (see here).

Finally, there are large gains to be had from designing the tax and benefit system skilfully: a government’s chosen level of redistribution can be achieved in more and less efficient ways. Stronger work incentives should be focused on those who are more responsive to such incentives (such as lone parents and parents of school-age children, as argued in the IFS’ Mirrlees Review). Labour’s reforms made some moves in this direction (see here). Another important goal should be simplicity and transparency. The current government’s Universal Credit offers a major opportunity to further this goal by replacing a jumble of overlapping means tests with a single integrated one, although reforms such as that to Council Tax Benefit risk undermining some of its potential advantages.

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http://www.ifs.org.uk/publications/6738 Thu, 06 Jun 2013 00:00:00 +0000
<![CDATA[Cutting the deficit: three years down, five to go?]]> Following the financial crisis in 2008, the UK – like many other advanced economies around the world – has been undertaking a significant fiscal consolidation. The current government plan is for eight successive years of tax increases and spending cuts intended to offset the permanent rise in public borrowing that became apparent after 2008. The UK’s fiscal consolidation started at the beginning of this parliament (in 2010–11) and is expected to continue until 2017–18, which will be well into the next parliament.

According to recent analysis from the International Monetary Fund (IMF), in 2010, the UK is estimated to have had the fourth highest level of structural government borrowing among the 29 advanced economies for which comparable data are available. However, at least according to plans published so far, the UK is intending the fourth largest fiscal consolidation among this same group of countries and so by 2017 the IMF forecasts that the UK will have a lower level of structural borrowing than many other advanced economies – being below the average in the Euro area and below the average among the G7 and G20 countries.

The UK’s fiscal consolidation began in 2010–11, when the Labour government’s fiscal stimulus package was withdrawn and the incoming coalition government implemented some immediate spending cuts and some in-year increases in indirect taxes (including increasing the main rate of VAT from 17.5% to 20% from January 2011). Additional austerity measures are due to be implemented each year through to 2017–18. Taken together, the measures announced since the March 2008 Budget are expected to reduce public borrowing by 9.1% of national income (or £143 billion in today’s terms) by 2017–18, as shown in the Figure. This is larger than the 6.5% of national income (£101 billion) fiscal tightening originally planned by the coalition government in 2010. Since then permanent downgrades to the outlook for the UK economy and public finances have led the government to pencil in further austerity measures, but these are not scheduled to be implemented until after the next general election. (Box 5.1 in the 2013 IFS Green Budget provides more detail on how these figures are calculated.)

The current financial year is forecast to see a somewhat smaller fiscal tightening from discretionary policy changes (1.2% of national income) than seen in recent years (1.5% in 2012–13 and 1.8% in 2011–12). While discretionary spending cuts and tax increases were implemented in 2012–13, the level of cash borrowing last year was almost exactly the same as in the previous year. This is due to underlying upward pressure on the cash level of public spending, and weak economic performance leading to tax revenues growing only marginally; thus cash borrowing fell very little between 2011–12 and 2012–13. A similar story is forecast for this year: a combination of a weak outlook for economic performance, underlying upwards pressures on spending and further austerity measures being implemented means that cash borrowing is forecast to be largely unchanged once again.

By the end of this year, the government plans to have implemented just over half (52%) of the total planned consolidation. However, within this, the tax rises and investment spending cuts have been relatively front-loaded, while the benefit cuts and the cuts to day-to-day spending on public services have been relatively back-loaded. By the end of this financial year, virtually all of the planned tax increases (95%) and cuts to investment spending (90%) are planned to have been implemented, while only 58% of the total cuts to benefit spending and under one-third (31%) of the overall cuts to other current (i.e. non-investment) spending will have been achieved. The allocation of some of the remaining cuts to non-investment spending will be announced in the Spending Round on 26 June, which will allocate departmental budgets for the 2015–16 financial year.

It is worth noting, however, that the composition of the additional austerity measures planned for 2015–16 and beyond could change. First, it is possible that the Spending Round this summer could announce further cuts to, for example, spending on benefits or tax credits from 2015–16, which would ease the required squeeze on other current spending: for example, if the government wanted to continue cutting departmental spending in 2015–16 at only the same rate as is now planned on average over the four years from 2011–12 to 2014–15, they would need to announce a further £1 billion of cuts to other areas of non-investment spending. Second, history suggests that net tax rises are often announced in the 12 months following a general election (see Figure 5.13 of the 2013 IFS Green Budget); any new tax increases could be used to reduce the spending cuts required after 2015, something which the Budget document (paragraph 1.59) makes clear is a possibility

Figure: Timing and composition of the fiscal consolidation

Timing and composition of the fiscal consolidation

Note: This figure updates the numbers presented in Figure 5.8 of the 2013 Green Budget to include the policy announcements made in Budget 2013 and some minor changes to our methodology. The Green Budget contains details of the methodology and sources used to construct this figure.

The data underlying this figure can be found here

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http://www.ifs.org.uk/publications/6683 Wed, 08 May 2013 00:00:00 +0000
<![CDATA[Deficit unchanged]]> The March Budget forecast by the Office for Budget Responsibility (OBR) was for the headline deficit, excluding the impact of transfers related to the Royal Mail Pension Scheme and the Asset Purchase Facility, to be £120.9 billion in 2012–13, compared to £121.0 billion in 2011–12. This £0.1 billion projected fall in the deficit meant that the Chancellor’s Autumn Statement assertion that “[the deficit] is falling and it will continue to fall each and every year” remained on course to be met. This was achieved by Government departments’ pledging to underspend their budgets by a greater degree than normal, with some payments deliberately pushed from 2012–13 into 2013–14.

The evolution of borrowing through the last four financial years is shown in the Figure below. Between its peak in 2009–10 and 2011–12 overall borrowing is estimated to have fallen by almost a quarter in cash terms (from £158.9 billion to £120.9 billion). By contrast, for most of 2012–13 borrowing is estimated to have been running above the level seen last year. It was not until the first estimate of borrowing in February 2013 was released – the day after the Budget – that cumulative borrowing over the year to date was estimated to be lower than over the same period in 2011–12. Borrowing over the first eleven months of 2012–13 is currently estimated to have been 3% below the amount borrowed over the first eleven months of 2011–12.

Figure: Reducing the deficit?

Public sector net borrowing

Note: Public sector net borrowing excluding the transfer of assets of the Royal Mail Pension Scheme (£28 billion in April 2012) and the transfer of Asset Purchase Facility assets from the Bank of England to HM Treasury (£3.8 billion in January 2013 and £2.7 billion in February 2013).

On Tuesday, the Office for National Statistics is due to release its first estimate of public sector net borrowing in March 2013 and, therefore, for the whole of 2012–13. Whatever these data indicate – whether they suggest borrowing was slightly higher or slightly lower in 2012–13 than in the previous year – will not be the last word on the matter as revisions to past data are inevitable. We will not know for some time whether the deficit in 2012–13 was actually higher or lower than the deficit in 2011–12.

Whatever Tuesday’s figures suggest, it is important to bear in mind that there are no direct economic consequences either way. In economic terms it is irrelevant whether the deficit is slightly higher or slightly lower in 2012–13 than in 2011–12. Either way the bigger picture is the same: the Government has implemented a combination of tax rises, welfare spending cuts and cuts to spending on public services and brought about a reduction in the deficit between 2009–10 and 2011–12. However, while 2012–13 also saw further austerity measures being implemented, weak economic performance has meant that the deficit was largely unchanged from its 2011–12 level. The same is forecast to be true in the current financial year: the OBR's forecast is that borrowing will fall by just £0.9 billion to £120 billion in 2013–14. This would leave the deficit largely unchanged for three years.

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http://www.ifs.org.uk/publications/6663 Fri, 19 Apr 2013 00:00:00 +0000
<![CDATA[Women working in their sixties: why have employment rates been rising?]]> Today the Office for National Statistics released its monthly report on employment in the UK. Employment was essentially unchanged at 29.7 million in January 2013, higher than the pre-recession peak of 29.6 million in April 2008. Previous IFS research has attributed this strong employment performance in part to increased labour supply as a response to wealth losses during the financial crisis and changes to pensions and benefits implemented since the last recession, which encourage individuals to be in work.

The remarkably rosy picture for total employment belies contrasting trends between different groups. The employment rate amongst 25–29 year olds was 77.5% in the last quarter of 2012, the most recent period for which data on employment rates disaggregated by age are available. This is well below the peak of 80.4% seen in 2008. On the other hand, employment rates for older people have continued to increase over this same period. Indeed, the employment rate of 60–64 year old women has grown at the same rate since early 2010 as it did during the decade up to 2010. The proportion of 60–64 year old women in work rose from 25.6% in 2000 to 34.1% in 2010 while from 2010 to late 2012 it rose by a further 2.2 percentage points (to 36.3%) in just under three years.

What explains such contrasting experience between the young and the old? There are long term trends which have seen employment rates for older women rising for many years. But since 2010 increases in the state pension age for women have played a central role. Our estimates suggest that this has been responsible for the greater part of increased employment among 60–64 year old women since 2010.

Since April 2010, the state pension age for women has increased from 60 to 61½, and it is legislated to reach parity with that for men (at age 65) in 2018. In recently published IFS research we estimate that the increase in the state pension age for women from 60 to 61 that occurred between April 2010 and April 2012 increased employment of 60 year old women by 7.3 percentage points.

Using this estimate, we can calculate how employment rates would have evolved if the female state pension age were still 60. These new results, presented in the Figure below, show that – in the absence of the increase in the state pension age – employment rates of women aged 60 to 64 would have risen by only an estimated 0.3 percentage points between 2010 and 2012 (to 34.4%), instead of the large growth to 36.3% that was actually seen. In other words, the increase in the female state pension age explains an estimated 85% of the growth in the employment rate of this group that has occurred since early 2010.

Figure: Employment rates for 60–64 year old women since the crisis began with and without state pension age increase

 Employment rates for 60–64 year old women since the crisis began with and without state pension age increase

Source: Authors’ calculations using Labour Force Survey.

Our research also finds that the increase in the female state pension age has increased employment rates of affected women’s husbands – albeit to a lesser extent than the women’s own employment rates – explaining some of the resilience in employment rates of older men that has also been observed since 2010.

Is it possible that the increase in employment rates for older workers is a cause of the lower employment rates for younger people? In the short term, especially if demand for workers is weak, it is possible that firms might substitute towards keeping on older workers rather than hiring younger workers. However, having more older individuals in work will also boost overall demand in the UK economy and therefore increase demand for workers of all types. Previous IFS research finds no evidence that encouraging early retirement for older workers led to an increase in the employment rates of younger people. In the longer run, therefore, it seems particularly unlikely that higher rates of employment for older people would lead to lower employment rates of younger people.

In summary the vast majority of the increases in employment rates among older women seen since 2010 can be explained by the increase in the state pension age for women, which began to rise from 60 in April 2010. This has already led to the majority of 60 year old women being in paid work for the first time ever. As the state pension rises further throughout this decade, this trend of increasingly long working lives for women is likely to continue.

This observation is part of a project funded by the Nuffield Foundation.

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http://www.ifs.org.uk/publications/6662 Wed, 17 Apr 2013 00:00:00 +0000
<![CDATA[Reforms to alcohol taxes would be more effective than minimum unit pricing]]> Last week the Prime Minister David Cameron told MPs that he was determined to “deal with” the “problem of deeply discounted alcohol in supermarkets and other stores” and said that the Government was considering the results of a consultation into a proposed minimum unit price for alcohol.

New analysis by IFS researchers, published as an IFS Briefing Note today, argues that a reformed system of alcohol excise taxes focused on strong drinks would be more effective at targeting those drinking above recommended levels than would a minimum unit price for alcohol.

A tax-based reform would also raise additional tax revenues for the government. In contrast, minimum pricing would generate significant windfall revenues for alcohol retailers and manufacturers and reduce revenue from alcohol taxes.

Together, these findings point to a tax-based approach as preferable to minimum unit pricing in dealing with problem drinking. Since tax reform would require EU-wide agreement, we argue that the government should work now to win the necessary support to enable such reforms to be implemented, even as the debate about the compatibility of minimum unit pricing with EU legislation continues to rage.

The research draws on data recording the off-trade alcohol (purchased in supermarkets and off-licences) bought by more than 21,000 British households during 2010. Two main policy reforms are compared:

1. A minimum price for alcohol of a 45p per unit;
2. A reform of alcohol excise taxes so that the tax rate depends explicitly on alcohol content. Rates vary across alcohol types and increase directly in line with alcohol strength.

The total amount of off-trade alcohol purchased following each reform falls by the same amount: around 2.4 billion units (where a ‘unit’ is 10ml of pure alcohol) from an initial level of 37 billion. However the effects of the policies differ in important ways. The research compares how these policies impact on households according to the average amount of alcohol they buy. This gives an important measure of whether or not they are well-targeted on heavy drinkers. The impact on government tax revenue and industry revenues is also assessed.

Figure 1 shows the average percentage change in alcohol units purchased across households grouped by initial purchase levels. For heavy drinkers (those purchasing more than 35 units per adult per week on average), a 45p per unit minimum price reduces alcohol purchases by around 8%. For moderate drinkers (fewer than 7 units), the fall is 4%. Reform to the system of excise taxes would reduce purchases by heavy drinkers by 9.5%. Moderate drinkers would see a fall of just 2.6%. This tax reform is better targeted on heavy drinkers than the minimum price.

Figure 1. Average change in units of alcohol purchased, by policy and purchase group

Average change in units of alcohol purchased, by policy and purchase group

Sources: Calculated from Kantar Worldpanel 2010 data.

Both policies raise total consumer spending on off-trade alcohol by a similar amount, around £550 million for the minimum price, and £640 million for the tax reform. The policies differ enormously in how that extra spending is distributed between government tax revenue and industry revenue. The minimum unit price reduces tax revenue by £290 million (drinkers reduce their purchases without any compensating increase in tax rates), but increases industry revenue by £840 million. In contrast, tax reform would increase tax revenues by £980 million.

Both reforms would probably be slightly regressive. Low-income drinkers tend to buy cheaper and stronger alcohol than high-income drinkers purchasing similar amounts of alcohol units. The government should be more concerned with the distributional effects of policy as a whole. Nonetheless, if policy makers were concerned about the distributional consequences of alcohol pricing policies in particular then some of the revenue raised through tax reform could be used to help ameliorate this concern. This is an option not available for minimum pricing.

The analysis looks only at off-trade alcohol which accounts for about three in every four alcohol units purchased. Minimum unit pricing and tax reform are likely to have different implications for the on-trade (alcohol in pubs and restaurants). On-trade prices are much higher, so a minimum unit price would have little direct impact there. Tax reforms would affect on-trade alcohol as well. To the extent that problem drinking takes place in the on-trade it is not clear that we would only want price reforms to affect off-trade consumption. If those who drink to excess on-trade purchase stronger products, then an excise tax reform would still look well-targeted. Furthermore, a tax reform targeted on alcohol strength may well still raise off-trade prices relative to on-trade since, on average, alcohol purchased off-trade is stronger than alcohol purchased on-trade.

It is somewhat curious that the recent debate around alcohol pricing has focused so much on a minimum unit price. Much less has been made of the fact that the current, complex set of alcohol taxes does a poor job of targeting harmful drinking. Reforming the way in which we tax alcohol could provide a better route to reducing harmful drinking than the introduction of a minimum price. It would reduce alcohol purchases among heavy drinkers, have less impact on moderate drinkers, and raise additional useful revenue for the government. Heavy drinkers also buy cheap alcohol, but a minimum price would be less well targeted than the tax reform, reduce tax revenues and increase the revenues of alcohol retailers and manufacturers.

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http://www.ifs.org.uk/publications/6645 Mon, 18 Mar 2013 00:00:00 +0000
<![CDATA[The rapidly changing state]]> On Wednesday the government announced that the 2013 Spending Review will be published on 26 June. The Review is expected to cover spending decisions for 2015–16, though in the Autumn Statement the Chancellor pencilled in cuts stretching through to 2017–18. By that time, departmental spending will have been cut by nearly 19% in real terms since 2010–11, if current plans are followed. This is an unprecedented period both in terms of the scale of the consolidation and in terms of the extended period of year-on-year spending cuts. In this Observation, we look at a different aspect – what is happening to the composition of public spending. On current forecasts, public spending will take the same proportion of national income in 2017–18 as it did in 2003–04. But it will be being spent on quite different things.

Given forecasts from the Office for Budget Responsibility (OBR) for the size of the economy, total public spending is planned to fall from its peak of 47.4% of national income in 2009–10 to 39.5% by 2017–18. This is a dramatic fall, but historically it is the figure for 2009–10 which is unusual. Spending as a share of national income increased by 6.7 percentage points in just two years between 2007–08 and 2009–10, largely as a result of the loss to national income associated with the financial crisis and recession.

In fact, after eight years of austerity, spending as a share of national income is forecast to be back close to its long-run average, and at almost exactly the same level it was in 2003–04, about halfway through the last government’s period in office. However, while spending as a proportion of national income is forecast to be essentially the same in 2017–18 as it was in 2003–04, the composition of that spending will be very different. This is illustrated in Figure 1, which shows the proportion of total public spending accounted for by a number of large components of spending. Figure 1 also shows the level of spending in real terms. It is important to note that while spending as a share of national income is the same in these years, since the economy is forecast to be larger in 2017–18 than it was in 2003–04, real spending (in 2012–13 prices) in 2017–18 is planned to be £125 billion more than in 2003–04 – an increase of 22%.

The biggest difference between the two years is in spending on debt interest payments, which is forecast by the OBR to increase from £28.4 billion in 2003–04 to £62.0 billion in 2017–18. This is an increase in real spending of 118%, and would leave debt interest payments accounting for 4% more of total spending in 2017–18 than they did in 2003–04.

In addition, expenditures on health and on pensioner benefits are forecast to account for greater proportions of total spending in 2017–18 than they did in 2003–04, with real growth in spending of 36% and 37% respectively. These trends are driven by the policies of both the last government and the current one, which are in fact remarkably similar in many respects in terms of the relative priority given to different areas of spending. Whilst the last government increased spending across the board, it raised spending on health faster than spending on other public services. Whilst this government is responding to the very big deficit it inherited by cutting public service spending rather dramatically, it is protecting health spending. In both periods, health spending continued to rise as a proportion of the total. Both governments have also been relatively generous to pensioners. The last government raised means-tested benefits for pensioners rather rapidly. This one has largely protected pensioner benefits from the cuts inflicted on the rest of the social security budget.

Spending on non-pensioner benefits is also forecast to increase in real terms, by 14% from £79.4 billion to £90.5 billion, but to account for a slightly smaller proportion of total spending in 2017–18 than in 2003–04. This is actually one area where the spending priorities of the current government appear to differ from those of the previous government: spending on working-age benefits rose rapidly under the last government as a result of discretionary policy choices, whilst this government is making relatively large real cuts.

Spending on debt interest, social security benefits and health accounted for just over half of total public spending in 2003–04, but all bar £14 billion of the £125 billion increase in public spending is forecast to be accounted for by these components. Real spending on all other areas, including education, defence, public order and safety, and all other non-health public services, is forecast to increase on average by a fairly meagre 5% between 2003–04 and 2017–18, and to take up an ever smaller proportion of total public spending.

The government is currently making big choices about the shape of the state as well as about its size. On current plans, we are moving ever more rapidly towards a state focused on welfare and particularly on health and on pensions. As the population ages, this focus on health and pensions will become still more evident. However, whether spending a diminishing fraction of national income on other public services is a sustainable choice is an open question.

Figure 1: Proportion of total public spending accounted for by various components

Proportion of total public spending accounted for by various components

Note: Total public spending and debt interest spending in 2017–18 are forecasts from the OBR. Pensioner benefits forecast is the Department for Work and Pensions (DWP) forecast of DWP benefit expenditure directed at pensioners. Other social security forecast is the OBR forecast for total social security and tax credits less DWP benefit expenditure directed at pensioners. Health spending forecast assumes that real health spending in 2017–18 is equal to the 2010–11 level.

IFS public finance observations are generously supported by the Economic and Social Research Council (ESRC).

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http://www.ifs.org.uk/publications/6642 Mon, 18 Mar 2013 00:00:00 +0000
<![CDATA[Making tax policy]]> Taxes, like death, are unavoidable. But we can design our taxes. We are not bound to have a tax system as inefficient, complex, and unfair as our current one. To improve things, we need to see the system as a whole, we need to design the system with a clear understanding of the population and economy on which it operates, and we need to apply economic insights and evidence to the design. We also need a much more informed public debate and a much better set of political processes than the ones we currently have.’

So my co-authors and I said in the introduction to the Mirrlees Review published in 2011. The question is: what is it that prevents better decision-making and the creation of a better system? That is an issue discussed in an IFS Briefing Note published today.

It’s not the lack of importance. Four pounds in every ten generated in the economy is collected in tax. The way the tax system is designed inevitably has a huge effect on the operation of the economy. That is inescapable. By designing the system better, there are really substantial economic benefits to be reaped. As we showed in the Mirrlees Review, the costs of a poorly designed tax system run into many billions of pounds in reduced output and welfare. In that review, we also set out one possible strategy for unlocking some of these benefits, a strategy based on treating the tax system as just that, a system, and recognising that there are often substantial costs associated with treating similar activities differently.

And it’s not that there haven’t been some attempts to improve the process of tax policymaking. The current government has attempted to produce a more coherent structure for developing tax proposals, from policy formulation through to legislation and implementation. This new approach to tax policymaking is backed up by the Tax Professionals Forum. There is also the innovation of the Office of Tax Simplification.

Nor is it a want of consultation. The amount of consultation in the current policymaking process is almost overwhelming.

But there do seem to be three very substantial barriers to better policy.

First, tax policy is made annually (or increasingly biannually) in Budgets (and Autumn Statements). No government or opposition lays down a strategy for the tax system as a whole. There is every indication that policies are made in isolation, and with little sense of how they fit together over the long run. While there is much consultation, most of the effort is put into tinkering with the existing system to try to make the bits that don’t work well work a bit better without necessarily thinking more fundamentally about why the bits in question are not working well, or continue to give rise to ‘avoidance’ issues. There is little attention paid to any form of long-term strategic framework for the development of the tax system as a whole.

Second, there is a remarkable lack of challenge within the executive and effective scrutiny and challenge from the legislature. The Treasury challenges spending departments. Who is to challenge the Treasury when it makes tax policy? The enhanced role of HM Treasury, in the wake of the O’Donnell Review, may at times have limited the challenge that comes from HM Revenue and Customs. While the Treasury Select Committee and the Public Accounts Committee have increased their oversight of tax policy, they remain poorly resourced for focusing on such a large and complex issue.

Third, the general quality of political and public debate is limited, allowing poor policy to be passed off as good all too easily, resulting in an unhelpful focus on specific parts of the tax system, and often making change politically difficult. Very specific elements of the system – notably rates of income tax – achieve totemic significance far beyond their true importance, while changes to other parts of the system are often given wholly inadequate attention.

Tax policy is inevitably a difficult and highly political area. But there are things that can be done to improve the process for making policy.

There should be a tax strategy and objectives set out by each Chancellor against which policy proposals can be measured. This would increase transparency and accountability and, if followed, would also increase stability and certainty.

More challenge and scrutiny should be introduced into the policymaking process both within the executive and by the legislature. If necessary, parliament should be given greater resources, the House of Lords should play a greater role, and consideration should be given to creating a specific select committee devoted to tax policy.

We need an explicit process for reviewing the effectiveness of tax policy post implementation.

There is a case for at least a public review of the working of the relationship between HM Treasury and HMRC.

The Autumn Statement should be more explicitly focused on consultation on fiscal policy and the presentation of the latest economic and fiscal forecasts. It should not be an additional opportunity for Chancellors to pull rabbits from hats.

There is an urgent need for an improvement in the public debate about tax policy.

And of course we need politicians willing to be honest in their communication, open and long term in their thinking, analytical in their approach and courageous in their decisions. National welfare really is reduced by billions of pounds because we have a tax system that is not well designed. Finding ways to improve the policy development process should be a matter of priority for all political parties.

We need to see taxes as part of a system rather than individually, we need a strategy against which to judge proposals, and we need more transparency and more challenge and accountability in the tax policymaking process.

Note: Paul Johnson will be presenting this material at a joint IFS and Institute for Government event Better Budgets: Making Tax Policy Work on Wednesday 20 February 2013.

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http://www.ifs.org.uk/publications/6612 Wed, 20 Feb 2013 00:00:00 +0000
<![CDATA[Better options exist to help low earners than 10p tax rate]]> In a speech in Bedford today, the Leader of the Opposition, Ed Miliband, has proposed reintroducing a 10% income tax rate on a narrow band of income, to be paid for by a new ‘mansion tax’ on residential properties worth more than £2 million. This observation discusses the merits of both of these policies and suggests more economically sensible policies that would have broadly the same effects.

‘Mansion tax’

Mr Miliband did not give precise details of the design of his ‘mansion tax’ in his speech, but a similar proposal from the Liberal Democrats in their 2010 General Election Manifesto would have involved a tax based on 1% of a property’s value above £2 million. Thus, a property worth £3 million would face a charge of £10,000 a year. No firm costings are available for such a tax, but in 2010 the Liberal Democrats estimated that 70,000 properties would be affected and the total yield from this tax would be £1.7 billion a year, implying that the average charge would be over £24,000 per year. Of course, a higher or lower charge could raise more or less revenue.

The ‘mansion tax’ has a sensible logic underpinning it: if residential property is to be taxed, it makes sense to levy such a tax in proportion to property value and base it on current valuations. By contrast, Council Tax, the existing tax on residential property in England and Scotland, has neither of these features as it is based on 1991 property values and is set far from proportional to those values, with higher-value properties significantly under-taxed: for example, in a local authority setting the current English average band D rate, someone with a property at the midpoint of band D will pay 1.85% of its 1991 valuation in Council Tax whereas someone with a property at the midpoint of band G will pay 1.00% of its 1991 valuation. Therefore, rather than adding a mansion tax on top of an unreformed and deficient council tax, it would be better to reform council tax itself to make it proportional to current property values. As with the mansion tax, it would be the most valuable properties that saw the largest increases in tax liability from such a reform.

10p tax rate

A 10p tax rate previously existed between 1999 and 2007 before it was (in)famously abolished for non-savings income by Gordon Brown in his last Budget as Chancellor, and still exists for savings income that falls into the first £2,710 of taxable income. Reintroducing Labour’s 10p rate in full would reduce tax revenues by around £7 billion a year and benefit basic rate taxpayers by up to £271 a year, though given the numbers above, it is unlikely that anything close to this amount could be raised through a mansion tax alone. To introduce a £1,000 10p tax band, which would benefit all 23.5 million basic-rate taxpayers, one would need to raise £2 billion, or around £30,000 on average from each of the 70,000 owners of ‘mansions’. (Higher-rate taxpayers would not benefit from the Labour party’s proposals as they would reduce the point at which the higher 40p income tax rate starts to be applied. The proposal would therefore slightly increase the number of higher rate taxpayers, which is something the current Government has done to limit the gains to higher rate taxpayers from its increases in the income tax personal allowance.)

A 10p tax rate would reduce taxes for those on low incomes and strengthen their work incentives. A far simpler and more sensible way of achieving these aims would be to spend the same amount of money on increasing the personal allowance – a policy on which the current government has already spent £9 billion a year. This would have virtually the same impact on individuals’ tax payments (see figure below), be slightly more progressive, take some people out of income tax altogether and avoid the complexity involved in introducing a new income tax rate. An even better alternative, which would help those who already pay no income tax because their incomes are below the personal allowance but do pay employee National Insurance Contributions (from April, there will be 1 million such people earning between £7,748 and £9,440), would be to increase the point at which individuals start paying employee National Insurance Contributions. This would also bring the income tax and National Insurance systems more in line and would take some people out of direct tax altogether. And if one wanted to focus the gains from the policy on low-income working families rather than basic-rate taxpayers generally, increasing Working Tax Credits would be another sensible alternative to look at.

Figure: Effect of a £1 billion giveaway through either a 10p tax rate or an increase in the personal allowance on combined income tax and employee NICs schedule

 Effect of a £1 billion giveaway through either a 10p tax rate or an increase in the personal allowance on combined income tax and employee NICs schedule

Note: Reforms considered are £1,000 10p tax band and £500 increase in the personal allowance. In both cases, there is an offsetting reduction in the higher-rate threshold so that higher-rate taxpayers are unaffected.

Summary

Both the proposals made today by the Labour party will be familiar to tax policy watchers. One, the mansion tax, reflects a problem with the current tax system – council tax is regressive as high-value properties are under-taxed relative to low-value properties – but does not take the idea forward to its logical conclusion. The other, the proposal for a new 10p starting rate of income tax, has no plausible economic justification. It would complicate the income tax system and achieve nothing that could not be better achieved in other ways. It appears to repeat the same error perpetrated by Denis Healey in 1978 (undone by Geoffrey Howe in 1980), Norman Lamont in 1992 and Gordon Brown in 1999 (which he himself undid at considerable political cost in 2007). To have observed lower starting rates of tax being introduced and abolished by governments of both complexions over the last three decades and then to propose the same thing again suggests a remarkable failure to learn from history.

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http://www.ifs.org.uk/publications/6606 Thu, 14 Feb 2013 00:00:00 +0000
<![CDATA[Welcome simplification of state pensions but younger generations lose]]> The Government’s proposed new state pension system will involve everyone accruing the same level of state pension each year whilst working (so long as they earn above the lower earnings limit), or claiming benefits for being unemployed, looking after children aged 12 or under, or caring for sick or disabled adults. Anyone with 35 years of qualifying activity of this kind will receive a fixed pension of £144 a week.

A lot is being claimed for these reforms. The reforms have some desirable features but – as is often the case with pension reforms – the overall effects will be more complex. The gains from the proposed reforms are as follows:

  • The proposed system looks straightforward and – in terms of its clarity –appears to be a clear improvement on the complex miscellany of rules which govern the current system.
  • There will be some winners from the proposals. In particular, those who expect to have significant periods of self-employment are likely to gain. Currently they accrue rights to the basic state pension (BSP) but not S2P. Therefore, they would be likely to receive more state pension under the proposed system than they would get under the current rules. However, the case for the self-employed paying a lower rate of NI than employees would then be weakened, and the Government may decide to increase their NI contributions in return for this increase in benefits.
  • A second potential group of winners, at least in terms of state pension rights, is members of contracted out defined benefit (DB) occupational schemes. The proposed reforms would end contracting out and thus increase the state pension rights that this group will accrue. Whether or not they ultimately receive a higher pension overall will depend on whether the DB schemes in question make use of the ability that the Government plans to grant them to adjust the terms of the scheme accrual to deal with the extra costs imposed by ending contracting out. The government has said it does not intend to reduce accrual rates within public sector schemes – although any increase in pension rights for public sector workers will be at least partially offset by their higher employee National Insurance (NI) contributions.
  • There will also be a larger group of winners in the short-run – specifically, those who reach State Pension Age after 2017 and who have 30 years of BSP accrual but who have not yet earned a state pension, including S2P, of £144 a week. This group includes some low earners and some of those who spent time out of the labour market caring for children or disabled adults prior to 2002. However, this group will also be made up of those who have spent some significant period contracted out of the second tier state pension – that is, those who chose to give up their rights to additional state pension in return for either paying a lower rate of NI or receiving a refund of NI contributions which they will have invested in a private pension scheme. This latter group are, overall, higher-than-average earners. Of course, those who made a conscious decision to remain contracted-in may feel aggrieved that they took the wrong bet on future government policy change; among this group, those who have already accrued £144 or more of state pension rights will stop accruing any more from 2017 and hence would retire with a lower state pension than they might have expected.

But there are also some groups that will be worse off financially as a result:

  • These proposals imply a cut in pension entitlements for most people in the long run. This is because, since 2002, coverage under the current pension system is almost as broad as under the proposed system (activities including employment, unemployment and looking after children aged under 12 are all credited as contributions), and the annual pension accrual from such activities is higher under the current pension system. For example as set out in the table below, in 2017–18, most low earners and non-workers will under the current system accrue £5.05 (£3.59 plus £1.46) of additional weekly state pension rights for ‘contributing’ for one extra year, provided they have not already accrued 30 years of contributions at that stage (those who already have 30 years, would accrue £1.46 of additional weekly pension). Higher earners would accrue £5.81 a week of state pension (or £2.22 if they already had 30 years of contributions). In the proposed new system, these same people would accrue £4.11 of additional weekly state pension (or nothing if they had already accrued 35 years of contributions). The key point is that £4.11 is less than £5.05 (what most lower earners would accrue under the current system) and the gap for high earners is, of course, even greater.
  • Therefore, in the long run, the reform will not increase pension accrual for part time workers and women who take time out to care for children. In fact, in common with almost everyone else, these groups would end up with a lower pension at the state pension age under the new system than they would do under the current system.
  • In common with all pension regimes, one needs to take account of how both rights and pensions in payment are indexed. At present S2P in payment is indexed to CPI, while BSP is triple-locked (at least for this parliament) and, presumably, the flat-rate pension would be indexed to at least earnings. Simply comparing the value of BSP plus S2P with the FRP at the state pension age will therefore overstate the extent to which rights have been reduced, since overall the state pension under the proposed system would be indexed more generously.
  • The term ‘long term’ applies to anyone who will have spent 30 years or more in creditable activities (including employment, looking after children and other caring) since 2002. This, therefore, certainly includes all those who entered the labour market from 2002 onwards (that is, those born in 1986 or later) and arguably also applies to those born from about 1970 onwards.
  • Those who expect to have fewer than 10 years of contributions or credits will be particular losers from the reforms, since they will receive no state pension under the proposed scheme – though the Department for Work and Pensions (plausibly) claims that the majority of people in that position are those who have spent only a short part of their working life in the UK.

We might also be wary of claims by ministers that this will be the final radical reform of state pensions. Similar claims were also made for the reforms announced in 1998, 2002 and 2006. Such frequency of reform makes it harder for individuals to plan for retirement appropriately. That said, it is perhaps more plausible than usual that today’s proposals will prove to be the last radical overhaul for a while, not least because it is moving in the same direction as the reforms implemented in the last parliament and also because a simpler system may prove to be more robust. We have spent more than 25 years gradually unpicking the State Earnings Related Pension Scheme (SERPS), which was first introduced in 1978 without sufficient consideration of the long-term consequences for the public finances.

Overall, the proposals expected in today’s White Paper look like they will bring about a welcome simplification. However, it is important to be clear that – while there will be a fairly complex pattern of winners and losers from the reform in the short-term – the main effect in the long run will be to reduce pensions for the vast majority of people, while increasing rights for some particular groups (most notably the self-employed).

Table: Summary of current and proposed state pension systems

 Summary of current and proposed state pension systems

* Caring for a sick or disabled person for more than 20 hours a week, or a registered Foster Carer, and claiming Carer's Credit.
** Primary legislation requires that the level of the BSP should be increased each year in line with average earnings growth. The current government has committed to a more generous indexation arrangement (the triple lock) for the duration of the current parliament.
*** Individuals can accrue additional State Second Pension entitlement in each year between age 16 and the year before reaching State Pension Age. Therefore, the maximum years of contributions varies depending on an individual’s SPA. For those with an SPA of 65, the maximum years of contributions is 49. For those born on or after 6th April 1978, the SPA is currently set to be 68 and therefore the maximum years of contributions will be 52.

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http://www.ifs.org.uk/publications/6547 Mon, 14 Jan 2013 00:00:00 +0000
<![CDATA[The Effects of the Welfare Benefits Up-rating Bill]]> The Welfare Benefits Up-rating Bill, which gets its Second Reading in the House of Commons tomorrow, proposes to cap the annual increases in most working-age benefits at 1% in cash terms in 2014–15 and 2015–16, in addition to the 1% cap on increases already confirmed for 2013–14.

By default, working-age benefits and tax credits are up-rated each April in line with the Consumer Prices Index (CPI) in the preceding September. CPI inflation was 2.2% in September 2012 and is forecast to be 2.6% and 2.2% in the Septembers of 2013 and 2014 respectively. The government plans instead to uprate the majority of these benefits by 1% for the next three years (though only the proposed April 2014 and April 2015 cash increases are included in the bill). Given current forecasts of inflation, this implies a cumulative 4% real cut in the benefits affected. The actual real-terms cut, though, will depend on future levels of inflation. If inflation is much lower than forecast then the real cuts will be small. If it is higher than forecast then the real cuts will be bigger than is currently expected. Similarly the effect of the measures on benefit levels relative to earnings levels will depend upon future rates of earnings growth. There is an arbitrariness to this eventual outcome. That is the result of specifying future benefit changes in nominal terms rather than, for example, relative to actual price or earnings changes.

When announcing the policy, the Chancellor drew attention to the fact that out-of-work benefit rates have grown substantially faster than earnings since 2007, as shown in Figure 1. This essentially reflects the fact that earnings have not kept pace with inflation, whereas rates of out-of-work benefits (Income Support, Jobseeker’s Allowance and Employment and Support Allowance) have risen broadly in line with prices (though there have been discretionary cuts to the rates of other benefits and tax credits).

Figure 1. Earnings and out-of-work benefits (Jan 2007 = 100)

 Earnings and out-of-work benefits

Sources: Past earnings from ONS series DTWM, ROYK, MGRZ, MGRQ, past benefits from DWP (JSA personal allowance for a single person over 25), forecasts of inflation and earnings growth from OBR

If earnings fall relative to benefit levels, then being in work becomes less financially attractive, all else equal. At present, out-of-work benefits for a home-owning couple without children stand at 27.7% of what the family’s net income would be if one of the couple earned £560 per week. If instead earnings had grown as fast as benefit rates since 2007, that fraction would have been 25.3%. However, higher wages would not have significantly affected the incentive to work for all groups. For a lone parent with two children and rent of £100 a week working 16 hours a week at the minimum wage, out-of-work income is 80% of in-work income in both scenarios, because almost all of the additional earnings are lost in withdrawn benefits.

There is, of course, nothing special about relativities in 2007. Historically, earnings have tended to rise in real terms and hence outstrip price-indexed benefit rates (although, particularly for families with children, above-indexation increases have seen some entitlements grow considerably faster than prices). Relative to that “normal” scenario, the recent fall in earnings compared to out-of-work benefits looks even more striking. On the other hand this is a reminder that when real earnings growth returns, current policy implies that benefit rates will fall relative to earnings.

Figure 2 shows the distributional effect of the benefit reductions contained in the Welfare Benefits Up-rating Bill in the context of all the Autumn Statement tax and benefit announcements and the consolidation package as a whole. This shows that the majority of the impact of the Autumn Statement announcements will come through the changes to up-rating policy set out in the Bill, but that this is only a small fraction of the net ‘takeaway’ from households resulting from the overall fiscal consolidation.

As far as the effects of benefit up-rating measures are concerned, reductions in entitlement are unsurprisingly concentrated in the bottom half of the income distribution. The lowest-income decile group see the largest fall in entitlements as a percentage of income (1.5%) as a result of measures in the Bill, and the second decile see the largest decrease in cash terms, losing about £150 per year on average.

Because the proposed uprating changes apply to almost all benefits and tax credits, both in-work and out-of-work households are affected. Of 2.8 million workless households of working age, 2.5 million will see their entitlements reduced, by an average of about £215 per year in 2015 –16. Of 14.1 million working-age households with someone in work, 7.0 million will see their entitlements reduced, by an average of about £165 per year. Note that this figure includes 3.0 million families who lose only from the cuts to Child Benefit, at an average of about £75 per year (monetary amounts are in current prices).

As the chart shows, other elements of the consolidation package have been much more significant, especially for those with the very highest incomes. It is important to see the effects of this Bill alongside the other tax and benefit changes, as well as falling real earnings which have hit those in the middle and upper parts of the overall distribution the hardest.

Figure 2: Distributional impact of tax and benefit reforms

January 2010 - April 2015 inclusive, as if Universal Credit fully in place

 Distributional impact of tax and benefit reforms

Note: Income decile groups are derived by dividing all households into 10 equal-sized groups according to income adjusted for household size using the McClements equivalence scale. Source: Authors’ calculations using 2010–11 Family Resources Survey and TAXBEN, the IFS’ tax and benefit micro-simulation model.

When cutting public spending dramatically to help reduce an unsustainable budget deficit it is almost inevitable that spending on benefits and tax credits – which account for 30% of the government’s total budget – will be targeted. This policy achieves savings through an across-the-board reduction in the real value of benefits for people of working age at a time when real earnings have been falling.

But we don’t know two things. First, the actual effects of the bill on real benefit rates are unknown, because they depend on future price levels. This exposes the poorest in society to inflation risk. Second, we don’t know the government’s view on how benefit rates should be indexed in the longer run. We ought to.

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http://www.ifs.org.uk/publications/6539 Mon, 07 Jan 2013 00:00:00 +0000
<![CDATA[Withdrawal symptoms: the new 'High Income Child Benefit charge']]> On Monday, Child Benefit will effectively become an income-related benefit for the first time, reducing public spending by an estimated £1.5 billion in 2013–14. We estimate that about 820,000 families, in which at least one adult has a taxable income exceeding £60,000 per year, stand to lose all their Child Benefit via a new income tax charge unless they change their behaviour in response. And about 320,000 families in which the highest-income adult is on between £50,000 and £60,000 would have some, but not all, of it clawed back. The affected families stand to lose an average of about £1,300 per year. The remaining 85% of families currently receiving Child Benefit will be unaffected for now, although more will be affected in time because the £50,000 threshold is planned to be frozen in cash terms.

In the context of a large fiscal consolidation, one can understand why the government is looking at universal benefits going to those on higher incomes as one candidate for cutbacks. But various features of the design of this particular policy look problematic.

First, much attention has understandably focused on inequities of treatment between 1-earner and 2-earner families. The means test uses information only on the taxable income of the highest-income family member so, for example, a 2-earner couple with taxable income of £100,000 split equally between them would retain all Child Benefit, but a 1-earner couple or lone parent with taxable income of £60,000 would lose all of it. This kind of situation does not arise with existing means-tested welfare payments, which are based upon family income. (But note that, because a family’s Child Benefit entitlement will depend upon the income of the highest-income individual, this is not simply an argument about family versus individual assessment: this policy is an unusual hybrid of the two.)

A second unusual feature of the reform relates to its impact on incentives for individuals to reduce their taxable income by, for example, working less or contributing more to a private pension. All families’ Child Benefit entitlements will be exhausted once the taxable income of the highest-income adult reaches a fixed level – £60,000 – regardless of how much Child Benefit has to be withdrawn. To achieve this, the rate at which it is withdrawn as income rises above £50,000 has to vary with the number of children in the family, i.e. with the amount of Child Benefit the family receives. Specifically, affected taxpayers will pay back one per cent of their family’s Child Benefit for every £100 by which taxable income exceeds £50,000. One per cent of Child Benefit is £10.56 per year for a 1-child family, and an additional £6.97 per child for larger families. Hence the marginal tax rate between £50,000 and £60,000 is increased by about 11 percentage points for the first child and by an additional 7 percentage points for each subsequent one. So, for example, while about 320,000 people will find that their marginal income tax rate increases to more than 50%, about 40,000 of them - those with three or more children - will find that it jumps to at least 65%. This is illustrated by the Figure, which shows marginal income tax rates for taxpayers with different numbers of children.

Figure: Marginal income tax rates in 2013-14 for the highest-income member of families with children

Source: Author’s calculations.

This unusual feature of the policy has another consequence in the long run. Since higher Child Benefit entitlements imply higher withdrawal rates, marginal tax rates between £50,000 and £60,000 will also have to rise over time as cash-terms Child Benefit rates rise in line with prices (or indeed in line with anything else). This may sound obscure and technical, but in time it would be important. For example, indexation of Child Benefit rates at 2% per year would increase these marginal rates by a further 5 percentage points for a 3-child family over one decade. To avoid this, some families with an adult on more than £60,000 would have to be allowed to retain some of their Child Benefit. But there are currently no provisions to do this: the £60,000 withdrawal end-point is not a parameter that is planned to be uprated over time.

That is an important detail, but the government could and should address it without any structural upheaval. Other problems are more fundamental to the design of the policy. It creates a series of administrative complexities, including the need for up to 500,000 more individuals to fill in income tax self-assessment forms according to HMRC. But perhaps the biggest concern is the incoherence it creates in the welfare system. We already have the Child Tax Credit, and soon its imminent replacement, namely the child additions within Universal Credit. The reform to Child Benefit will mean that we have two systems of income-related support for children. But the relationship to income will be completely different in each case: based on family income in one case and the income of the highest-income family member in the other; withdrawn at different rates as income rises; and with the withdrawal starting at very different income levels.

With the introduction of Universal Credit, the government will integrate six of the seven existing means-tested benefits and tax credits into one. IFS researchers have argued that the basic principles behind this move have much to commend them. But almost simultaneously, the government is introducing a new and separate means test for Child Benefit which will work in a completely different way, as well as making the seventh existing means-tested benefit – Council Tax Benefit – much more complicated by asking every Local Authority in England to design its own scheme. It is unclear whether the net effect of all this will be to improve the welfare system.

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http://www.ifs.org.uk/publications/6527 Fri, 04 Jan 2013 00:00:00 +0000
<![CDATA[A defining issue? The government’s pledge to raise the share of revenue from green taxes]]> Amidst all the discussion of the Chancellor’s fiscal rules following the Autumn Statement, rather less attention has been paid to another tax-related target. The Coalition Agreement set out a commitment to “increase the proportion of tax revenue accounted for by environmental taxes.” The Environmental Audit Committee reported last month that whether or not this pledge is met depends on how ‘environmental taxes’ are defined. This observation looks at the status of this pledge after the Autumn Statement, and asks whether such a target is sensible in the first place.

The Treasury finally clarified its interpretation of the pledge in July:

  • environmental taxes should make up at least as big a part of total revenue in 2015/16 as in 2010/11;
  • only taxes whose primary objective is to encourage pro-environmental behaviour change (rather than, say, revenue-raising) count as ‘environmental’.

International bodies such as the OECD and Eurostat, however, define environmental taxes not according to their intent, but on whether the tax encourages pro-environmental outcomes. On this basis, the ONS classifies taxes such as fuel duty and air passenger duty as environmental, which the Treasury does not.

The table summarises Treasury and ONS definitions of environmental taxes. We also suggest a third definition, which perhaps best reflects all those taxes which are environmental either in terms of intent or outcome, and for which we have revenue forecasts to 2015/16. This includes company car taxes which, like vehicle excise duty, depend on the fuel efficiency of the car. However, in line with international practice, it excludes VAT on fuel duty since VAT is a general consumption tax rather than a particular environmental tax. As shown at the foot of the table, we find that the definition of green taxes does indeed affect whether or not the target is met.

Three definitions of ‘environmental taxes’, and compliance with target

 Three definitions of ‘environmental taxes’, and compliance with target

Note: Figures for 2010/11 are out-turns and 2015/16 are forecasts. Revenues are taken from the OBR Economic and Fiscal Outlook, consistent with the December 2012 Autumn Statement. The exception is company car taxes, where forecasts are taken from a written ministerial statement to the House of Commons on 16 July by Economic Secretary to the Treasury, Chloe Smith.

On the Treasury definition, the government would easily meet its pledge: the green tax share is set to more than double, from 0.4% to 0.9% of revenues. Green taxes in 2015/16 could fall by £3.3 billion (56% of forecast environmental receipts that year) before the target is missed.

On the ONS definition, however, the green tax share will fall from 7.8% to 7.1% of revenues, breaching the target. Revenues from this set of taxes would have to rise by £5.3 billion (11%) in 2015/16 to meet the target.

On our definition, the pledge is also missed, with the green tax share falling from 7.3% to 7.0%. Green taxes would need to rise by £2.3 billion (5%) to hit the target.

Why do the results differ? Total green taxes are substantially lower on the Treasury definition, mainly because it excludes fuel duties which are estimated to raise £27.8 billion in 2015/16. Including fuel duties makes the pledge much harder to meet: their share of total revenues is set to fall by 0.8 percentage points by 2015/16.

Excluding fuel duties also allows the Chancellor to make further concessions on duties in future years without jeopardising the target. Indeed, if fuel duty is not considered an environmental tax, it actually makes the target easier to meet by reducing total ‘non-environmental’ revenues. The Autumn Statement announced that the planned duty rise for January 2013 was to be cancelled, and future planned inflation adjustments in duties were pushed back by five months from April to September each year. Together these reforms cost around £1.7 billion in 2015/16, the year in which compliance with the green tax target is to be judged. This is almost the entire amount by which, on our definition, the pledge would be breached.

It may well be reasonable to take different views on the precise definition of what constitutes a green tax. More fundamentally, we should ask whether the pledge to raise their importance in total revenues has any particular merit, setting aside the definitional issues. Ideally, taxes (including green taxes) should be raised in the most effective way, rather than to hit some essentially arbitrary target for receipts from one part of the system. Whether environmental taxes make up a bit more or a bit less of total revenues in 2015/16 than they did in 2010/11 is not of much real consequence. Moreover, the green tax share of revenues is not really a good indicator of a government’s environmental credentials. The tax system can be ‘greened’ without raising more money: reforms to vehicle excise duty to base payments on fuel efficiency are one example. Other environmental policies such as regulation and subsidies operate outside the tax system but could still have important environmental benefits. Some green tax revenues may erode away as people change their behaviour in response to the tax. The green tax share also depends on total revenues which can be very sensitive to overall macroeconomic conditions.

It took the government more than two years to lay out the rules against which it wished its green tax target to be judged. In the end, its chosen definition makes the pledge easy to accomplish but implies a very limited role for green taxes. If they really do make up less than 1% of total receipts, then any ambition to move towards a significant role for such taxes in the future (such as that adopted by the Liberal Democrats at their 2010 conference) appears to be a very long way away.

More fundamentally, pledging to meet certain targets which are then defined in such a way as to make them trivial both to meet and in their apparent importance does not look like an effective way of gaining credibility. A green tax definition more in line with international convention would be much more constraining and require the government to take policy action. As a result, there will almost certainly be an argument at the next election as to whether or not the pledge was met. A better argument would be that it wasn’t really worth making in the first place.

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http://www.ifs.org.uk/publications/6491 Mon, 10 Dec 2012 00:00:00 +0000
<![CDATA[70th anniversary of the Beveridge report: where now for welfare?]]> ‘Benefit in return for contributions, rather than free allowances from the State, is what the people of Britain desire’

Sir William Beveridge, 1942

Published by parliament on 1 December 1942, the Beveridge report proposed a system of national insurance in which flat rate benefits, paid for by flat rate contributions, would provide support in the event of unemployment, ill health or old age.

70 years later these foundations remain visible in some elements of the welfare state. Entitlement to contributory Jobseeker’s Allowance, contributory Employment and Support Allowance and the state pension is still determined by National Insurance (NI) records. However, even this continuity is something of an illusion. The Basic State Pension (BSP), by far the largest of the remaining “contributory” benefits, is no longer contributory in any real sense – it is virtually universal. The unemployed, the sick and those caring for children all build up BSP entitlements as though they were making NI contributions.

In truth very little of today’s welfare system bears even a passing resemblance to the system envisaged in the Beveridge Report. To some extent this is the product of the substantial differences between the context in which the report was written and the world we live in today. His proposals were for a country in which, for the most part, men worked and married women didn’t, the only lone parents were widows, and life expectancy was lower than the pension age. The UK today is a very different place. From 96% in 1949 the share of working age men in work has fallen to 76%, while the share of working age women in work has risen from around 40% to 66%. At the time of the report less than 1 in 20 births was outside marriage; today more than 1 in 5 children grow up in a lone parent household. Male life expectancy has climbed from around 63 in 1940 to 78 in 2010, but the male state pension age remains the same as in Beveridge’s day.

These changes in employment, family structure and longevity exposed the limitations of the report. A system based on the contributory principle could not accommodate groups in obvious need of support but without a history of contributions, such as lone parents and the long-term unemployed. And as early as the 1950s, the pension demands of an ageing society led to the abandonment of any actuarial link between contributions and benefits. National Insurance Contributions stopped being flat rate in 1961.

As the role of the contributory principle in the welfare system has declined over time, successive governments have relied increasingly on means-testing to determine eligibility. This shift has been particularly dramatic for those of working age, as illustrated by the figure. Between 1978-79 and 2012-13, the share of expenditure on working-age welfare payments accounted for by means-tested benefits has increased from 26% to 80%. Of the £95 billion budget for working age benefits and tax credits this financial year, more than £75 billion will be means tested, compared with spending of less than £10 billion on contributory benefits. (Note that we have included Child Benefit in the set of means-tested benefits for 2012-13). Much of the increase in the share of means-tested expenditure is the result of extending the reach of the social security system beyond tightly defined groups (the unemployed, carers etc.) to all those with low incomes. In 2011-12, the government spent £22 billion boosting the incomes of families in work through tax credits, an idea that would have seemed bizarre to Beveridge who took it for granted that those in work would not need support.

Expenditure on working age welfare

Note:All social security spending on pensioners is excluded, not just that on specific pensioner benefits. Child benefit expenditure in 2012-13 is counted as means-tested.

Source: Authors’ calculations from Department for Work and Pensions Benefit Expenditure Tables and HMRC accounts.

Why does this history matter? For three reasons. First, because the result of appending a means-tested system to a social insurance framework is more complexity and less transparency than necessary. Second, because we maintain the fiction of an insurance system through National Insurance Contributions, which in fact act just like an additional income tax for most people most of the time. As we have argued previously, this is complex, costly and distorting and seems to be used primarily to make tax rises less transparent. And third because this history should lead us to recognise the need for our welfare system to adapt in a planned way as the world changes.

70 years after the Beveridge Report, the government faces some big choices as it seeks to make substantial cuts to the social security budget. These decisions need to be taken with the long term in mind and with a view to creating a coherent system that is both affordable and effective in meeting the needs of a changing population.

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http://www.ifs.org.uk/publications/6475 Mon, 03 Dec 2012 00:00:00 +0000
<![CDATA[What is the impact of a 45p minimum unit price for alcohol?]]> Today the Home Office has published its consultation on policies to reduce the social costs associated with alcohol consumption. The most high-profile measure is a planned minimum unit price (MUP) for alcohol for England and Wales aimed at ensuring that “alcohol can only be sold at a sensible and responsible price”. The Government proposes that the minimum price should be 45p per unit (a unit is 10ml of pure alcohol); the Scottish government is already planning to introduce a MUP of 50p from next April.

As we have argued before, a preferable way of establishing a price floor for alcohol would be to reform the existing alcohol tax system in two ways. First, move towards a more equal tax treatment of different types and strengths of alcohol in which the tax is based on alcohol content. Second, restrict alcohol from being sold for less than the total tax due on each product to prevent tax increases from being absorbed by retailers. Whilst this reform would affect all alcohol, not just cheaper products, it would at least ensure any additional revenues flow to the Exchequer. By contrast, a minimum price would act as a transfer to the alcohol industry. The size of any windfall from minimum pricing and precisely who benefits is unclear: it would depend on the supply- and demand-side responses to the policy and the contractual arrangements between producers and manufacturers. Nevertheless the sums involved could be large: if there were no behavioural response at all, we estimate that a 45p MUP could transfer almost £1.4 billion per year from alcohol consumers to the off-licence alcohol industry.

To look at the effect of a 45p MUP we use detailed data recording the off-licence alcohol purchased by more than 21,000 households in 2010. The data do not include alcohol bought in pubs and restaurants. However, it is unlikely that a minimum price would have much direct effect for on-trade prices.

The consultation claims that minimum pricing is intended to “reduce the availability of alcohol sold at very low or heavily discounted prices”. However, we find that very nearly 60% of off-licence units cost less than 45p (Table 1), suggesting that the impact of minimum pricing is not just on the very cheapest alcohol. There are big differences across alcohol types: 85% of cider units would be directly affected by a 45p MUP, whilst alcopops and sparkling wines are relatively unaffected.

Table 1: Average off-licence retail price per unit and proportion of units under 45p, by alcohol type

Average off-licence retail price per unit and proportion of units under 45p, by alcohol type

Source: calculated using data from Kantar Worldpanel, 2010. Note: prices uprated to October 2012 values using the all-items RPI.

The effects also vary across different types of household. Low income households would see the largest increase in prices. Households with incomes below £10,000 per year pay on average 43p per unit, and 69% of their units cost less than 45p. This compares to an average cost of 53p per unit for those with incomes above £60,000, for whom 44% of units cost less than 45p.

Heavy drinkers would also be more directly affected. Households consuming fewer than 7 units of off-licence alcohol per adult per week pay just over 50p per unit on average, compared to almost 42p for those consuming more than 35 units per adult per week. Despite this, the impact of minimum pricing would certainly be felt by moderate drinkers as well. More than 48% of units purchased by those drinking less than 7 units per adult per week cost less than 45p, compared to 73% of units for the heavy drinkers.

Table 2 estimates the increase in total food and drink spending that would result from a 45p MUP, assuming no changes in consumer or retailer behaviour except that alcohol sold below the minimum price rises to 45p per unit. The average effect is about 0.9% of grocery budgets, or £32 per year in cash terms. The impact is quite similar for different income groups on average. The largest effect, 8.3% of grocery budgets on average, is felt by heavy drinkers with household incomes below £10,000 per year. However, only 3% of households in this income group fall into this consumption range (a similar share to other income groups). By contrast, almost a quarter of households in this income group do not consume off-licence alcohol at all, and so would not be directly affected by minimum pricing.

Table 2: Proportional increase in food and drink spending following 45p minimum price, by income group and alcohol consumption level (units per adult per week)

 Proportional increase in food and drink spending following 45p minimum price, by income group and alcohol consumption level (units per adult per week)

Source: calculated using data from Kantar Worldpanel, 2010. Note:

The most important issue in determining the impact of minimum pricing will be whether those who generate the greatest social harms from their consumption drink less as a result of the policy. That will depend on how well targeted on those drinkers a minimum price is and how their consumption responds to price rises – something we know relatively little about. Even less is known about how producers and manufacturers might respond and what this will mean. For example, the Office of Fair Trading recently noted that a MUP could give retailers an incentive to market low-cost alcohol more aggressively as it will raise the profit margin on each unit sold. Other important questions are what happens to the price of alcohol which is already selling above the minimum price? What happens to the range of alcohol offered for sale? What happens to the prices of other products besides alcohol? All of these issues will be crucial in judging the efficacy of the policy and should form part of any robust evaluation of its impact. It would be preferable, though, to pursue reforms which would allow something close to a minimum price to be implemented through the alcohol tax system.

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http://www.ifs.org.uk/publications/6462 Wed, 28 Nov 2012 00:00:00 +0000
<![CDATA[Possible changes to the Retail Prices Index: what they are and why they matter]]> In October the Office for National Statistics announced a consultation on possible reforms to the Retail Prices Index (RPI). These reforms could have far-reaching consequences. Today, we are publishing a working paper with our thoughts on technical aspects of the proposed changes.

The UK has two main measures of consumer price inflation, the Retail Prices Index (RPI) and the Consumer Prices Index (CPI), which can give quite different impressions of how prices are changing from year to year. Some of the differences between these two measures are quite easy to explain. For instance, the CPI does not include mortgage interest costs while the RPI does. But there is one difference that has been a source of confusion for those using the two indices: the RPI and CPI use different mathematical formulae to work out how prices are changing, meaning that even if they were fed the same raw price data, the two would report different inflation rates.

This impact of this specific difference between the RPI and CPI is known as the ‘formula effect’. Historically, it has consistently pushed up RPI inflation relative to CPI inflation (see Chart 1). Users of these indices have long been entitled to ask what reason is there for this difference – why is a given method preferable in one index but not the other? These questions only became more pertinent when the size of the formula effect nearly doubled in size following a seemingly minor change to the way clothing prices were sampled in 2010. That’s why in October the ONS started seeking views on whether to change the formulae used in the RPI to bring them in line with those used in the CPI (other options in the consultation would serve to reduce the formula effect without eliminating it entirely).

Chart 1: RPI and CPI inflation rates and the formula effect, 2005-2012

 RPI and CPI inflation rates and the formula effect, 2005-2012

Source: Office for National Statistics

So what are these different formulae and why should the ONS want to change them in the RPI? Indices like the RPI and CPI have to combine many different prices into a single inflation figure. They both start by working out the price changes of individual ‘items’ (such as ‘white unsliced bread’) from a detailed set of price quotes (such as prices of different brands of white unsliced bread). In the RPI, in some cases, a simple average is taken of the price changes of the individual brands. This is the RPI’s ‘formula’, which the ONS is considering replacing. In the CPI, on the other hand, a geometric average is usually taken. This method was first proposed in an essay on gold prices written in 1863 by the British economist William Stanley Jevons, and is now called the ‘Jevons index’. This difference may sound extremely arcane, but it has a big effect. According to estimates of the size of the formula effect shown in Chart 1, using the same averaging methods in the RPI as in the CPI would reduce RPI inflation by just under one percentage point on average each year.

The case against the current RPI formula essentially boils down to the fact that it can give quite odd results. For example, if prices for some item go up one year and then fall back to their original level the next, the RPI will show that item as being more expensive at the end of the period. This does not seem like a very desirable property for a price index to have, and few other countries still use the RPI method partly for this reason. The CPI’s geometric average does not lead to the same problem. However, as we point out in our working paper, moving to the CPI method would not prevent the RPI as a whole (rather than the RPI for particular items) giving these sorts of results, because of the way inflation rates for the individual items are later combined together into an overall figure. Indeed, the same problem occurs with the overall CPI as well. So this issue needn’t be fatal for the RPI’s formula, though taken together with other problems it does add to a cumulative case for change. The working paper goes into more detail about this and other issues.

In any case, even if we could all agree that the current RPI method is inappropriate, reforming it will inevitably create losers. Plenty of contracts are signed guaranteeing one party or the other a return based on RPI inflation. For instance, owners of inflation-indexed bonds get a return equal to RPI inflation plus some yield each year (protecting the value of investments from being eroded by unexpected increases in prices). If RPI inflation were to be reduced, then they would see their investments fall in value, with holders of long term bonds suffering the greatest losses. Importantly, most benefit payments and tax rates have already switched to being linked to the CPI and so any change to the RPI would not affect them. One exception might be increases in excise duties such as fuel, alcohol and tobacco taxes, which are still linked to RPI, though one would expect the government to adjust the way these are uprated if the RPI were changed.

The ONS consultation will close by the end of November, and the intention is that any change would be implemented from March 2013. The eventual decision would have to be considered by the Bank of England, who would assess whether or not the change would be “materially detrimental” to bondholders. If so, responsibility for approval would then pass to the Chancellor. Of course, from his perspective, a reduction in the amount of interest he needs to pay to the holders of government debt would be a welcome windfall - helping him cut the deficit at a stroke. Jevons himself used his own index to assess the consequences of new gold discoveries on prices and noted that "The most remarkable effect of the depreciation of gold is a considerable reduction in the National Debt". Using his index in the RPI might have rather similar consequences today.

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http://www.ifs.org.uk/publications/6457 Tue, 27 Nov 2012 00:00:00 +0000
<![CDATA[Late changes to Council Tax Benefit reforms]]> In a ministerial statement last week the government announced a significant change to its policy to localise Council Tax Benefit (CTB) from next April. In this observation we ask why such a significant change has been announced to a policy two years after it was first announced, less than six months before councils will have to implement it and after many have already consulted on the structure of proposed schemes.

CTB provides support to 5.9 million low-income families, more than any other means-tested benefit or tax credit in the UK. The government is proposing to localise support for council tax from 2013–14, abolishing CTB across Britain and giving grants to local authorities in England and to the Scottish and Welsh governments to design their own systems for providing support for council tax to low-income families. On top of this, the government planned to cut by 10 per cent the funding it provides for council tax support. This would save around £500 million a year.

We have analysed the effects of these proposals in some detail, concluding that localisation would create considerable complexity just as Universal Credit is being rolled out with the intention of simplifying things. It also has the potential to undermine many of the improvements to work incentives that Universal Credit is intended to deliver. For councils to save the full 10 per cent by which funding was being cut by making the system less generous, either the means test would have to be so severe that some people would be worse off after a pay rise – or else councils would have to collect some local tax from the very poorest for the first time since the poll tax. Many councils are consulting on schemes which would have these sorts of consequences.

Just last week - two years after the policy was originally announced, less than four months before local authorities have to finalise their new schemes, and only a week before the third reading of the bill in the House of Lords - new proposals have been forthcoming. In a ministerial statement a £100 million package was announced. This money – which amounts to a fifth of the total planned savings – will be available to councils whose schemes meet a particular set of criteria that the government considers “best practice”. It will, apparently, be available for one year only.

Councils will be eligible for the money if nobody currently on full CTB ends up paying more than 8.5% of their council tax liability (in practice, the costs of collecting such small amounts from very low income households who are not used to paying council tax mean that councils may well prefer to give a full rebate to such households); if the rate at which the benefit is withdrawn as income rises is no higher than 25% (compared with 20% at the moment); and if there are no “cliff edges” in the system.

Even with an extra £100 million to soften the blow, it is hard to see how most councils could design schemes that meet these criteria within the reduced funding intended for council tax support. So it looks as if the government is aiming to pay councils not only to design schemes that the government likes, but to design schemes that don’t cut support as much as councils’ funding is being cut, leaving them to make up the shortfall from elsewhere in their budgets.

It is hard to square this development with a policy whose stated aim was to devolve responsibility. And why the additional money should be appropriate in the first year of the policy and not later is unclear. But perhaps most worrying is what this says about the policy-making process. The potential downsides that the government seems to be trying to ameliorate – losses for the poorest households and weakening of work incentives – have been obvious to many observers for a long time. Yet this announcement has come very late in the process. The bill had already completed its passage through the House of Commons and scrutiny by a committee of the Lords had finished: last week’s announcement came on the eve of a key Lords debate on amendments to the bill, and just a week before the third reading in the Lords. Many councils have already been running public consultations on draft proposals (as the bill requires them to do) yet are now being incentivised to change their proposals at the last moment – perhaps only to revert to their original plans when this extra funding is withdrawn a year later.

The case for well thought through reform of the welfare system is overwhelming. The dangers of less fully considered reform - as this one appears to be - are considerable.

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http://www.ifs.org.uk/publications/6410 Thu, 25 Oct 2012 00:00:00 +0000
<![CDATA[The £10 billion question: where could the Chancellor find welfare cuts?]]> In his speech to the Conservative party conference today, the Chancellor of the Exchequer again stated an intention to reduce welfare expenditure by a further £10 billion per year by 2016–17.

Given the £18 billion per year of welfare cuts already planned by 2014–15, total welfare spending in that year is currently forecast to be £214 billion. Of that, £94 billion will be spent on state pensions and Pension Credit. If these are protected from cuts, the additional £10 billion of savings would have to be found from the remaining £120 billion of welfare spending: a cut of 8.3% in that part of the budget. The figure below illustrates who is currently entitled to these benefits and tax credits, showing average entitlements for families in each decile group of the working-age income distribution. It shows that approximately ¾ of the entitlements go to the lowest-income half of working-age families, and ¼ to the top half (note that Child Benefit is already set to be withdrawn from families containing an individual with annual taxable income exceeding £50,000 from January 2013, which will reduce the fraction of welfare entitlements going to higher-income families).

Figure: Average weekly entitlements to benefits and tax credits among working-age families in 2012–13

 Lifetime repayments under old and new systems

Note: Income decile groups are derived by dividing all families into 10 equal-sized groups according to income adjusted for household size using the McClements equivalence scale. Decile group 1 contains the poorest tenth of the population, decile group 2 the second poorest, and so on up to decile group 10, which contains the richest tenth.

Source: Authors’ calculations using 2009–10 Family Resources Survey and TAXBEN, the IFS’ tax and benefit micro-simulation model.

One simple way of reducing welfare expenditure would be not to go ahead with the usual indexation of benefits in line with prices next April. The Chancellor asked “how can we justify the incomes of those out of work rising faster than the incomes of those in work?” A freeze for all working-age benefits and tax credits would save around £2 billion per year. But the Chancellor’s comments might suggest that this would only apply to out-of-work benefits (Jobseeker’s Allowance, Employment and Support Allowance and Income Support), which would – as the figure makes clear – substantially reduce the potential savings.

The Prime Minister and the Chancellor have mentioned two other specific areas where they believe the current benefit system is too generous. The first is Housing Benefit for the under 25s, who comprise almost 400,000 (8%) of the 5 million Housing Benefit claimants. Abolition of Housing Benefit for this group would save nearly £2 billion per year. Realistically though, it seems highly likely that some of the group will be made exempt from this cut. A crucial issue here is how the government would distinguish between those who can and cannot reasonably be expected to live with their parents. For example, more than half of Housing Benefit spending on under-25s goes to individuals who themselves have dependent children: might the government include them in the group who could reasonably be expected to live with parents? The answers to these kinds of questions will determine how much less than £2 billion per year the government would save from this policy, and how workable it would be in practice.

The second area that has been highlighted is state support for large out-of-work families. We have argued previously that this principle seemed implicit in an existing government policy: the overall household benefits cap, to be introduced in April 2013, will in practice only affect families with large numbers of children and/or high housing costs. If the government believes that these families are currently entitled to too much, it is better to be explicit about that when designing welfare policy so that the perceived problem is targeted as precisely as possible, rather than addressing it indirectly via an overall cap on benefits. In terms of the revenue consequences, though, this does not get us to £10 billion per year of welfare cuts. About 330,000 out-of-work families have at least three children, meaning that to save £1 billion a year would require entitlements to be cut by an average of £3,000 per family for this group.

As always, then, there are all sorts of tradeoffs and issues to think about when designing welfare policy. It is clear, however, that there is more we have yet to hear about if the government is to cut the welfare budget by an additional £10 billion per year.

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http://www.ifs.org.uk/publications/6362 Mon, 08 Oct 2012 00:00:00 +0000
<![CDATA[Reforms to higher education finance: who wins and who loses?]]> The Government’s reforms to higher education funding - involving an increase in the cap on tuition fees to £9,000 per year and the removal of most direct funding for teaching - have now been implemented. This has led to greater variation in fees across universities, and even across different subjects within the same university, although average headline fees are, at £8,660 per year, close to the cap.

Accompanying this, however, are changes designed to make the student finance system more 'progressive'. Its basic principle remains unchanged: loans are available to undergraduates for tuition fees and living costs, which they pay back once in employment. Compared to the old system, however, the earnings threshold above which graduates make repayments has been increased from £15,795 p.a. to £21,000 p.a. (in 2016 prices), the maximum period over which those repayments are made has risen from 25 to 30 years, and many graduates will face above-inflation interest rates for the first time ever. Up-front cash support for most students has also risen, including a £50-million government contribution to the National Scholarship Programme to support students from the poorest backgrounds. This will triple in value to £150 million by 2014.

Recent IFS research, supported by the Nuffield Foundation, provides the first detailed analysis of the financial implications of these reforms for students, graduates, taxpayers and universities. The new system eventually saves the taxpayer around £1800 per graduate, driven by a dramatic cut in direct public funding to universities. But for universities, this cut is more than offset by almost £15,000 in additional fee income per graduate - a 140 per cent rise over the old system. Thus the total amount spent - from both private and public sources - on higher education is expected to increase as a result of these reforms. On average, universities will be better off financially as a consequence.

The average student will also be better off while at university, enjoying an increase in cash support of some 12 per cent. But the main 'winner' from the reforms is the taxpayer while the main 'loser' is the average graduate, marking a significant shift in the burden of higher education funding away from the public sector and towards private individuals.

However, these headline changes for the average graduate mask some important variation. To consider in more detail the impact of the reforms on graduates, we estimate how much each graduate in a cohort would be expected to repay over their working life. Figure 1 shows how this total repayment varies with total lifetime earnings, under the old and new systems. The two lines cross at around the 27th percentile of the earnings distribution; in other words, the poorest 27 per cent of graduates will actually be better off under the new system.

Figure 1. Lifetime repayments under old and new systems

 Lifetime repayments under old and new systems

Low-earning graduates benefit from the increase in the earnings threshold, which (combined with the debt write-off after 30 years) ensures that the majority of their loan is never repaid. This makes the new system substantially more progressive than its predecessor: the richest graduates are likely to repay ten times as much as the poorest, and would even pay back more than the value of what they borrowed.

What does this imply for university attendance amongst disadvantaged students? The progressive features of the repayment system should provide some grounds for optimism: as long as students are well informed and not averse to the kind of debt involved - repayments of which only depend on one’s ability to pay - participation rates should not suffer. But there are grounds for concern if students have difficulty understanding the complexities of the new system - which are substantial - or if they are deterred by the prospect of higher borrowing regardless. Efforts to increase participation amongst students from disadvantaged backgrounds will require clear, precise information to be provided about the costs and benefits of going to university in both the short and long run. Only time will tell if that goal has been achieved.

 

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http://www.ifs.org.uk/publications/6346 Tue, 02 Oct 2012 00:00:00 +0000
<![CDATA[Pensions for the masses]]> On Monday, a very radical reform of workplace pensions in the UK will start to be rolled out across the country. The majority of employees who work for large private sector companies will - for the first time - find themselves enrolled automatically into an employer-sponsored pension scheme; for some of these people it will be the first time that their employer has offered to make a contribution to any pension scheme - a minimum of 3% of gross salary (within a band), provided the employee contributes at least 4%. Employees have the choice to opt out subsequently, but those doing so will risk losing the contribution from their employer. Ultimately, most employees aged between 22 and the State Pension Age will come within the scope of this policy, but it will take some time - these new rules will not cover all employers until February 2018. A new, state-owned pension provider - the National Employment Savings Trust (NEST) - has been established to ensure that all employers can provide their employees with access to a relatively low-cost pension scheme.

Automatically enrolling employees into a pension scheme is likely to have a significant impact on the number of private sector employees who contribute to a pension. In 2011, just one-in-three private sector employees were members of a workplace provided pension scheme (compared to over four-in-five public sector employees). An increase in pension coverage is likely for two reasons. First, evidence suggests that when employees are defaulted into a pension more will remain a member of that scheme than would have made an active decision to join a scheme. Second, many private sector employees will find themselves able to receive a pension contribution from their employer for the first time, which will make pension saving financially more attractive. The low level of coverage among private sector employees pre-reform gives plenty of scope for a significant increase in pension coverage.

While there are good reasons to expect pension coverage to increase, the impact on overall saving is less clear. This is for a number of reasons. First, evidence suggests that defaulting employees into pensions leads to more individuals choosing to contribute the default amount, perhaps because individuals decide not to bother reviewing this level of contribution in the belief that the default amount has, in some sense, been recommended. While this would lead to an increase in pension saving among those who would not otherwise have saved in a private pension, it would lead to a reduction in saving among those who would otherwise have chosen to save more than the default amount. Second, if individuals do increase their pension saving as a result of this reform, this does not necessarily mean that overall saving will rise. An increase in pension saving could be funded by a reduction in the amounts households save in other forms or, arguably even worse, by some running down their debts less quickly than they would have done. Third, the cost of increased employer contributions (and any additional costs to businesses of administering new systems) will need to be financed from a combination of lower wages, higher prices or lower profits; all of these could depress saving.

Although the impact on total saving in the economy is ambiguous, automatic enrolment should nonetheless lead to a significant boost in pension coverage among private sector employees, and those who have good reasons for not saving in a pension at the present time remain free to opt out if they wish. Current economic conditions may lead to opt out rates being higher than was anticipated when this policy was first suggested by Adair, now Lord, Turner in 2006. Evidence on the actual impact of automatic enrolment - on pension coverage, pension saving, overall saving, and levels of earnings - should be gathered in order to help inform future decisions over the precise policy design. However, a challenge for anyone hoping to answer these questions is that the reform is being implemented in a way that will make robust estimation of its impact difficult; careful consideration of data will be needed to shed light on precisely what effect automatic enrolment is having. Simply getting more people to save in a pension will not achieve the Government's overall objectives if it is also accompanied by a reduction in the amounts saved into pensions or saved in other forms.

There are a number of features of both automatic enrolment and the establishment of NEST that will need to be monitored closely and perhaps reformed once the initial impact of the policy changes has been seen. On automatic enrolment, two key decisions will be whether the default minimum contribution rates should be changed, and whether administrative burdens on employers (which have been of particular concern to small businesses) could be further eased without inducing other negative consequences. As far as NEST is concerned, a key decision to be made is whether any of the additional regulatory restrictions on NEST (such as annual contribution limits and restrictions on transferring existing funds in), which do not apply to other pension providers, should be lifted. Ideally, in the longer-term there would be open competition between pension providers, with NEST being neither advantaged nor disadvantaged relative to other market players.

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http://www.ifs.org.uk/publications/6343 Fri, 28 Sep 2012 00:00:00 +0000
<![CDATA[GCSEs - in need of reform? ]]>

Tomorrow, thousands of 15 and 16 year olds will receive their GCSE results. In the future, these exams may be considerably different. It has been reported that the education secretary, Michael Gove, is planning to make radical changes to the structure of GCSEs in England. One potential change is to ensure there is only one exam board such that there is no competition between providers encouraging schools to choose the easiest option. The other is to replace the current system of GCSEs with a dual system of exams, one harder and one easier. Recent analysis by IFS researchers throws light on the desirability of these potential reforms and whether they would actually represent a substantial change compared with the current system. The evidence also raises a third and more fundamental question: what are GCSEs for?

Since the first group of 15 and 16 year olds sat GCSEs in 1988, grades have trended up year-on-year. Between 1996 and 2011, the proportion getting five GCSEs at A*-C (including English and Maths) increased from 35% to 58%. These increases could reflect improvements in student's knowledge. However, the sheer pace of this increase may reflect 'grade inflation', with exams getting easier. It is hard for outsiders to judge - itself a problem to the extent that it reflects a lack of confidence in the system. And the regularity of the year on year increases can reinforce that concern.

However, there are reforms that could reduce perverse incentives for schools in the current system, which is one motivation behind reforms to GCSEs proposed by the education secretary.

Choosing exam boards and qualifications

The qualifications system in England and Wales currently involves a number of exam boards competing for shares in a regulated market. One danger is that they might compete by offering qualifications that are easier to pass. A school choosing between two qualifications which will count the same in league tables, and perhaps to the outside world more generally, has a clear incentive to choose the one it thinks more of its students will pass - the easier one. It is hard to judge the degree to which this has actually contributed to rising GCSE results and multiple exam boards may be able to offer more diversity than just one. However, the incentives are clear. The theoretical case for eliminating such perverse incentives seems strong.

Rising GCSE results in the late 2000s were also buoyed by a proliferation of "GCSE equivalent" qualifications, which meant that by 2009-10 42% of pupils took 'Vocational-Related Qualifications', 30% took BTECs and 10% took GCSEs in vocational subjects. These 'GCSE-equivalent' qualifications tend to be taken by more disadvantaged pupils. Work by IFS researchers showed that schools that had moved most aggressively into these GCSE-equivalent qualifications were also the ones that improved their league table position by the most. This is suggestive evidence that schools use variation in qualification difficulty to game the league-tables. Correlation is not causation, but evidence also led the Wolf Review to similar conclusions. The government is currently implementing the recommendations of this review, including slimming down the number of vocational qualifications that count towards league tables.

A dual system

At the same time, Mr Gove is reported to be considering replacing GCSEs with a dual system of harder exams like the old O levels and easier ones like the old CSEs. His stated aim is to challenge more able students and to ensure that higher standards are maintained. Given that there are already different tiers of GCSEs and many other vocational qualifications, it is not yet clear how much difference any such change would make in practice. Nor is it clear how a new system of exams would affect the behaviour of schools and parents.

Of course there is much room for improvement in school standards. According to international rankings, the UK performs around the OECD average for reading and maths, slightly above average for science, but well behind high-performers such as Canada, Finland and South Korea. Perhaps Mr Gove's proposals could help deal with this?

The trouble is that if you dig under the average results from international comparisons what you find is that the performance of pupils in England is rather unequal with some strong associations between social class and performance. A worrying finding from the research cited above is that it has tended to be poorer pupils who have been directed away from traditional GCSEs in recent years. Recent research published in Fiscal Studies also suggests that by international standards there is a particularly big gap between social groups in the performance of the most able - with the most able pupils from lower social groups doing much worse than the most able from more privileged backgrounds. Seeking to stretch the most able pupils from all backgrounds may well help to deal with some of these problems. However, there may well be other factors holding back able pupils from disadvantaged backgrounds, such as differences in pupil attitudes or aspirations. Such a policy also seems unlikely to aid less able pupils in general.

The role of GCSEs

There is perhaps a third more fundamental question that we should be asking, and which certainly needs to be stated clearly before any reforms are introduced. And that is, what exactly are GCSEs for? England is actually rather unusual in having a high stakes school leaving exam at 16. Most countries focus on exams when most young people in fact leave school at 17 or 18. The system in England looks rather like a left over from a time when the majority of young people did expect to leave school at 16. Now that the vast majority stay on past 16 to do further qualifications there must be some question over the role of a set of exams which may signal to some that leaving at 16 is expected, particularly in the context of government policy to raise the "education participation age" to 18.

GCSEs do perform other roles as well. They are often used to hold schools to account for their performance and are one of the only external measures of attainment universities can see when making offers of places. However, other measures of school success could be used in league tables (such as a core of subjects or post-16 results) and may well be more desirable if schools have been using the present system to boost their league table position. It would also be odd to justify retaining GCSEs on the basis they are used for university admissions. Currently, the majority of children don't go to university and other reforms could improve the flow of information to admissions tutors, such as entrance exams or running the application process after A-Level results have been published. England is also extremely unusual in allowing those who do stay on past 16 to drop study of maths and English, as was pointed out in the Wolf Review.

Perhaps an even more radical rethink of the role of GCSEs and the structure of the public examination system is called for if we are to ensure that these exams serve a valid purpose and young people are best served for the future.

























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http://www.ifs.org.uk/publications/6298 Wed, 22 Aug 2012 00:00:00 +0000
<![CDATA[Behavioural economics and tax reform]]> Recent years have seen a rapid expansion of interest in behavioural economics, which draws on ideas from psychology to shape economic theory. A burgeoning body of evidence – both from experimental laboratory studies and out in the field – suggests that behavioural insights can help to better explain observed behaviours. This observation considers three ways in which behavioural economics might be important for the design, implementation and reform of tax and benefit policy.

First, as we discuss in much more depth in new research funded by the Nuffield Foundation,* behavioural insights help in thinking about how people respond to policy. The way taxes and benefits are presented (even in seemingly trivial ways like their name) can have an effect on their impact: previous IFS research has demonstrated that Winter Fuel Payments are much more likely to be spent on gas and electricity than unlabelled income. People may also respond differently as policies become more complicated, perhaps because they resort to simpler rules of thumb to guide decisions when things become hard to process. For example, there is evidence that people confuse marginal tax rates (how much of the next pound earned will be taken in tax) with average tax rates (how much of everything earned is taken in tax) when deciding how much to work, perhaps because average rates are easier to understand if the structure of marginal rates is complicated.

Second, behavioural insights could help explain why tax reform is often hard to implement, despite the evidence set out in the recent Mirrlees Review of the likely benefits of sensible reforms. The Review made the case that policymakers should think about reform in the context of the whole tax and benefit system, when thinking about issues like progressivity or work incentives for example. However, experimental evidence has found that people suffer from a phenomenon known as ‘disaggregation bias’: a tendency to focus on individual components of something rather than the whole. Since taxes and benefits interact in a number of ways, reforms to the system inevitably involve changes to different component parts amongst which the big picture effects can be lost. For example, expanding the base of VAT and using other taxes and benefits to compensate low income households could help improve the overall efficiency of the tax system and leave it as progressive as before on average. But the regressive nature of the VAT reform in isolation would almost certainly be the focus of attention of such a change and make the package of reform less acceptable. Governments may respond to disaggregation bias on the part of voters, but policymakers may well suffer the same bias themselves since their attention is often focused on a single aspect of the wider system.

Behavioural factors can also mean that even small tax changes are sometimes hard to implement. The model of prospect theory suggests that people feel a loss much more acutely than a gain of equivalent size, and that the additional pain caused by larger losses gets smaller and smaller. As a result, lots of small tax increases could be perceived as more costly than a single big rise. This could help explain why tax escalators, which increase tax rates by a small amount year after year, have often not been implemented as planned. Similar issues might even have some resonance for why recent attempts to impose the full rate of VAT on (amongst other things) takeaway pasties and fixed holiday caravans (raising probably less than £100 million) failed, whereas a £12 billion increase in the VAT rate went ahead.

Finally, as the IFS has long argued, tax and benefit policy should be based as far as possible on good evidence. This is equally true in thinking about what behavioural insights mean for policy, and our research looks in detail at the evidence base. Some recent evidence has come from policy trials looking at the impact of ‘nudges’ which relate to aspects of tax policy. For example, HMRC and the Behavioural Insights Team at the Cabinet Office conducted an experiment with the wording of letters sent to people asking them to pay outstanding taxes. People receiving a letter telling them about compliance rates in their local area were much more likely to respond quickly than those sent a generic letter, suggesting a role for ‘social norms’ affecting behaviour. Such findings help us to understand the usefulness of behavioural insights in making aspects of tax policy more effective, and we applaud the growing use of controlled experiments in this way.

However, behavioural economics is not just about developing ways to nudge people, and our research makes it clear that these wider insights are important for tax and benefit policy more generally. The most pressing evidence gap relates to measuring the welfare costs of getting policy ‘wrong’ by not taking behavioural insights into account. For example, how much higher are optimal cigarette taxes if people cannot commit to giving up? Are back-to-work bonuses or benefit sanctions more effective to stop people procrastinating when searching for work and how large should they be? What will the new system of Universal Credit mean for people’s perception of stigma in the benefits system and take-up rates?

The challenge going forward therefore seems to be developing the evidence base to answer these sorts of questions. This will involve three elements: 1) carefully considering how behavioural issues might impact on policy at the design stage 2) ensuring that policy evaluation (as far as possible) allows us to disentangle potentially conflicting behavioural factors that might drive people to respond to interventions in different ways and 3) using the results to develop and refine theories of behaviour.

*The Nuffield Foundation is an endowed charitable trust that aims to improve social well-being in the widest sense. It funds research and innovation in education and social policy and also works to build capacity in education, science and social science research. The Nuffield Foundation has funded the project on which this observation is based, but the views expressed are those of the authors and not necessarily those of the Foundation or the Institute for Fiscal Studies. More information is available at http://www.nuffieldfoundation.org.

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http://www.ifs.org.uk/publications/6267 Thu, 19 Jul 2012 00:00:00 +0000
<![CDATA[Are you really "in the middle"?]]> How rich are you? When asked this question, most people think they are in the middle. From people in the poorest third of the income distribution, up to people in the richest five or ten per cent, many will happily report that they think they're in the middle. Obviously, not everyone can be in the middle and IFS has used the latest data on household incomes to give you an accurate picture of where you actually are in the distribution.“Where do you fit in?” is a simple tool that lets you know your position in the income distribution and can be accessed online here or downloaded as an iPhone App

So how can you compare your income to that of other people in the UK? One way is to compare your salary to that of other people working in the UK. In 2011, the median gross salary for people in full-time work was around £26,000 per year. But this does not tell the full story. Of the 48 million adults in the UK, about 11.7 million are above state pension age and mostly live off income from pensions. About 5 million working-age adults live in households where no-one works and are thus largely dependent on out-of-work benefits. There are many people in work receiving benefits as well. Some people have income from self employment or investments and some pay higher taxes than others. All of these factors affect the total income that households can use to spend on the items of their choice, and hence their material living standards.. Moreover, a single person on the median salary of £26,000 will tend to have a significantly higher standard of living than a person supporting a spouse and child on the same salary.

While there are many ways to measure income, let alone broader measures of living standards, here we use the same definition as the government in its official income statistics. We measure total household income after direct taxes (including council tax) are deducted and after all benefits are received. We also make an adjustment for family size so that it is possible to compare the living standards of households with different numbers of people living in them.

In using “Where do you fit in?” all you have to do is enter the number of adults and children in your household, add up the take-home income of each person (don’t forget to include any benefits you receive) and enter how much council tax you pay. Our tool will show you where you and your household fit into the UK’s income distribution. Who can we call average? That depends on family type. Imagine a family with two adults and two young children. If both parents go to work and each of them earns a gross salary of £19,000 per year, then they have a net income of around £600 per week. Adjusting for household size, this leaves them with income near the middle. Interestingly, this is only just above the level of gross earnings that a recent report by the Joseph Rowntree Foundation deemed necessary to achieve an adequate standard of living for this family type, according to society’s view of acceptable living standards. Thinking about other family types in the middle of the distribution, a couple without children who both have gross annual salaries of £14,000 would also be right in the middle.

Those towards the bottom of the income distribution are more likely to be on benefits. For example, a single unemployed person living alone receiving Jobseeker’s Allowance plus Housing Benefit of £80 per week to cover their rent would be at the 10th percentile. A single pensioner with similar housing costs and dependent on the Basic State Pension and Pension Credit would be at the 32nd percentile.

At the other end of the spectrum, many might be surprised to find that a childless couple each earning £30,000 (before tax) would find themselves in the top 10% of the income distribution and would be in the top 1% if earning £85,000 each. Of course, those with children need rather more to achieve the same living standards. A single earner with two children would need to be on close to £100,000 to be in the top 10% and £285,000 to be in the top 1%.

Overall those in the middle of the distribution have income about twice the level of those at the 10th percentile, while income at the 90th percentile is twice that at the median. Within the top 10%, incomes shoot up as you get closer to the top of the distribution, and have been ‘racing away’ more and more quickly over time in recent history.

We hope that you find “Where do you fit in?” informative. Punch in your numbers and you might be surprised where you end up.

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http://www.ifs.org.uk/publications/6266 Tue, 17 Jul 2012 00:00:00 +0000
<![CDATA[The fiscal challenge ahead]]> The Office for Budget Responsibility's (OBR's) second fiscal sustainability report, published today, reminds us of the daunting task facing governments even after the current economic and fiscal crisis has abated. Demographic change and the potential loss of revenue from some important taxes will open up a further hole in the public finances of the same sort of magnitude as that which the current fiscal consolidation is designed to deal with. In other words we are likely to need to find many tens of billions of pounds, and probably another £100 billion or more, of spending cuts and tax increases to deal with these pressures.

There is some good news. We do have some time to prepare. Whilst the current £123 billion of fiscal consolidation is planned to take place over a seven year period, the OBR is looking 50 years ahead. In addition there are signs that the government is paying some heed to growing demographic pressures - announcements, for example, to increase state pension ages to 66 by 2020 and 67 in 2026 with the possibility of then linking it to changes in longevity.

But the scale of the change is such that much more will be required. On the spending side there are two main budgets which, under current policies, will be dramatically increased by demographic change - that for state pensions and that for health care. As we showed, based on last year's OBR report, even on conservative assumptions, between them health and pensions are projected to account for half of everything that government does by 2060. As today's OBR report illustrates in stark terms, there are really big uncertainties here about what will happen to health spending. If it increases only as a result of ageing, it will take up an additional 2.3% of national income by 2060. If, on the other hand, spending on health rises faster than this - as it has typically done in the past - as productivity rises less fast than in the rest of the economy, then spending on health could more than double to over 16% of national income. If taxes aren't increased to accommodate these costs then other budgets will have to be squeezed quite dramatically or the quality and quantity of services provided free at the point of use by the NHS scaled back considerably.

As we also pointed out, to some significant extent the state has already adjusted to shifting pressures. Demographic change and spending pressures are not new. In 1979, health accounted for one pound in every ten spent by government. That proportion has already nearly doubled. It is set to go on rising. Social security spending has also taken an increased share of spending over the last 30 years rising from 23% of the total to 29%. That means of course that other elements of spending have been squeezed - defence, housing and support for industry have all lost out. Are there now budgets which can cope with a similar squeeze over the coming decades? The housing budget has all but disappeared as has government spending on industry and subsidies for teaching at universities. There is a limit to what can be found from defence. Budgets for the Ministry of Justice, the Home Office and grants to local government are all being cut by more than a fifth over this spending review period with more pressure likely to come in the next period. Low hanging fruit is becoming harder to find.

So what about the other side of the government balance sheet - tax revenues? Here, unfortunately, the OBR also paints a rather gloomy picture with respect to some significant sources of revenue which are in imminent danger of falling or disappearing entirely. We have seen in the last month how difficult this government, in common with its predecessor, is finding raising fuel duties even in line with inflation. Put this alongside increasing efficiency of cars and the result is a long term decline in revenues from a tax which currently raises around £30 billion a year. This decline is likely to continue and, if we are to meet our climate change targets, these revenues should eventually disappear entirely. As we have argued the long standing economic case for moving to a system of road user charging is becoming ever stronger.

Other pressures on the revenue side include those on taxes from North Sea oil and gas, which the OBR forecasts will fall to very low levels by 2040. In addition there are likely to be continuing pressures on other tax bases, notably corporation tax, as a result of globalisation and potentially increasingly fierce international tax competition. Up until now industrialised countries, including the UK, have been remarkably successful at maintaining corporate tax revenues over long periods (despite high profile cases of large companies managing to minimise tax payments). But we are beginning to see international constraints impact on tax system design, not least in the introduction of the so called 'patent box' designed to impose a much lower rate of corporation tax on profits derived from patents - profits which are considered more internationally mobile.

Of course the future is uncertain. But the OBR's report highlights an inescapable fact - we will need to make a whole series of very big and serious choices over the coming decades about the type of state we want to live in. In the end we have only three choices - increase taxes, rein in and reform spending on health and pensions, or cut other areas of spending. There really is no fourth way.

As we have said before this requires a serious debate. We need to think about how we want to run and fund our health service. We urgently need a serious debate about the structure of our tax system. At the very least we will need to replace the revenues lost from motoring, oil and, probably, corporate taxes. If we decide to accommodate some of the spending pressures by taxing more, then some combination of income tax, National Insurance Contributions and VAT are likely to have to take the strain. As we have argued forcefully in the Mirrlees Review there are many ways of changing the tax system to make it more efficient. If we are to do more with the system then it becomes all the more important that it be as efficient as possible. And that will mean tackling some long standing problems that politicians of all persuasions have consistently shied away from. As well as needing to grasp the nettle of road pricing we need, among much else, to sort out a VAT system which applies zero rates to more spending than almost any other comparable country, a council tax system which remains based on relative house prices in 1991 and is regressive with respect to its tax base, and our income tax and national insurance systems that run pointlessly and confusingly in parallel with one another.

The OBR's analysis is welcome and it is powerful. It should be sparking a national debate about how to respond to the challenges it is warning us about.

IFS public finance observations are generously supported by the Economic and Social Research Council (ESRC).

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http://www.ifs.org.uk/publications/6257 Thu, 12 Jul 2012 00:00:00 +0000
<![CDATA[Whitehall departments overachieve budget cuts in 2011–12]]> Today HM Treasury published Public Spending Statistics which contain, for the first time, estimated spending outturns by Whitehall departments for 2011-12. The figures show that, in total, departmental spending was £6.7 billion lower than was planned this time a year ago. Had departments spent all their planned budgets in 2011–12, departmental spending would have fallen in cash terms by £4.4 billion between 2010-11 and 2011-12 - a real terms fall of 3.5%. As a result of the underspends, cash departmental spending actually fell by £11.0 billion, which equates to a 5.2% real terms fall.

The £6.7 billion underspend is comprised of a £5.3 billion underspend by Whitehall departments, and £1.4 billion of funding held in reserve by HM Treasury this time last year that subsequently did not need to be allocated to departments. The £5.3 billion underspend is equivalent to 1.4% of departments’ budgets. In other words, on average departments spent 98.6% of the money they were allocated in 2011–12; although – as we shall show – there was considerable variation in the relative size of underspends across departments.

One obvious reason why departments might underspend is that they might have been given permission by the Treasury to move funds into the next financial year under the new ‘Budget Exchange System’. Under this system departments who surrender any underspend (up to a 'reasonable limit') in advance of the end of the financial year can get an equivalent increase in their budget in the following year. However, of the £5.3 billion underspent by departments in 2011-12, only £0.9 billion was successfully surrendered by departments through the Budget Exchange, and will now be available to be spent in 2012-13. This means that over 2011–12 and 2012–13 the total government deficit is on course to be £4.4 billion lower (i.e. £5.3 billion less £0.9 billion) as a direct result of these underspends.

The majority of individual Whitehall departments underspent on their 2011-12 budgets. The figure below shows, for departments who underspent by more than £0.1 billion, the proportion of their budgets that were surrendered through Budget Exchange (and will therefore be available to spend in 2012-13) and the proportion of their budgets that were underspent and will not be transferred into future years. The department that underspent the largest proportion of their budget was the Department for Energy and Climate Change whose £0.4 billion underspend was 13.9% of their 2011–12 budget. In absolute terms, the largest underspender was the NHS – the biggest Whitehall department – who underspent by £1.7 billion (of which only £0.3 billion was surrendered through Budget Exchange), which is equivalent to 1.6% of its 2011–12 budget.

The use of Budget Exchange varied across departments, even amongst those who ended up underspending on their budgets. For example, the Department for Transport underspent by £0.7 billion (or 5.1% of its budget), of which none was transferred through Budget Exchange, while the Department for Culture, Media and Sport underspent by £0.1 billion (or 5% of its budget), of which around half was transferred to 2012-13 through Budget Exchange.

Figure: Underspends by departments (departments who underspent by more than £0.1 billion)

Figure: Underspends by departments

Note: Chancellor’s Departments includes HM Treasury, National Savings and Investments, Government Actuary’s Department, HM Revenue and Customs, National Investment and Loans Office, Royal Mint and Crown Estate Office.

Small underspends would not be surprising – indeed it would be amazing if every department managed to spend its allocation exactly. But relatively large underspends that are not qualifying for Budget Exchange might seem strange, and particularly so in an era where most departments are facing cuts. One possible explanation is that departments have been trying hard to ensure that they do not end up with an overspend, which might be particularly unfavourably looked on by the Treasury in the current era of austerity. Another is that Whitehall departments have looked ahead to the cuts they face in 2012–13, 2013–14 and 2014–15 and decided that over-delivering on the cuts to date would leave them better placed to keep within these tight budgets going forwards. Departmental spending plans for 2012-13 now currently imply an average real cut of 0.8% in real terms from their 2011-12 level, which would have been a 2.6% average real cut if departments had spent their planned budgets in 2011-12. Whatever the motivation behind the underspends, to the extent that departments are underspending while still maintaining the quality and quantity of public services being provided, this is good news.

IFS public finance observations are generously supported by the Economic and Social Research Council (ESRC).

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http://www.ifs.org.uk/publications/6249 Fri, 06 Jul 2012 00:00:00 +0000
<![CDATA[Measuring and addressing child poverty]]> Today’s figures show that the previous government’s relative child poverty target for 2010-11 was missed, despite large reductions in that measure of child poverty since 1998-99. And in the latest year of data, relative child poverty fell, but not because low-income households with children got any better off in absolute terms.

The government has re-stated its commitment to the 2020-21 income-based child poverty targets that it inherited (and had voted for). As we argue below, this leaves the government in the position of having a target looming in just eight years, without policies which are likely to transform the distribution of income anywhere near radically enough over that kind of timescale. The government has also re-iterated its view that income-based child poverty targets have important limitations, and that relative poverty measures are problematic. It has announced it will be consulting on defining broader measures in the Autumn.

There are bound to be reasonable disagreements over what child poverty means and how to measure it (as well as how to address it). All sorts of things - income, spending, health, education, access to services - matter to the well-being of the poorest children, and there is obviously scope for debate about the relative importance of each. And the argument over whether poverty should be thought of in “relative” or “absolute” terms has been going on for centuries.

So what are the issues, and what can we say about them?

Absolute versus relative poverty

The fact that relative poverty can fall without absolute living standards increasing (as happened in 2010-11) is not a new discovery: it follows straightforwardly from defining poverty in relative terms. And in the short run we probably do care most about how the poorest children are faring in absolute terms on the chosen measures - are their incomes, educational attainment and so on higher or lower this year than last? Year-to-year movements in relative income poverty which simply reflect volatility in middle incomes - and hence in the relative poverty line - would lead one to perverse conclusions if such measures were the only ones being considered.

But what about the long run? Society’s intuitions about what constitutes a minimum acceptable standard of living do seem to be rooted in time and place to at least some extent. The real income levels that society is willing to tolerate at the bottom of the income distribution are rather higher now than they were in the Victorian era. So we probably do want to think about the poor in the context of the living standards of their contemporaries and the resources available to the society in which they live.

Absolute living standards matter and, over longer periods, so do relative living standards. Each measure provides different information. Each is relevant, and each is clearly incomplete. A single number cannot be expected to capture all of the concerns that someone might have about the distribution of living standards. Reasonable people will disagree about the relative importance of each, and it is probably sensible to keep an eye on both (as the previous and current governments have done, at least in terms of the poverty indicators that they officially track(ed)).

Poverty with respect to what?

Whether absolute or relative, a poverty measure needs to specify the object of concern. The previous government clearly believed that material living standards are at the core of what poverty is about: it chose to track three income-based indicators of child poverty, and included them (plus one more) in its 2010 Child Poverty Act which set ambitious targets for 2020-21.

But income does not perfectly capture even material living standards. For example, it does not account for the availability and quality of public services, or for the ability of people to spend more than their income by drawing on savings or in anticipation of higher income later. Many students have low incomes, but we might want to think about them quite differently from the long term sick and disabled who have little prospect of higher incomes in future.

And one might see poverty as about much more than material living standards. Broader indicators of children’s well-being, such as their physical and/or mental health, matter. In the context of child poverty one could go even further, viewing it as about not only current outcomes but about lack of opportunity or ‘life chances’. The current government seems to have both of these in mind when talking about child poverty, and included health-based indicators and measures of educational participation and outcomes in its Child Poverty Strategy. One can certainly quibble about which things are taken to be constitutive of poverty, rather than causes or symptoms of it, or indeed which measures simply represent other things that we care about that have nothing to do with poverty per se. But there are without doubt a variety of dimensions of well-being that we should care about, each with multiple causes and multiple consequences, and it is sensible to be interested in all of them (whilst thinking carefully about what causes what, and how patterns of deprivation can be broken).

The 2020-21 income-based targets

Whilst supplementing them with a broad range of other indicators - which is sensible - the government is retaining the 2020-21 income-based child poverty targets that it inherited (and which both governing parties voted for in 2010). But the role of those targets is increasingly unclear, given other aspects of government policy.

IFS researchers have shown that the large reductions in income poverty among children under Labour relied very heavily on fiscal redistribution towards low-income households with children. For example, in 2010-11 about £18 billion more was being spent on benefits and tax credits aimed at families with children than if Labour had just applied default indexation rules since coming to power (see here). This is not surprising, given that the government was pursuing quite short run income-based targets, first for 2004-05 and then for 2010-11: tax and benefit changes tend to have rapid and relatively predictable impacts on incomes.

But fiscal redistribution is not costless. There is an inescapable trade-off between increasing redistribution and strengthening financial work incentives. And a pound spent on benefits is a pound not spent on other things which might improve children’s lives more cost-effectively in the long run, such as education, health or social services (or indeed a pound spent on completely different objectives).

The government has made clear that it does not view further large increases in fiscal redistribution as appropriate, at least in the current fiscal climate. Some people will agree with that judgement, and some will not: the extent to which the costs of increased fiscal redistribution are worth incurring is of course a subjective question. But there does seem to be a tension between this judgement and the retention of the income-based 2020-21 child poverty targets. Why? Because the targets loom in just eight years. Over short periods - and anything less than a generation is probably short term when it comes to making radical and politically feasible changes to the income distribution - it is difficult to think of tools beyond fiscal redistribution which would achieve a transformation of the large scale required.

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http://www.ifs.org.uk/publications/6194 Thu, 14 Jun 2012 00:00:00 +0000
<![CDATA[The road ahead for motoring taxes?]]> The case for a radical overhaul of the way that motoring is taxed is set out in a report, funded by the RAC Foundation, that we are publishing today. We recommend a move to a widespread system of road pricing. The revenues raised could be used to reduce other motoring taxes. Such a move would generate substantial economic efficiency gains from reduced congestion, reduce the tax levied on the majority of miles driven, leave many (particularly rural) motorists better off, and provide a stable long-term footing for motoring taxes without necessarily raising net additional revenue from drivers.

The economic rationale for road pricing is compelling. Road use generates costs which are borne by wider society instead of the motorist. These 'externalities' mean that in the absence of taxation or pricing, there is an inefficiently high level of road use. Taxes can help bring private demands into line with the socially desirable level. Several different externalities are associated with motoring. Some, like carbon emissions from burning petrol and diesel, are easily addressed through fuel duties as the costs depend entirely on fuel use. Others, notably congestion but also the costs of noise and accidents, vary enormously according to where and when someone drives. Driving in rural areas late at night imposes no congestion cost upon other motorists. Driving in conurbations at rush hour generates large congestion costs. Taxes on fuel cannot vary according to time and location, and so are fundamentally unable to account for this variation. Taxes on road use, however, would be able to do so. The potential efficiency gains from better-targeted taxes are large: the 2005 Eddington Review estimated benefits of up to £25 billion per year.

The figure below illustrates the point. Drawing on figures from the Department for Transport, it shows an estimate of the marginal external cost associated with each kilometre of road use from least costly on the left to most costly on the right. They vary enormously from just 0.9p per kilometre to 245p per kilometre (and, if anything, these figures probably understate the variation in the marginal externality). For a car of average efficiency, driving a kilometre leads to a fuel duty payment of around 5.5p irrespective of location and time. The bluntness of fuel duties is clear. Even ignoring other taxes on motoring, perhaps half of kilometres are taxed too much, one-quarter taxed at roughly the appropriate level, and one-quarter taxed too little, often substantially so.

Figure 1. The distribution of the marginal external costs of motoring

Source: Authors' calculations based on Department for Transport (DfT) data.
Notes: The marginal external cost distribution is derived using estimates of the total motoring externality for all major types of road (conurbation, urban and rural) across different congestion bands. These have been weighted to construct the distribution by using estimated 2010 values of the proportion of total distance driven on each combination of road type / congestion band.

There is a second, fiscal, argument for road pricing. Fuel duties and Vehicle Excise Duty (VED) raise around £38 billion per year. But these revenues do not appear to be sustainable in the medium-term. Forecasts from the Office for Budget Responsibility suggest that by 2029/30, revenues from these taxes will be some 0.9% of national income lower than today. This equates to more than £13 billion per year in current terms. This decline is partly down to improved vehicle efficiency and the growth of electric vehicles. In the extreme case in which all vehicles were electric, revenues from fuel taxes and VED would disappear altogether - but the problems of congestion would clearly remain.

How could this revenue be replaced? £13 billion is approximately equivalent to a 3½p increase in the basic rate of income tax, an increase in the main rate of VAT to almost 23%, or a 50% rise in rates of fuel duties. None of these options are particularly palatable, and there is little sense in ever higher fuel duty rates for the shrinking base of motorists relying on conventional fuel. Indeed, the difficulty of sustaining revenues through further duty rises has already been demonstrated by the consistency with which both this government and its predecessor have announced, and then failed to implement, duty increases. From their peak in March 1999, real (inflation adjusted) fuel duty rates were 16% lower by December 2010. Real fuel duty per kilometre driven fell by 13% between 2000 and 2010, from 6.3p to 5.5p.

Road use, however, appears to be a more sustainable tax base. The Committee on Climate Change estimates that total distance driven in the UK will rise by almost one-quarter from 516 billion vehicle kilometres in 2010 to 637 billion by 2030. Revenues from road pricing would not erode as vehicles become more efficient, and the charge - assuming it varied by where and when the driving occurred - would provide the right signals to deal better with variation in congestion costs.

As we have argued elsewhere, there are multiple long term pressures on taxes and spending. Just as we need prepare for, and debate how to pay for, demographic change, so we should be taking the time to debate and design a system of road pricing. The groundwork needs to be laid now. In this context the potential reforms to ownership of the strategic road network recently outlined by the Prime Minister simply enhance the need for a sensible, joined-up strategy. Before signing long-term leases to let private firms manage key roads, the government should consider carefully whether this would compromise the ability to implement national road pricing if it - or a future government - were finally to accept the overwhelming logic for it in the years ahead.

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http://www.ifs.org.uk/publications/6174 Tue, 15 May 2012 00:00:00 +0000
<![CDATA[Labour market changes unlikely to reduce inequalities]]> Politicians often say they want to see income inequality or poverty fall. The most explicit current example of such an ambition is the set of targets in the 2010 Child Poverty Act. Meeting these would require large increases in the real incomes of low-income households with children, and a very substantial narrowing of the gap between these households and those on middle-incomes, by 2020-21.

Political and economic constraints mean that achieving these targets solely by using benefits and tax credits to redistribute to low-income households looks virtually impossible, particularly in the context of the Government’s plan to eliminate the budget deficit mostly through spending cuts (rather than tax rises). It is natural, therefore, to ask whether the targets could be hit by transforming the distribution of private income over the next eight years. With this in mind, research co-authored by us and published today considers the likely impact of changes in the mix of jobs over the rest of this decade on typical measures of income poverty and income inequality.

The research combined long-run projections of the state of the labour market produced by the Institute for Employment Research at the University of Warwick with a model of household incomes produced by the IFS. Our previous work had already suggested that relative poverty would rise between now and 2020, partly because, over the period as a whole, wages are likely to grow in real terms while income from benefits and tax credits will be pegged to inflation, and partly because of the cuts to welfare spending announced by this government. In our new research, we found that projected changes in the mix of job types (where “job types” are defined by industry, occupation, skill level, gender, region, and full-time or part-time status) over this decade are likely to widen inequalities in household incomes further, and will consequently cause measures of relative poverty to rise further too. This is mostly due to the anticipated continuation of long-running labour market trends: for example, high-wage occupations are expected to continue to replace middle-wage occupations, but with little change in the prevalence of low-wage occupations in a so-called “hollowing out” of the labour market.

We also looked at plausible alternative scenarios for the labour market. The scenarios held the total number of jobs in the economy fixed, but changed the sorts of jobs available, or the people working in these jobs, or the pay differentials between different sorts of jobs. Even scenarios which one might reasonably expect to reduce inequality and relative poverty often have surprisingly little overall impact on the income distribution. One reason for this is that many individuals on low pay do not live in households with a low income, usually because they live with other adults who are also earning, and this means that labour market trends which may help the low paid are not necessarily well-targeted on households with low incomes. For example, reducing the gender pay gap would benefit women in low-income households but would also benefit women in high-income households, with almost no net impact on income inequality or relative poverty. Of course, this is not to suggest that one should not be interested in narrowing the gender pay gap for reasons other than reducing household income inequalities, but it highlights that governments should be clear about which objectives are achieved by which policies. Another reason is that a relatively large fraction of households with low income do not have anyone in work. This constrains the extent to which labour market changes can reduce poverty or inequality, unless the total level of employment can be substantially increased.

Of course, it is impossible to account fully for everything which may affect the distribution of income, and there remain important unanswered questions. For example, the research did not consider the scope for training and skills policies to increase the total level of employment in the economy. We did allow for the direct effects of Universal Credit on household incomes, but did not consider how the associated changes to financial incentives and the requirements imposed upon recipients to look for better-paid work would affect incomes. But with relative child poverty projected to reach almost 26% in 2020-21 in our baseline scenario, there is no way that Universal Credit alone will get the Government back on track to hit its 2020 target of reducing this measure of poverty to just 10%.

This research adds to the evidence that policy-makers who want to reduce income inequalities in the coming years will have to swim against a rising tide of inequality-increasing changes in the mix of job types, and a less redistributive tax and benefit system. The targets for 2020-21 specified in the Child Poverty Act were always ambitious (requiring a lower rate of relative child poverty than the UK has experienced in the past 60 years), and it looks increasingly doubtful that anything could bring about the transformation required in the time available, given constraints such as the fact that many of the parents of 2020-21 have already left education. If the Government disagrees with this assessment, it needs to explain urgently and credibly how such a rapid and spectacular transformation is going to take place. The only other constructive way forward is surely for the Government to set itself different objectives which do reflect its view of what is both achievable and desirable. It is difficult to see the value of extremely ambitious targets without a credible plan for meeting them.

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http://www.ifs.org.uk/publications/6173 Wed, 09 May 2012 00:00:00 +0000
<![CDATA[How significant is a minimum unit price for alcohol of 40p?]]> The Home Office has today published its alcohol strategy which contains a number of measures designed to curb excess alcohol consumption and the associated social harms. The most high-profile is the plan to introduce a minimum price per unit of alcohol in England and Wales (a similar policy is currently before the Scottish Parliament), with 40p per unit set as an illustrative rate.

As in our previous analyses of minimum pricing, we continue to argue that a preferable approach would be to introduce a floor price for alcohol through the duty system, moving towards a more equal tax treatment of alcohol by type and strength combined with a restriction on selling alcohol below the total tax levied on it. Such a system could be designed to achieve an increase in the price of low cost alcohol similar to that that from a minimum price. But it would have the advantage of raising money for the Exchequer, whereas a minimum price would transfer revenues to the alcohol industry instead. If set at 40p, we estimate that these transfers could be as much as £850 million per year. The alcohol strategy document suggests that the government will "... work with industry to use any additional revenue to provide better value to customers in other areas ..." though quite how this could be enforced or monitored is hard to see.

How significant would a 40p minimum price be? We examine the policy using detailed data recording the off-licence alcohol purchased by more than 19,000 households in 2010. The data do not include alcohol bought in pubs and restaurants. However, it is unlikely that a minimum price would have much direct impact for on-licence prices.

Table 1 shows that the average off-licence alcohol unit sells for around 44.8p. Overall, 47% of units would be directly affected by the proposed minimum price. The policy would therefore have a significant impact for off-licence alcohol retailing, and would not simply affect the very bottom of the price distribution. There are also substantial differences across alcohol types. Over 80% of cider units are directly affected. By contrast, alcopops and sparkling wine would be relatively unaffected.

Table 1: Average retail price per unit and proportion cheaper than 40p, by alcohol type

 

Average retail price per unit

 

Source: calculated using data from Kantar Worldpanel, 2010. Note: prices uprated to February 2012 values using the all-items Retail Prices Index from the Office for National Statistics.

Off-licence purchase prices vary by household income and by overall alcohol consumption level. The average price for those with incomes below £10,000 per year is around 42p per unit, compared to 51p for those above £60,000. Households consuming fewer than 7 units of alcohol per adult per week pay almost 49p per unit, compared to 41p for those consuming more than 35 units. The policy would therefore affect low income and heavy drinkers more directly. Moderate consumers, though, are quite substantially affected as well: 37% of units purchased by those drinking fewer than 7 units per week cost less than 40p, compared to 59% for those drinking more than 35 units.

Table 2 estimates the average increase in total food and drink expenditure by income and consumption group following a 40p minimum price. It assumes that there is no change in consumer or retailer behaviour other than an increase in the price of alcohol below the threshold. The average cost is about 0.6% of grocery budgets, or £21 per year in cash terms. The largest impact is felt by low income, heavy drinkers who lose 5.9% of their grocery budget on average. The measure is slightly regressive overall, though the differences across income groups are not particularly large and it would not seem sensible to judge the policy simply on its distributional effect.

Table 2: Increase in food and drink grocery budget following 40p minimum price, by income group and average weekly off-licence consumption level

 

Average retail price per unit

Source: calculated using data from Kantar Worldpanel, 2010. Note:

This analysis does not attempt to model the behavioural response to minimum pricing. However, many of the potential effects are hard to predict. In particular, how would retailers and manufacturers change the price of more expensive alcohol? What would happen to the range of products on the market? What would happen to non-alcohol prices? These indirect effects could be very significant. The coalition may benefit from a Scottish laboratory if the policy is implemented by Holyrood first. The impact of minimum pricing in Scotland should therefore be robustly evaluated with the policy in England and Wales being responsive to any lessons learned.

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http://www.ifs.org.uk/publications/6084 Mon, 26 Mar 2012 00:00:00 +0000
<![CDATA[A £10,000 personal allowance: who would benefit, and would it boost the economy?]]> Despite the planned net fiscal tightening of £123bn per year by 2016-17, the coalition government has sought to cut income tax for low-income individuals by increasing the income tax personal allowance to £10,000 by 2015-16. Significant increases to this allowance - the amount of income that is not subject to income tax - have already been implemented or announced, at a combined cost to the government of nearly £5 billion per year: it increased by £1,000 in 2011-12 to £7,475, and it will increase by a further £630 in 2012-13 to £8,105 (£700 and £210 more than it would have gone up by under default indexation rules in those years respectively).

How much more would it cost the government to meet its target of reaching a £10,000 personal allowance by 2015-16? Normal price indexation of the personal allowance (the assumption underlying the Office for Budget Responsibility's forecasts for the public finances) would mean that it would reach £8,885 in 2015-16 without any discretionary policy changes given current inflation forecasts. Compared to this baseline of £8,885, a personal allowance of £10,000 in 2015-16 would mean that tax revenues were £5.3 billion lower in that year. To reach that ambition earlier, as several Liberal Democrat and Conservative politicians have recently advocated, would reduce income tax revenues by more than this, as shown in the table below:

Year £10,000 personal allowance introduced   Annual cost to the Exchequer
2012-13   £8.9bn
2013-14   £7.7bn
2014-15   £6.5bn
2015-16   £5.3bn

 

Note: Costs are for the year in question: if the personal allowance were subsequently increased in line with inflation (the default indexation policy), the cost would remain roughly the same. Alternatively, if the personal allowance were frozen at £10,000, the cost would fall as shown in the table.

Source: Author's calculations using the IFS tax and benefit microsimulation model, TAXBEN, run on uprated data from the 2009-10 Family Resources Survey.

These figures all assume that the threshold at which the higher 40p rate of income tax starts to be applied is unaffected. This means that higher-rate taxpayers get the same benefit from the higher personal allowance as those who remain basic-rate taxpayers. If the government wanted to lower the cost of achieving a £10,000 personal allowance, it could prevent higher-rate taxpayers from benefiting at all by reducing the threshold at which the 40p rate starts to be applied: this would reduce the cost to the Exchequer from £5.3 billion to £3.3 billion in 2015-16. This approach would lead to a significant increase, of around 600,000 in the number of higher-rate taxpayers. Under current policy proposals this would also mean that about 200,000 more families with children would lose their Child Benefit because an adult in that family would become a higher rate taxpayer after the lowering of the higher rate threshold (these Child Benefit savings would account for about £300 million of the reduced cost to government of meeting its £10,000 target in this way).

The gain from increasing the personal allowance to £10,000 in 2012-13 (without changing the higher rate income tax threshold) would be £379 a year to each individual taxpayer aged under 65 with an annual income between £10,000 and £116,210. There are three groups of individuals who would not benefit: those aged 65 or over, who already have tax allowances exceeding £10,000 (other than those with incomes above around £29,000 who see their allowance reduced to the level of the allowance for those aged under 65); those who do not have incomes high enough to pay income tax anyway (more than a third of the adult population); and those who have the personal allowance fully withdrawn as their income exceeds £120,000. Those with incomes between £8,105 and £10,000 would see their income tax liabilities fall from less than £379 to zero. A gain of £379 is of course larger as a percentage of income to a low-income individual than someone with a higher income, although it is important to remember that the poorest third of adults do not benefit at all because their incomes are already below the personal allowance.

But if we examine the distributional impact at the family level (which is normal for this sort of analysis, since we would expect at least some degree of income sharing within families) we get a different pattern to the one we might expect. This arises because two-earner couples, who tend to have higher family incomes, can benefit twice over from the increase in the personal allowance because both members of the couple would see their income tax liabilities fall by £379, meaning that they would gain £758 in total. Thus, the highest average cash gain occurs in the second-richest tenth of the income distribution (some of the richest tenth would not benefit because of the withdrawal of the personal allowance above £100,000, lowering the average gain for this group). As a percentage of income, the gain is roughly the same from just below the middle to just below the top of the income distribution, with the bottom and the very top gaining by less than this.

To summarise, the common assertion that increasing the personal allowance is progressive is true if one considers the gains across individual income taxpayers. It is not true if one considers the gains across all families as relatively few of the poorest families contain a taxpayer and two-earner couples gain twice as much in cash terms as one-earner families.

Distributional impact of increasing personal allowance to £10,000 in 2012-13, by income decile group

Income deciles

Notes: Income decile groups are derived by dividing all families into 10 equally-sized groups according to income adjusted for household size using the McClements equivalence scale. Decile group 1 contains the poorest tenth of the population, decile group 2 the second poorest, and so on up to decile group 10, which contains the richest tenth.

Source: Author's calculations using the IFS tax and benefit microsimulation model, TAXBEN, run on uprated data from the 2009-10 Family Resources Survey.

Some have argued that a higher income tax allowance would be a good way of introducing a short-term fiscal stimulus for the economy. In our annual Green Budget, we argued that the case for a fiscal stimulus was not clear cut, but said that if the government did choose to introduce one, it should be timely, targeted and temporary. Increasing the personal allowance does not seem to meet any of these criteria. An increase in the allowance would not be especially timely: individuals would not see the effect in their pay packets until the Autumn. It would not be well targeted: the Office for Budget Responsibility suggests that increased investment spending or spending on benefits (or indeed cuts to the main rate of VAT) would deliver a larger direct boost to the economy in the near-term. And being a long term government ambition it would not, of course, be temporary.

Increasing the income tax allowance takes low income people out of income tax. Therefore, it is the best way of focusing income tax cuts on those with lower incomes. And it will strengthen work incentives, especially for low earners. But it is important not to claim too much for a policy which, especially in the current fiscal climate, is expensive. By definition it will not help those on the lowest incomes, who do not pay income tax anyway. And in the current context it is clearly not the best way of delivering a short term fiscal stimulus - and it should not be pursued for that reason. Any stimulus needs to be timely, targeted and temporary.

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http://www.ifs.org.uk/publications/6045 Fri, 09 Mar 2012 00:00:00 +0000
<![CDATA[How can policymakers raise household saving?]]> Concern that too little saving is done by a significant number of UK households has long been a motivation for government policy. This is particularly the case for retirement saving: the Pensions Commission estimated in 2004 that perhaps nine million people were under-saving for their retirement. The issue is potentially wider than retirement saving alone: recent IFS research found that the median family had little more than a thousand pounds in liquid financial wealth in 2005. However, any intervention by policymakers designed to increase household saving rates should ideally be based on high quality evidence on the efficacy of different policies.

Today, a new British Academy policy centre report, authored by IFS researchers, is being launched. The report examines the evidence base for four different types of policy to promote household savings:

  • Using financial incentives such as tax-favouring and matching;
  • Financial education, training and information provision;
  • Choice architecture and 'nudges';
  • Social marketing, using techniques from commercial marketing to promote social goals.

 

The report critically assesses the literature on whether policies in these areas, both in the UK and abroad, have been successful in encouraging households to save more. Many of these policies have been actively pursued in the UK. Financial incentives include generous tax treatment for pension saving, and matching policies such as the previously piloted Saving Gateway. The government has recently consulted on a review of Personal, Social, Health and Economic education in schools which could recommend making financial education a statutory component. Under choice architecture, 'auto-enrolment' into employer provided pensions is set to be rolled out from October. This compels employers to default most workers into a pension scheme from which employees can subsequently choose to opt-out, rather than the current system into which people typically need to opt-in.

The report concludes that, despite the obvious importance attached to the issue in the UK and internationally, significant gaps in the evidence base for whether policymakers can raise overall household saving remain. There are of course some high quality exceptions, but relatively few studies are able to combine credible counterfactuals (what would happen to saving and wealth in the absence of the policy?) with good measures of total savings. For example, there is convincing evidence that financial incentives can raise the amount saved in the favoured savings vehicle. There is much less compelling evidence on whether these incentives increase total savings or just represent assets being shifted from one form of saving to another.

Similar issues arise in assessing 'nudge'-inspired policies like changing default options for pensions saving. There is plenty of evidence that auto-enrolment raises participation in pension schemes (often substantially) but much less sense of the extent to which it raises total saving, if at all. Auto-enrolment can lead some people to save less than they otherwise would have done: most people who auto-enrol stick to the default contribution levels and investment funds which are often quite conservative.

Many studies assessing financial education or training look at the impact of policies on financial knowledge or on intended changes to savings behaviour, but there is not much good evidence that these outcomes translate into genuinely higher household saving rates.

Some other key conclusions from the study are:

  • Not much evidence can be found on the long-term impacts of these policies, and whether they help entrench saving habits;
  • Interventions are sometimes packaged together (such as combining matching with financial education). It is hard to disentangle which aspects of the package are effective in isolation, and whether the impact of the policy as a whole exceeds the sum of its parts;
  • Relatively little evidence, except for that around financial incentives, is specific to the UK;
  • The possible use of 'social marketing' to promote savings has been little-researched.

While the evidence base is in general limited, this is not a reason for inaction if there is a genuine need for intervention. Indeed, it presents something of an opportunity for the government. The move to auto-enrolment in the UK, for example, ought to be robustly evaluated, to provide evidence not just on how the UK scheme should be improved but also for other countries thinking of similar reforms. New pro-savings policies should also be introduced in ways which allow their effects, short- and long-term, to be assessed properly, ideally through randomised trials. This requires proper measurement of total saving and wealth, considering possible spillovers to those not directly affected (for example, some studies of workplace financial education show an effect on the saving behaviour of non-treated workers or family members outside work), and perhaps allowing for random variation in the way policies are 'framed' which also appears to affect behaviour.

Of course while trials are important they may not always be appropriate or easy to implement. Thus evidence in this area needs to feed into the continued development of theoretical models of saving behaviour. Together with good household-level data on saving and assets (which has been much improved in the UK by the introduction of the Wealth and Assets Survey in 2006), this will allow researchers to assess the likely impact of policy compared to a modelled counterfactual even when trials are not feasible. Using multiple, complementary approaches in this way will hopefully mean a significant improvement in the evidence base in the future.

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http://www.ifs.org.uk/publications/6027 Wed, 22 Feb 2012 00:00:00 +0000
<![CDATA[Thoughts on a benefits cap]]> This week, debate over the Government's Welfare Reform Bill has returned to the House of Commons. An element that has grabbed a lot of attention is the proposed benefit cap for working-age households (excluding those claiming Disability Living Allowance or Working Tax Credit), which will be set at £350 per week for childless single people and £500 per week for other households. This is now expected to affect about 67,000 households in Great Britain when implemented in 2013-14, reducing their benefit entitlement by an average of £83 per week and cutting the benefits bill by about £290 million in that year. To put this in context, other planned cuts to welfare spending amount to about £18 billion per year by the end of this parliament, and will affect millions of working-age benefit recipients.

How could households be in receipt of more than £500 per week in benefits? Put simply, they must have either a large number of children or high housing costs (or both). A couple with four children and no private income would be entitled to about £373 per week in Jobseeker's Allowance, Child Benefit and Child Tax Credit. If they paid rent of £127 per week or more (plausible rent levels for those who rent privately or are in social housing in London), a Housing Benefit claim to cover this would result in total benefit income of at least £500 per week. A smaller family could also be affected by the cap if they live in a particularly high-rent area such as London and consequently claim a large amount of Housing Benefit (for an example, a 3-bedroom household who rent privately can claim up to £340 per week in Housing Benefit to cover their rent). The Government's Impact Assessment estimates that 69% of households that will be affected have at least three children, and 54% live in Greater London (where rents are high).

So what will this policy achieve, apart from reducing state benefit payments to about 67,000 households with lots of children and/or high housing costs? The Government has said that it hopes there will be two forms of behavioural response: families may move to cheaper accommodation to reduce their housing costs, and/or take up paid work because their out-of-work benefit entitlement will have been reduced. A third possible form of behavioural response is in fertility rates, since the cap will effectively reduce state financial support for some large families (see here for previous IFS research on fertility and financial incentives). If this were the main intended impact, though, one would expect to see the policy affecting only new claimants of child-contingent benefits. A fourth possible behavioural impact is for fewer people to cohabit, since the benefits cap is to apply at the household level, and hence living apart could split benefits across households and mean that neither is subject to a cap. This 'couple penalty' is presumably something the Government would not be keen on, as it has said that it wishes to reduce couple penalties in the tax and benefit system.

Crucially, is a benefits cap the best approach to take to deal with benefit payments that the Government deems excessive? If it thinks that the benefit system is giving some families a level of entitlement that is too high, it must believe that some benefit rates are inappropriately high. The best-targeted response would surely be to change those benefit rates. In this particular case, the logic underlying the Government's belief that no family should receive more than £500 per week in benefits would point towards cutting the amount families receive for having large numbers of children and/or reducing the value of housing costs against which people can claim Housing Benefit.

The apparent simplicity of instead just placing a cap on total benefit receipt might look appealing, and may well be politically expedient. But it seems incoherent for a Government to set a system of benefits which it evidently thinks gives some families excessive entitlements, and to then attempt to 'right this wrong' with a cap. If starting from scratch, this is surely not the approach one should want to take. And very shortly the Government will be starting from scratch - its planned Universal Credit is to replace almost all of the existing system of means-tested benefits and tax credits for those of working age. If it has a view on the maximum reasonable level of benefit entitlement for these people, then it should design Universal Credit (and in particular, the child and housing cost additions within it) to reflect that view. It is not clear what is gained from instead layering a cap on top of a system that is designed to allow higher payments.

The approach of tweaking particular benefit rates, rather than imposing a post hoc cap on total benefit receipt, would also force the Government to think carefully about (and be explicit about) the features of the current benefits system that it considers inappropriate. Apart from improving the quality of its solution to the perceived problem, this may also improve the quality of wider debate about the issue. After all, it would make it crystal clear what precisely the debate is about.

 

 

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http://www.ifs.org.uk/publications/6012 Thu, 02 Feb 2012 00:00:00 +0000
<![CDATA[Reforming VAT: a promising proposal, but much more still to be done]]> On December 6th, the European Commission published a communication outlining proposals for reform of the EU VAT system with the aim of making it simpler, more efficient and more robust. As part of the evidence gathering for this communication, a study on the workings (and failings) of the existing VAT system by a consortium of economic institutes, including the IFS, was commissioned. Here we briefly discuss the plans set out by the European Commission and some of the findings of our study. To summarise, if the Commission's proposals are fully realised, complying with VAT procedures, particularly when trading across borders, would be considerably simpler, and the system should be more robust to fraud: hence, the plans represent a genuine improvement over the existing system. However, although the plan envisages some reduction in the scope of VAT exemptions and reduced rates, here significant problems look set to remain. This reflects the fact that responsibility for the use of reduced rates of VAT and exemptions largely lies with the Member States themselves, rather than the Commission.

One focus of the Commission's proposal is on improving VAT administration, with the hope of reducing compliance costs for firms, and increasing the capacity of revenue authorities to detect and prevent fraud. A central website which would provide information on VAT rules and rates for each EU member state is proposed, as is the provision of both more information about policy changes and improved facilities for consultation prior to policy changes. More radically, the Commission advocates a standardised VAT declaration by 2013, and potentially, further standardisation of VAT procedures and forms, and the adoption of a One Stop Shop approach where many traders would need to only deal with the tax authority of one member state (generally the country in which they are based). Such moves could reduce compliance burdens for businesses engaged in cross-border trade, especially smaller businesses. Our study shows that reductions in the costs of complying with different VAT rules in different countries could boost cross-border trade, GDP and household consumption so such efforts should be welcomed. Plans to encourage the sharing of information and best practise between national revenue authorities and to investigate the potential of a trans-national anti-fraud team also seem sensible.

Another promising proposal is to abandon the long-standing objective of moving towards a VAT based upon taxing cross-border trade at the rate of VAT applicable in the exporting country (the origin principle). Doing this will allow the Commission to focus on improving the operation of the existing EU VAT system largely based on the destination principle: taxation in the importing country at the importing country's VAT rate. Such a system has real benefits. For instance, cross-country differences in rates of VAT should not distort where firms choose to source their inputs from: they pay the domestic rate of VAT whether they buy things from a domestic supplier or a supplier based in another EU country.

Perhaps more controversially, the Commission envisages broadening the VAT base with efforts to reduce the extent of exemptions in the public interest (including in the public sector), and in the provision of passenger transport services. This will initially focus on areas where the distortions to the European Internal Market and competition with non-exempt firms are greatest. The report also recognises that the plethora of reduced rates of VAT increases the complexity of the system for relatively little gain. A review of the current rate structure of VAT is proposed, with the aim of abolishing reduced rates that are harmful to the Internal Market, or that apply to goods for which consumption is discouraged by other EU policies, whilst ensuring similar goods and services face the same VAT rate.

This represents a step in the right direction, but will leave many exemptions and reduced rates in place. However, as stated by the Commission "the Member States are primarily responsible for limiting as far as possible the scope of such [reduced] rates", and they also have some discretion about when to apply exemptions. Implementing a reduction in the use of exemptions and reduced rates is likely to be political difficult: those sectors benefiting from them will lobby against their abolition, and it is unlikely to be popular with national electorates either. But doing so would bring real economic gains.

Exemptions, in particular, are anathema to the whole principle of VAT. Where they exist, there are significant distortions to decisions by firms of whether to self-supply or purchase goods and services from the market, and to competition between exempt and non-exempt firms and firms in different EU countries. There is also an increase in compliance and administrative costs for those firms that have to allocate input tax between exempt and taxed transactions. Through these mechanisms, exemptions reduce productivity and output, impede the Internal Market and reduce the international competitiveness of European industries. They also mean forgoing significant revenues: for instance, it is estimated that the VAT exemption of financial services costs the UK Treasury around £10 billion a year.

The case for most reduced and zero rates of VAT is little better. While VAT rate differentiation can be progressive, other taxes and transfers can target the rich and the poor more directly, achieving more redistribution for a lower cost. Whilst it is true that poorer households typically spend a larger fraction of their budgets on items such as food or domestic energy (subject to reduced rates of 0% and 5%, respectively, in the UK) the rich spend more in absolute cash terms. This means that it is in fact to rich households that most of the cash the government is forgoing goes to, making the case for such reduced rates rather weak. Similarly, the particular features of VAT mean that it is rarely well targeted for encouraging the use of 'socially beneficial' goods and services. Reduced rates of VAT can only encourage purchases by final consumers, when often business use of the goods in question can be equally beneficial (such as for environmental products); and the encouragement provided is proportional to price, when often the benefit from consumption is no greater for more expensive varieties of the good in question.

 

Furthermore, reduced rates of VAT distort households' spending patterns and thus tend to reduce welfare. As part of our study for the EU Commission we examined the welfare consequences of abolishing zero and reduced rates of VAT. We found that because of less distortion to household's spending decisions, removing all zero and reduced rates and using the revenue to reduce the main rate would lead to welfare gains amongst the winners that exceed the welfare losses of the losers to the tune of £1.1 billion in the UK. This is a clear measure of the loss of economic efficiency resulting from the current system. Whilst such a reform would, on its own, be regressive, changes to direct taxes, tax credits, and benefits could be used to address this concern, redistributing the gains from winning households to the poorer losing households. We have previously shown how this could be done.

Hence, whilst the European Commission's proposals are a good step towards improving the functioning and structure of VAT in the EU, it would be a shame if they were seen as all that was required to improve the system. As also emphasised in the recent Mirrlees Review, a more fundamental broadening of VAT to cover more goods and services at the standard rate could bring real economic gains, not least a significant reduction in complexity, and on average need not leave poorer households worse off.

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http://www.ifs.org.uk/publications/5958 Mon, 19 Dec 2011 00:00:00 +0000
<![CDATA[Inconsistent and inefficient UK carbon prices]]> The United Nations Climate Change Conference will take place in Durban, South Africa, between 28th November and 9th December 2011. Representatives from governments and international organisations will meet to try and agree on ways to reduce global greenhouse gas emissions.

Emissions reduction is like a form of investment, with upfront costs for an expected long-run benefit. Agreeing on who should bear the costs, in what form, and by when, is one of the most complex issues for global politics today. One principle, though, is clear: minimising the total cost of achieving lower emissions requires that it is done in the most efficient way possible. Failing to do this risks resulting in greater costs than need be or even a consequent loss of confidence in carrying through policies to combat climate change. As we describe the UK's current policies leave plenty of scope for improvement.

The damage caused by an individual's emissions affects everyone through climate change effects, but this 'externality' is not taken into account in the private decision of how much to emit. One way for policy to address this is to set an appropriate carbon price and so shift the cost back to the polluter.

A single, consistent carbon price across different sources of carbon emissions (and ideally across countries as well), is a necessary condition for minimising the cost of emissions reduction. To see why, suppose there were a carbon price of £20 per tonne applied to all emissions. This would give firms and households an incentive to carry out measures to reduce their emissions that cost less than this for each tonne of carbon saved. Suppose instead that firms faced a price of £30 while households faced a price of £10. Firms would now engage in more costly measures to reduce emissions, and households would do less. The total cost of reducing emissions by the same amount as before would rise.

Reducing the cost of carbon for households relative to firms might be done with distributional concerns in mind. But it is not at all clear that distributional objectives are best met through variable carbon prices rather than other parts of the tax and benefit system. Furthermore, higher carbon prices for firms may well ultimately fall on households through higher prices or lower wages, but in ways which are much less transparent (and thus harder to compensate for) than direct carbon charges on the household sector.

Existing policies impose both explicit and implicit prices on carbon emissions, which vary greatly across energy sources and energy users. In the UK all electricity produced by burning fossil fuels is subject to the EU Emissions Trading System. Layered on top of this, businesses face the Climate Change Levy (CCL) and the Carbon Reduction Commitment (CRC). The CCL charges firms on the basis of their use of gas or non-renewable electricity. Companies in some industries also get discounts of up to 80% in exchange for making a Climate Change Agreement. The CRC is a trading scheme, which requires firms that exceed a particular threshold of electricity use to purchase allowances for each unit. It has some interaction with the EU ETS, and this layering of trading schemes creates particular complexities. Households are not subject to the CCL or CRC. Indeed, household use of gas for cooking and central heating attracts no carbon tax at all. The figure shows the total carbon prices faced by households and businesses across a number of emissions sources in 2011-12 and 2013-14.

 

There are some things we exclude from the chart below. First, domestic energy is also subject to the reduced 5% VAT rate, so it is effectively subsidised by the tax system. Second, there are additional effects on energy bills of various cross-subsidies for efficiency measures and green energy production, such as the Carbon Emissions Reduction Target and the Feed-In Tariff.

It is not really possible to determine what the effective carbon price is for vehicle fuels. If we assume that all the tax levied on these fuels were there to capture the cost of carbon, then the effective carbon price would be a massive £251.74 per tonne for petrol, and £219.43 for diesel. In reality, most of the social costs imposed by driving take the form of congestion costs, so we should think of much of the tax as capturing these costs rather than emissions.

 

Implicit Carbon Prices

Carbon prices

Note: Only the CCL, Renewables Obligation, CRC, Carbon Price Support Rate, and EU Emissions Trading Scheme are included here. The business rate assumes participation in the CRC.

As can be seen from the figure, taking the current set of policies, for which we can straightforwardly estimate the carbon price, it is clear that households are charged much lower carbon prices than firms, and that gas used for heating is charged a lower price than electricity.

In addition, all users face lower implicit carbon prices on coal-fired electricity relative to gas-fired electricity. Businesses pay £22.20 more, and households £6.90 more, for a tonne of carbon emitted from gas-fired rather than coal-fired electricity. This is because neither the CCL nor the Renewables Obligation (RO) discriminate between non-renewable fuels on the basis of their carbon content, raising the implicit carbon price for the relatively less polluting gas compared to coal.

This inconsistency in carbon prices will continue in the coming years, with the gas-coal differential for business electricity rising slightly to £22.70 in 2013-14. The introduction of the Carbon Price Support Rate (due to be implemented in April 2013) will help ameliorate the dispersion of carbon prices because it depends explicitly on carbon content and applies to domestic and non-domestic sectors alike. But this effect is small, and is offset by the expansion of the Renewables Obligation, which does not depend on the carbon content of non-renewable fuels.

The current system is not the uniform carbon price necessary for emissions reduction to be done in the least costly way, but rather a complicated tangle of policies. Other interventions, such as targeted subsidies and product regulations are likely to be needed to achieve emissions reductions. But there is no reason these should substitute for, rather than complement, a uniform, transparent carbon price.

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http://www.ifs.org.uk/publications/5927 Fri, 25 Nov 2011 00:00:00 +0000
<![CDATA[Small beer? assessing the Government's alcohol policies]]> The March 2011 Budget raised the duty on strong beers (above 7.5% ABV) by 25% and cut the duty on weak beers (2.8% or less) by half. The Home Office has also announced plans to ban 'below-cost' alcohol sales in England and Wales, with 'cost' defined as the total tax (duty and VAT) due on each purchase, though precisely when the ban is to be implemented is unclear. In Scotland, the SNP Government has introduced a Bill to implement a minimum price per alcohol unit from 2012, following an unsuccessful attempt to do so last year. A new Briefing Note published today looks at these three policies in depth, using detailed data recording the off-licence alcohol purchases of more than 25,000 British households.

The changes to beer duty came into force in October. For the products affected, the effect is significant: the total tax (including VAT) due on a 4 x 440ml purchase of 2% ABV lager fell from 78p to 39p, whilst at 8% ABV the tax rose from £3.33 to £4.17. However, strong beers made up just 0.8% of all off-licence alcohol units purchased in 2010 and weak beers just 0.2%, so the policy has a big effect on a very small part of the market. The biggest impact is likely to be on households who consume large amounts of alcohol (more than 35 units per adult per week), who buy 23% of all off-licence units but 53% of strong beer units. Notably, the reform did not affect cider. This means that, on a per-unit basis, the duty on a strong 7.6% ABV beer (23.2p) is now more than three times higher than the duty on a 7.6% ABV cider (7.1p). Rather than switching to low-strength beer, the reform might encourage strong beer drinkers to consume strong cider instead.

A ban on 'below-cost' sales introduces a de facto minimum price for alcohol. For example, a litre bottle of vodka at 40% ABV could sell for no less than £12.25 and a 75cl bottle of wine at 12.5% ABV for no less than £2.17. The impact of the ban is likely to be small: only 1% of off-licence units retailed at less than the tax due in 2010 (see Table). Spirits sell below cost more often whereas cider and alcopops virtually never do. We find no evidence that large supermarkets were more likely to sell below cost; rather, discount stores, off-licences and corner shops were more likely to do so. Nor is there strong evidence that households who drink more bought below cost products more often.

Average off-licence prices per alcohol unit and proportion of units below 45p and 'cost', 2010

 

Average off-licence prices

Note: prices in December 2010 values. Source: Calculated from Kantar Worldpanel data.

 

These two reforms would have only marginal effects on the market for alcohol. By contrast, a minimum price could be a much bigger policy. Introduced across Britain at 45p/unit - the level proposed in Scotland last year - minimum pricing would directly affect 71% of off-licence alcohol units (see Table), and nearly 9 out of 10 households who buy off-licence alcohol. Unlike the below-cost ban, a minimum price would apply to all alcohols at the same rate. Lager and cider (which have low per-unit prices) would be particularly heavily impacted, whereas alcopops would not.

The effects would be largest for those who drink the most: about four-fifths of units bought by those consuming 30 or more units per week cost less than 45p. This lends some weight to the idea that minimum pricing targets heavier drinkers, but even amongst those consuming more moderately (6 to 10 units per week), two-thirds of units purchased would be affected.

A previous Observation and Briefing Note discussed some of the economic issues around minimum pricing. What would be most useful for the debate around minimum pricing would be convincing evidence not just of the direct effects, but the indirect impacts as well - how would retailers change the price of alcohol currently selling above the minimum price, or the price of other products? How would manufacturers change the range of alcohol products available once cheap goods are no longer competitive on price? As yet we do not have clear answers to these questions, but these secondary effects are extremely important in assessing the overall impact of minimum pricing.

In the absence of any behavioural responses or wider price changes, our estimates suggest that a 45p/unit minimum price would transfer £1.4 billion a year from drinkers to alcohol producers and retailers. If the intention is to raise the overall price of alcohol, it would seem preferable that these revenues flow to the Government instead. Annual real-terms increases in alcohol duties to 2014/15 are planned, but more fundamental change to the structure of alcohol taxes should be pursued as well. At the moment, different types and strengths of alcohol are taxed at very different effective rates per unit (see Chart), without a clear rationale. Whilst the tax system could not easily replicate a minimum price directly, a sensible starting point would be to tax all alcohol equally on the basis of alcohol content, perhaps in conjunction with a 'below-cost' ban, which would then introduce a floor price directly through the tax system. For example, taxing all alcohol at 25p/unit (the current rate for spirits) would increase the duty rate on typical beer and wine products by around 30% (and more than double the duty on typical ciders), and raise around £1.5 billion per year. Such a reform would require a change in EU Directives which restrict the basis on which alcohol is taxed, and the Government should seek to make this happen.

Effective rate of duty per alcohol unit by alcohol type, as at October 2011

Duty per alcohol unit by alcohol type

Source: Calculated from HMRC figures. Notes: Cider and perry rates are for 'still' ciders; different rates apply to 'sparkling' ciders which are a very small part of the cider market. Ciders above 8.5% ABV are treated as wine or spirits. Wine above 22% treated as spirits. Spirits duty rates apply to alcopops.

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http://www.ifs.org.uk/publications/5923 Thu, 24 Nov 2011 00:00:00 +0000
<![CDATA[Corporate tax revenues]]> In October most large companies (those with previous annual profits of over £1.5m) made the third of four instalments due in 2011-12 for their corporation tax. Oil and gas firms paid one of their three instalments. In March this year the Office for Budget Responsibility (OBR) forecast that corporate tax receipts for the current financial year would increase by 14.2%. Figures released today show that over the first seven months of this financial year corporate tax receipts were running 0.7% below the same period last year. In October receipts actually fell by 6.9%, compared to the same month last year, with the OBR attributing this to financial sector firms being adversely "affected by weaker investment banking activity, writedowns on euro area sovereign debt and provisions for the mis-selling of payment protection insurance" and a steep fall in gas and oil production, partly as a result of increased maintenance and temporary shutdown of fields.

Corporate tax raises significant revenues - around £43 billion, or 8% of total revenue in 2010-11. Corporate tax revenues (in cash terms) peaked in 2007-8, and fell in each of the two following years. Corporate tax receipts from North Sea oil companies fell particularly sharply. This trend was reversed in 2010-11 when corporate tax receipts increased by 18%. The strongest growth came from the financial services and North Sea sectors.

 

Corporation Tax net receipts, by sector, 2000-01 to 2010-11 (£ billions)

 

 Corporation Tax net receipts, by sector

 

Source: HMRC, Table 11.1

 

The financial services sector has tended to be a large contributor to UK corporate tax receipts. Revenues from this sector, as well as from North Sea companies, are among the more volatile. Going forward there are a number of uncertainties related to amount of revenue the government will raise from the financial sector. There is uncertainty about the future level of financial sector profits and whether they will remain in the UK. There is also some uncertainty over how the sector will be taxed going forward (the government introduced a Bank Levy in January this year and there are calls from, among others, the European Commission to introduce a so called 'Tobin Tax' on financial transactions).In its latest medium term forecast the OBR set out that the share of total receipts from the financial sector (including PAYE, NICs and corporation tax) is not expected to return to the 2007-08 peak by the end of the forecast period in 2015-16 (see Box 4.1)

Who pays tax?

First, it is important to remember that ultimately companies don't pay tax, people do. The actual incidence of corporate tax is borne either by the owners of capital (in the form of lower investment returns), by workers (in the form of lower wages) or by consumers (in the form of higher prices). Of these groups, capital tends to be the most mobile. As a result corporate tax tends to get shifted to workers or consumers - and especially workers - but with a larger distortionary effect than if these groups had been taxed directly. This is especially important in discussions about companies paying their 'fair share'. With this in mind, we discuss how tax payments vary across companies.

As you would expect, the large companies that earn the majority of profit also pay the largest amount of tax. In 2007-08 the largest 1% of companies (by taxable profit) accounted for around 80% of corporate tax receipts. Many small and medium companies pay no tax at all, either because the make no profits or because they have losses that can be carried forward and offset against tax liabilities. We also expect that as profit increases, the proportion of profit paid in tax will increase. This is because allowances, which act to reduce tax liability, become much less important at higher income levels.

Recent work by the Oxford Centre for Business Taxation provides a detailed analysis of the amount of tax UK firms pay as a percentage of their profits. This varies across companies depending on a large number of factors. They find that most large companies, and those within multinational groups, pay on average a higher proportion of their income in corporate tax. However, there are a small group of the very largest companies that appear to pay little or no tax in the UK.

Tackling tax avoiders?

Tax avoidance has attracted increasing attention in recent years, with a number of groups calling for government action to increase the amount of tax we collect from companies.

There are a range of ways in which firms seek to minimise their tax bill. We expect most firms to take full advantage of allowances and provisions in the tax code - no one expects companies voluntarily to pay more tax than is necessary. Some firms may be more aggressive in their tax planning and seek to exploit loopholes or favourable interpretations of uncertainty in tax legislation. While this activity is legal, many would argue that it is not in the spirit of the law. However, these activities are distinct from tax evasion, in which firms illegally manipulate their tax liability.

The precise characterisation of what counts as tax avoidance is subject to much debate and has many grey areas. The OECD defines tax avoidance as 'the arrangement of a taxpayer's affairs that is intended to reduce his tax liability and (...) is usually in contradiction with the intent of the law it purports to follow'. Of course, not all parties will interpret the 'intent of the law' in the same way. These issues and the possible ways in which the UK government could seek to address avoidance are reviewed in a recent Tax Law Review Committee paper.

We do not have precise measures of which firms are avoiding tax or by how much. The tax gap - the difference between the amount of tax that firms 'should' and actually do pay - is not only hard to define conceptually but is extremely difficult to estimate accurately. Clearly, this difficulty arises largely from the need to determine the correct amount of tax a company owes.

HM Revenue and Customs have produced an analysis on the UK tax gap, noting the many impediments to the exercise. The estimated corporation tax gap was £6.9 billion in 2008-09, which represented 14% of the overall gap - i.e. 14% of difference between total theoretical liabilities and all collected tax receipts.

The government are taking a number of steps to reduce tax avoidance, including considering the possibility of introducing a General Anti-Avoidance Rule (GAAR) - a broad set of principle-based rules designed to prevent tax avoidance. A report commissioned by the Government to consider the merits of a GAAR, and published yesterday concluded that "a moderate rule which does not apply to responsible tax planning, and is instead targeted at abusive arrangements, would be beneficial for the UK tax system" and that the focus should be on "abnormal" practices. But a grey area between what is normal and what is abnormal might be difficult to avoid.

 

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http://www.ifs.org.uk/publications/5885 Tue, 22 Nov 2011 00:00:00 +0000
<![CDATA[Rate cutting, base broadening: a reduced incentive for investment?]]> As part of a large package of corporate tax reforms, the coalition government announced a series of cuts in the statutory rate, alongside broadening of the tax base. The main rate of corporation tax was reduced from 28% in 2010 to 26% from April this year and will fall to 23% by April 2014. From April 2012, the main rate of capital allowances will fall from 20% to 18%, the special rate from 10% to 8% and the Annual Investment Allowance from £100,000 to £25,000. These changes operate to reduce the proportion of the previous year's expenditure on certain types of capital that can be deducted from revenue to calculate taxable profits.

Ed Miliband's accusation that the coalition's policy will be to the detriment of manufacturing firms appears to be based on the fact that the package of tax changes will be relatively more beneficial to high-profit firms that invest less in plant, machinery and buildings. This assertion is correct. However, the conclusion that this leads to a tax system rigged against investment fails to acknowledge that firms invest in many types of capital, importantly including intangible capital. Some of the relative winners will be those firms that make important long term investments in skills and ideas, which benefit relatively less from current allowances.

In addition, the OBR predicts that the cost of capital will be lower for new investment by non-financial companies. As ever there is a trade-off here. Corporate taxes are known to be distortionary. Rate cutting and base broadening have opposing effects on firm incentives to invest. Overall the package of measures will give the UK a slightly more competitive tax system. In the longer term making the system significantly more competitive may mean raising less revenue from corporation tax.

On the specific issue of the appropriate level of capital allowances an important principle to consider is that of neutrality - the tax system should aim not to distort firms' decisions over how to organise their activities, how much activity to undertake and where that activity is located. To do so creates inefficiencies and is therefore costly. Since we don't know the actual economic rate for depreciation for each asset, there is debate over the relevant rates. Broadening the tax base alongside cuts to the rate is a policy mix that that has been favoured by policy makers across the developed world for the last 30 years. Indeed, this was a trend followed by the last Labour government.

Changing the tax burden

The Treasury estimates that the package of tax rate and allowances cuts will be broadly revenue neutral - the 2014-15 revenue gain from reducing allowances, allowing for some changes in behaviour but not accounting for any change in the level of investment, will almost exactly offset the estimated cost of reducing the main rate. Within this there will be relative winners and losers.

Taken together the cuts to the statutory tax rates and capital allowances will benefit high-profit firms with lower investment in plant, machinery and buildings (excluding those subject to the Bank Levy) relatively more since they gain more from the rate cuts than they lose from the base broadening. The base broadening will have the largest impact on those firms that invest intensively in the types of capital-long-lasting equipment and machinery - that are subject to capital allowances.

However, this does not mean that the policy necessarily favours low investment firms. Some firms in the manufacturing sector, as well as some in capital-intensive service sectors such as transport, will be relative losers. But there are high investment firms that benefit relatively less from current capital allowances. Importantly, this includes firms that invest in intangible assets that are not subject to allowances (even though investments in skills and ideas can depreciate in conceptually the same way as a machine). Intangible assets represent an important input into production for most firms; in the UK knowledge investment overtook fixed capital investment in the mid-1990s and is now about 50% higher. Many firms, including those in high tech manufacturing, that make long term investments in skills and ideas, are likely to be relative winners of the package of reforms. Therefore, while the package of tax changes does represent a redistribution of the tax burden, the outcome cannot be characterised as simply as saying that high investment firms are losers and low investment firms winners.

The crucial point about a lower rate is that it will help attract (and avoid deterring) internationally mobile capital, which is often highly related to investment in intangible capital.

The OBR forecast included in the June 2010 Budget sets out its judgement that overall the cuts in the corporation tax rate will more than offset the reduction in investment allowances such that the 'cost of capital for new investment is lower for all non-financial companies, and the rate of return from the existing capital stock is higher'.

This is wholly consistent with the figures reported in the Commons library briefing note, showing that the reduction in the Annual Investment Allowance (from £100,000 to £25,000) is estimated to affect between 100,000 and 200,000 businesses. The report also highlights that the package is expected to boost investment and that more than 95% of businesses in the UK will be unaffected (because their qualifying capital expenditure will continue to be completely covered by the annual investment allowance).

How competitive is the UK corporate tax system?

The key aim of the government's package of corporate tax measures - which includes reforms to the 'controlled foreign company' (CFC) rules, a cut to the small profits rate and the introduction of a Patent Box - was to "create the most competitive corporate tax regime in the G20".

A recent report by the Oxford Centre for Business Taxation set out that while the UK has a relatively low statutory tax rate - it ranks 7th out of the 19 independent G20 countries (excluding the European Union) - accounting for less generous capital allowances means that the improvement in UK competitiveness is lower for some measures.

 

  • The UK's effective average tax rate (EATR) - the relevant measure for considering where firms locate discrete investment projects - is just over 26% in 2011, ranking it 9th. This represents a fall from 4th in 2002, and places the UK above the G20 average. The coalition's package of reforms, conditional on other countries not changing their tax systems, would place the UK 5th in the ranking.

 

  • The effective marginal tax rate (EMTR) - the measure relevant for considering the level of investment - is just under 23% in 2011, giving it a rank of 15th, which will fall to 14th by 2014.

 

Research suggests that part of the fall in statutory rates that has been seen across countries in recent decades can be attributed to governments lowering tax rates in response to lower rates elsewhere, in an attempt to attract and retain increasingly mobile capital. Over time, in the face of even more mobile capital and potentially greater tax competition, governments should expect to raise less revenue from corporate tax. Indeed, it may be difficult to substantially increase the competitiveness of the UK tax system with revenue neutral tax changes.

Cuts to corporate tax - which raises significant revenue; around £43 billion, or 8% of total revenue in 2010-11 - are often politically unpopular. However, it is worth noting that the ultimate incidence of corporate tax always lies with households and is borne either by the owners of capital (in the form of lower dividends), by workers (in the form of lower wages) or by consumers (in the form of higher prices). Capital tends to be much more mobile than workers or consumers, and so corporate tax tends to get shifted to domestic factors - and specifically labour - but with a higher associated deadweight cost than if those factors had been taxed directly.

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http://www.ifs.org.uk/publications/5738 Tue, 01 Nov 2011 00:00:00 +0000
<![CDATA[A fat tax in the UK?]]> Yesterday, the Government published a "call to action" which lays out its strategy for tackling obesity in England. The document sets out plans for government to work with the food and drinks industry to achieve a reduction in obesity. One measure for tackling diet related health problems is to introduce some form of 'fat tax'. Although not mentioned in the report, following the introduction of such a policy in Denmark last Monday, the Prime Minister David Cameron stated that introducing a similar tax in the UK "is something we should look at". The Danish tax places a surcharge on foods that contain more that 2.3% saturated fat, including products such as butter, milk, cheese, pizza, meat and processed food. Mr Cameron suggests that introducing a similar measure could be one way of tackling rising health costs and falling life expectancy among some groups of people. Many other countries are considering policies aimed at improving diet through increasing the prices of certain products (for example, Hungary recently imposed a tax on foods with high fat, salt and sugar content, various US States have adopted or contemplated soft drink taxes and the Scottish Government intends to introduce a minimum price for alcohol).

The rationale behind levying a tax on foods that are rich in saturated fat is that, by increasing their price, the tax will encourage people to eat less of these foods. The hope is that this will help curb consumption of saturated fat which, according to the Food Standards Agency, is on average 20% above the recommended level. Excessive saturated fat consumption is a risk factor for heart disease, so lowering consumption should lead to a reduction in the incidence of heart disease, all else equal.

IFS has recently received long-term funding from the European Research Council and the Economic and Social Research Council to investigate the impact of these types of policies.

It is important to be clear about what, precisely, the objective of such a policy is - what role is there for government in influencing what individuals decide to eat? Are people not in a better position than government to trade off their likes and dislikes and to choose to eat the products they favour most? The two main reasons why government intervention might be justifiable are:

  1. Some people may not be fully informed about the amount of saturated fat they can eat as part of a healthy diet and which products contain large quantities of fat. Providing information may seem like a natural response, but it may be that some people are difficult to reach or are not capable of processing this information accurately. Young children are the most obvious example. Raising the price of foods rich in saturated fat may help reduce consumption levels in a similar way to conveying information.
  2. While most of the costs of ill health arising from a poor diet are borne by the individual themselves, some costs are incurred by other members of society, for example, through increased health care costs and increased sick leave. When individuals decide what to eat they have no incentive to take these external costs into account; this results in a socially excessive level of consumption. By increasing the price of consuming fatty foods, a tax is one way of tackling this over-consumption.

Whether a 'fat tax' is the best policy response to high levels of diet related illness will depend on what of these failures in the market the government is targeting. Griffith and O'Connell (2010) discuss these failures and how well suited various policy options are to addressing them (see Griffith and O'Connell Public Policy towards Food Consumption, Fiscal Studies, vol. 31 no. 4 pp. 481-507) .

Before deciding that introducing a 'fat tax' is a good way to tackle poor diet, the government must also be clear about what element of diet it seeks to influence: is the aim to reduce consumption of all sources of saturated fat, only certain sources (for example, confectionary but not milk), or a set of nutrients often excessively consumed (like salt and sugar, in addition to saturated fat). This will influence the choice over the appropriate set of products to tax.

A second question is what impact any particular policy reform would have. This is not a simple question to answer. It depends on the specific structure of the tax, the market environment, and most importantly on how sensitive consumers are to changes in price. Both the structure of the tax (for instance, whether it is specific or ad valorem) and the nature of competition in the market will determine how taxes are fed through to prices. Griffith, Nesheim and O'Connell (2010) explore these issues by estimating the impact of a fat tax levied on butter and margarine and show that these considerations have a very substantial effect on how a tax would impact consumers, firms and government tax revenue (see Griffith, Nesheim and O'Connell Sin taxes in differentiated product oligopoly: an application to the butter and margarine market, CEMMAP Working Paper CWP37/10). Although the relationship between tax and price changes is a complicated and partially understood one, there are some things the government can do to maximise the potential rise in prices, given the magnitude of the tax; for instance, Griffith, Nesheim and O'Connell (2010) provide empirical evidence that a specific tax is likely to result in higher prices than a comparable ad valorem tax designed to raise the same amount of revenue.

The response of consumers to any price changes will be crucial. The more sensitive a consumer is to price the more effective the tax will be at reducing consumption of the taxed goods. But whether the tax is successful in improving diet will also depend on what individuals would choose to consume instead. A tax levied on butter, but not margarine, may be effective in curbing saturated fat consumption. But since margarines tend to contain more salt than butter, the policy may have the perverse consequence of exacerbating other health problems.

A final important point concerns whether a 'fat tax' would be regressive or progressive. As lower income households tend to spend a higher fraction of their total budgets on food, a disproportionate proportion of any such tax is likely to fall on their shoulders. But the point of such a policy is to encourage people to change their behaviour. Often lower income households are the most price sensitive, which would mean they are likely to change their behaviour most as a consequence of a price rise. To assess the overall effect of the tax and whether low or high income consumers would be affected more, we would need to set the costs imposed by the tax on consumers through higher prices against the potential health benefits arising through their changed behaviour.

Governments around the world are considering how policy can address the increase in diet related disease. One policy response that is increasingly being proposed and adopted is to introduce a 'fat tax'. For this to be an effective response to high and growing levels of diet related health disease, a number of circumstances must be met. Firstly, the government must be clear about why intervention is justified and how exactly it wants to improve diet. Secondly, to be effective, any tax must feed through into higher prices. Although the relationship between prices and tax is complicated, there is some evidence that by structuring the tax carefully, the government would be able to influence how much prices increase by. Thirdly, the price increases must bring about the desired changes in consumer behaviour. There is substantial debate about the role for government in fighting diet related health disease, and how government can best help. There is less evidence about what the impact of introducing policies like fat taxes would be: how exactly would the tax feed through to prices and how would consumers respond? Researchers at IFS are working on improving the evidence base to help policymakers understand the likely impact of various specific reforms.

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http://www.ifs.org.uk/publications/5712 Fri, 14 Oct 2011 00:00:00 +0000
<![CDATA[Can the UK learn from developing countries? The case for proper policy evaluation]]> On Monday the respected economist Professor Esther Duflo delivered the IFS annual lecture discussing approaches to helping the world's poor (see slides). Professor Duflo drew on several, novel examples of randomised controlled trials (RCTs) - a method which she has put to good use in much of her own research. Randomised trials have done much to improve social policies in the developing world, and a key lesson is that we should make greater use of this important tool for evidence-based policymaking in the UK.

In an RCT, a policy is evaluated by randomly assigning it to some individuals or regions (a "treatment" group) but not to others (a "control" group). The effectiveness of the policy can then be assessed by looking at differences in outcomes between these treatment and control groups. Common in medical research, RCTs are increasingly favoured by economists as well because, by removing contaminating factors correlated with both take-up of a policy and the outcomes of interest, they allow us to estimate a policy's direct, causal impact on outcomes of interest more easily. There are of course some limitations to the use of RCTs, and they will not be appropriate on all occasions, but they can often be extremely useful as a means to assess objectively how well particular programmes are working.

Because of this, RCTs are playing an increasingly important role in the evaluation of policy and are now especially common in developing countries where Professor Duflo's work has been particularly influential. IFS's own Centre for the Evaluation of Development Policy (EDePo) has been involved in evaluating the results of RCTs from India to Colombia in areas such as microfinance, reproductive health, early childhood development and education. The evidence gathered in such trials has had an important influence on policy for two reasons. First, estimates of program impacts estimated via a well designed and implemented RCT are clean and easy to communicate. Second, the availability of a RCT gives researchers a better understanding of individual responses to different initiatives - allowing them to estimate richer and more credible behavioural models which can be used to give valuable insights into possible reforms. In other words, such trials need not just give a thumbs up or thumbs down for a particular policy but can also tell us how they can be improved. For example, data from the RCT of Mexico's PROGRESA (a programme that among other things paid grants to families who sent their children to school), allowed IFS researchers to simulate responses to various changes in the grants. This led to recommendations to refocus the grants toward older pupils who were found to be more sensitive to the financial incentive - a reform which is now itself being piloted in two northern cities of Mexico.

By comparison, RCTs have been quite rare in the UK. While there are many examples of small scale trials, there are only a few examples of full policy evaluations of the kind seen in other countries (such as the Employment Retention and Advancement demonstration, and the Skills Conditionality Pilot) and several examples of policies that could have been trialled (such as the "synthetic phonics programme", and the Work Programme), which have instead been rolled out nationwide without any prior robust evaluation.

Are there perhaps good reasons for the lack of RCTs in the UK? One objection to their use might be their cost. However, the costs of conducting trials need to be set against the costs of implementing large and costly programmes before we have a good understanding of their effectiveness, and therefore a lack of evidence of whether the programme could be improved, should be expanded or whether it should be scrapped. Indeed, the fact that external donors to developing countries often demand RCTs of the policies they are funding, suggests that they can help to ensure value for money. A second objection is that it is unfair to "make guinea pigs" out of certain regions or people. Arguably, however, rolling out untested policies nationally makes guinea pigs of us all! There have also been occasions where policies have been piloted non-randomly in certain areas before being extended nationwide - and for which full randomisation would have been only a small, beneficial, and one would have thought relatively uncontroversial, extra step.

Evidence from RCTs now plays an increasing role in formulating policies in developing countries. The UK could gain by following their example. As Esther Duflo and her co-author Abhijit Banerjee write in their book Poor Economics we should "accept the possibility of error and subject every idea, including the most apparently commonsensical ones, to rigorous empirical testing".

 

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http://www.ifs.org.uk/publications/5709 Wed, 28 Sep 2011 00:00:00 +0000
<![CDATA[How does the UK's planned fiscal consolidation compare?]]> Yesterday the International Monetary Fund (IMF) published its latest Fiscal Monitor, which surveys public finance developments across the world and updates their fiscal projections. The UK launch of the report was held at the IFS in London on 5 October (here). The data in the report can be used to provide a useful comparison of the effects of the financial crisis on the public finances in the UK with the effects felt abroad, and some indication of how the coalition government's planned fiscal consolidation currently stacks up against those planned in other countries.

Back in 2007, out of the 28 advanced economies for which the IMF compiles data, the UK is judged to have had the fourth highest level of cyclically-adjusted borrowing (that is, underlying borrowing, after adjusting to take account of the estimated impact of the ups and downs of the economic cycle). In other words, the UK entered the financial crisis and recession in a relatively poor position, with a level of cyclically-adjusted borrowing that is thought by the IMF only to be exceeded by that seen in Greece, Ireland and Portugal. As we have previously shown this is because while public sector borrowing was cut by Labour over the period from coming to office in 1997 and the start of the financial crisis in 2007 it was not reduced by as much as in the vast majority of other major industrialised countries over this period.

The crisis also affected the UK economy and public finances relatively badly. The UK experienced the 9th largest deterioration in its fiscal position during the crisis, resulting in us reaching the fifth highest level of cyclically-adjusted borrowing across the 28 countries (with the UK's peak level of cyclically-adjusted borrowing reached in 2009).

Table: UK's level of and change in borrowing between 2007 and 2015, compared to 27 other advanced economies

 

 

 UK rank Notes

Cyclically adjusted borrowing  

Level  

2007 (pre-crisis)4th highestGreece, Ireland and Portugal higher

Peak year5th highestGreece, Iceland, Ireland, Spain higher

201516th highest 

Change  

Increase, 2007 to peak9th largest 

Reduction, peak to 20155th largestGreece, Iceland, Ireland and Portugal larger

Reduction, 2007 to 20154th largestGreece, Ireland and Portugal larger

 

The 28 advanced economies on which data comparable to the UK are available are: Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Greece, Hong Kong, Iceland, Ireland, Israel, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Slovakia, Slovenia, South Korea, Spain, Sweden, Switzerland and the United States.

 

The coalition government has set out a fiscal consolidation plan which is projected by the IMF to see cyclically-adjusted borrowing reduced year-on-year until 2015. This is currently forecast to be the 5th largest reduction in cyclically-adjusted borrowing among the advanced countries considered by the IMF - only Greece, Iceland, Ireland and Portugal are currently on course to see a larger reduction.

The Figure below compares the size, timing and ultimate effect of the fiscal consolidation planned by the UK's coalition government between 2010 and 2015 to the fiscal plans of various other countries who are judged to have had similar levels of cyclically-adjusted borrowing to the UK in 2010. These can be broadly divided into two groups: those with a similar profile of fiscal tightening to the UK (shown in panel a) who are forecast to end up in a much stronger fiscal position by 2015 than they were in 2010, and those with a much slower profile for tightening (if any) than the UK (shown in panel b), who on current plans are not expected to reduce their borrowing position as substantially by 2015.

Panel (a) shows that Greece and Ireland had a slightly worse borrowing position than the UK in 2010, but are forecast to be on course to cut borrowing similarly rapidly through to 2014. Portugal meanwhile also had a similar level of borrowing in 2010 but is forecast to be on course to complete its planned tightening in 2013. The UK is currently unique amongst these countries in that the coalition's planned tightening already continues through to 2015, and therefore the UK is currently forecast to end in a better borrowing position than both Greece and Ireland. All four of these countries (including the UK) are forecast to be in a much better borrowing position by 2015 than they were in 2010. The other country that is tightening faster than the UK between 2010 and 2015 is Iceland, but the profile for the consolidation over this period only tells part of the story for Iceland; their cyclically-adjusted borrowing has already been brought down by nearly 10% of national income between 2008 and 2010.

Panel (b) shows that Spain, Japan and the USA all have slightly better cyclically-adjusted borrowing positions than the UK in 2010. The USA and Spain are forecast to experience a similar magnitude of fiscal tightening to the UK between 2010 and 2013 but with little further tightening planned thereafter. This would leave them with a relatively weak cyclically-adjusted borrowing position in 2015, forecast at over 4% of national income, suggesting that further measures to reduce borrowing are more likely to be needed in those countries. Japan, whose fiscal position has been affected not only by the global recession but also by a series of natural disasters, is forecast by the IMF to have continued loose fiscal policy over each of the next five years and cyclically-adjusted borrowing still in excess of 7% of national income in 2015.

Figure 1: How do the fiscal consolidations planned in other industrialised countries compare to the UK's plans?

Graph A: cyclically adjusted borrowing

Graph B: cyclically adjusted borrowing

There are of course many other advanced countries, which have had lower levels of cyclically-adjusted borrowing over the last few years than the UK. Generally speaking these countries are currently planning only small fiscal consolidations over this period, if they are planning reductions at all.

This comparison of the coalition government's fiscal consolidation plans with those in other countries is a picture that may change over time. Some other countries - particularly those highlighted in panel (b) - may eventually extend their plans for tightening. But there is no escaping the fact that the UK was affected relatively badly by the crisis and the government's plans will need to be harsher than those of most other advanced economies if we do not want the UK to remain with relatively high levels of public sector borrowing, which is where it stood before the financial crisis and where it currently stands.

The UK launch of the latest IMF Fiscal Monitor was held at the IFS on 5 October - click here for more details.

 

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http://www.ifs.org.uk/publications/5693 Wed, 21 Sep 2011 00:00:00 +0000
<![CDATA[China is investing rapidly in skills and science: UK should do the same]]> China has experienced unprecedented investment in skills and science, which has resulted in rapid growth in innovative outputs. New evidence suggests that Chinese inventors have the capacity to engage in research at the technology frontier. Such trends have fuelled widespread concerns over Western economies' ability to maintain their dominance in knowledge creation and high skill employment. However, innovation is not a zero-sum game; the success of China need not be at the expense of the West. The key challenge for the UK and other knowledge economies is to invest now in order to foster a highly skilled workforce that is able to both compete for and engage collaboratively in tomorrow's breakthroughs and that is flexible enough to adjust to changing conditions.

Recent years have seen increasing attention on China's technological performance, which is unsurprising given the barrage of statistics showing that innovative activities in China are growing at an astounding rate. Over the last decade, there has been rapid growth in investment in Research and Development (R&D) such that the proportion of Chinese national income invested in R&D (1.1%) is now comparable to that in the UK (1.15%). At the same time, large investments in education have produced a proliferation of Chinese graduates, almost half of which study for science and engineering degrees.

This investment in research capacity has been translated into equally impressive growth in innovative outputs. For example, in 2010 China was the fourth largest filer of patent applications to the World Intellectual Property Organization. Under a simple extrapolation of current trends, China could overtake the US to be the world's largest filer of patent applications by 2015. Contrary to much of the academic literature to date but in line with public perception, the proportion of Chinese innovation that stems from fundamental research is at least as high as in the West. That is, Chinese inventors display the capacity to innovate alongside US and European inventors at the technology frontier. An important part of these trends have been driven by the investment of Western multinationals who account for 25-30% of the R&D investment in China and who increasingly create new technologies using Chinese inventors.

Given these trends, concerns over Western economies' ability to maintain their dominance in knowledge creation and high skill employment are not surprising - innovation has been the engine of economic growth and lies at the heart of increased living standards. Nor are they wholly unfounded. Recent work prepared for the European Commission concluded that if the recent trends in R&D continue then "in 2025, the United States and Europe will have lost their scientific and technological supremacy for the benefit of Asia". Others have articulated the potential for shifts in the global job market for science and engineering workers towards China to erode US dominance by diminishing the current comparative advantage in high tech production. However, there are many reasons why these trends are not necessarily bad news for the West. Firms locating activity in China, whether to adapt products to local markets or gain access to specific skilled workers at a lower cost, can lead to standard gains from trade - firms experience improved performance and may transmit knowledge back to the home country. There is evidence that knowledge flows across national borders and is less restricted by distance than was the case 20 years ago. Importantly, innovation is not zero sum game - that more research is being carried out in China does not necessarily imply that less will be undertaken in the West. Indeed, it might be expected that there are more synergies in the creation of new technologies than new goods or services such that an increase in knowledge output in China compliments, rather than substitutes for, knowledge created in the West. In addition, China represents a new market for technologies developed in the West.

The Policy challenge

The challenges for Western governments relate not to devising policies to deter investment in China or other emerging economies, but to ensuring that they make sufficient investments in their own economies such that they remain leaders in innovation. In large part this means ensuring that we have a high skilled workforce - that can engage, both competitively and collaboratively, in creating new knowledge and that is flexible enough to adjust to changing economic conditions - and that we invest sufficiently in science and research.

In a 2006 speech, China's President, Hu Jintao, launched a plan to make China an innovation-oriented economy and leading science and technology power, proclaiming that "by the end of 2020... China will achieve more science and technological breakthroughs of great world influence, qualifying it to join the ranks of the world's most innovative countries". In support of this ambition, the Chinese government has made unprecedented investments in research capacity and increased incentives for firms to invest in innovation. Juxtapose this with recent policy moves in the UK, and in the West more generally, where austerity packages to reduce borrowing have commonly involved real cuts to the budgets for science, direct research funding and higher education. Even where science budgets have been relatively protected from spending cuts, as in the UK, investment as a proportion of national income is due to fall in coming years. Failing to invest sufficiently in science and skills can be short sighted. The impact of such spending occurs in the long run, in the form of higher productivity and economic growth. Being able to compete with China in 10 years time requires investment in skills and research today. This was recognised in 2009 by US President Obama's American Recovery and Reinvestment Act that increased in spending on science, stating, "We'll provide new technology and new training for teachers so that students in Chicago and Boston can compete with kids in Beijing for the high-tech, high-wage jobs of the future."

The current economic climate should not prevent investment in our capacity for economic growth in the future. The impact of China's rise will depend largely on whether we are with them at the technology frontier or onlookers from the sidelines. We should choose the former.

 

 

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http://www.ifs.org.uk/publications/5668 Mon, 05 Sep 2011 00:00:00 +0000
<![CDATA[How rich are you?]]> How rich do you think you are, compared to everyone else in the UK? Do you feel pretty well-off, rather poor, or just 'in the middle'? It's a simple enough question, but you may be surprised by the answer. Today, the IFS launches its first ever iPhone app, which estimates where in the income distribution you and your household fit in.

Of course income isn't everything, and there are lots of ways of measuring income. We use the same measure as the government in its official poverty statistics - that is household income, after direct taxes (including council tax) and benefits, and adjusted for family size. This means that we don't count a millionaire's spouse as being 'poor' simply because they have no personal income. It also means that larger families need a higher income than smaller ones in order to attain the same standard of living.

Imagine we were to line up everyone in the UK according to this measure of household income, forming a 60 million-strong conga line. Ignoring the fact that such a conga line would stretch more than half way around the world, lets further imagine that it passes you by at supersonic speed over a single day starting at 00.00 am. Over the first minute, you might catch a glimpse of the very small number of mega rich individuals. For example you might see CEOs and premier league footballers dancing past accompanied by their partners, such individuals could be earning over £2.5 million a year and have a weekly net income of around £23,000, over fifty times greater than the person in the middle of the conga line (the median, who you will see in 12 hours time). By 0.15 am you would have seen the richest 1% of individuals, such as bankers, surgeons or top-flight lawyers accompanied by their partners. Assuming they had no children, they would need a weekly net income of at least £2,400 to be in this top 1% (requiring income of well over £225,000 per year before tax for a single-earner). That's an income six times greater than median income. By 2.24 am, you would have seen the richest 10% of individuals, and would now be seeing some surprisingly "ordinary" families. A couple with no children where each earns £30,000 a year before tax, giving them a weekly net income of £840, would just make it in to the top 10% of the distribution.

Fast forwarding to midday, we are now exactly half way through the conga and you would now be seeing the median individual. Many different families could occupy this position. A couple with no children would need a weekly net income of £420 (e.g. a single-earner couple with an annual salary of just over £30,000 before tax). A couple with two children would, however, need a weekly net income of about £640 (e.g. a single earner with an annual salary of £45,000 before tax). By 7.55 pm you would be getting to the 17% of individuals with household incomes below the poverty line (60% of the median income). These would include couples with two children with net incomes of less than £380 per week, and lone parents with two children whose net incomes are less than £300 per week. It would also include pensioner couples with weekly net incomes of less than about £250 per week.

At the very end of the line at 11.45 pm, we might expect to see the poorest of the poor. We would almost certainly see some people struggling to make ends meet, but this is not going to be true for everyone with a low income. We would also see a number of people with temporarily low incomes - students and some self-employed who have made losses in the most recent period.

Now let's ask again: whereabouts do you think you'd fit into this richest-to-poorest conga line? Odds are that you think you'd be somewhere near the middle - not at the front, naturally (unless your surname is Abramovich), not even particularly near the front, but somewhere towards the centre of the line. Odds are, however, that you're wrong. Research conducted for the Joseph Rowntree Foundation has shown that the majority of people in the UK appear to believe that they are 'in the middle' of the income distribution. Yet in reality (or at least in our imaginary conga line) many of these people are miles away from the middle. From poorer people in the bottom third of the income distribution, up to people in the top five or ten per cent, many will happily report that they think they're 'in the middle.'

If you're intrigued to know exactly where you fit in to our imaginary conga line - you're in luck. The IFS website has long offered a calculator called (imaginatively enough) 'Where Do You Fit In?' Punch in the number of people in your household, their income (after tax) and the amount of council tax you pay, and it'll tell you exactly where you fit in to the UK income distribution. Better still, today we've launched IFS's first iPhone app, which does the same - just follow this link or search for 'IFS' in the App Store. (Of course, if you own an iPhone, odds are you're already some way up the income distribution.) If you don't, you can carry out the same exercise on our website

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http://www.ifs.org.uk/publications/5631 Thu, 14 Jul 2011 00:00:00 +0000
<![CDATA[Higher debt for decades?]]> Much attention has focused on the damage done to the UK's public finances by the financial crisis and associated recession, and the painful tax rises and spending cuts required if borrowing is to be brought back to pre-crisis levels. A longer-term perspective is provided by the publication today of the Office for Budget Responsibility's (OBR's) first Fiscal Sustainability Report. This suggests that keeping the Government's finances in a sustainable position in the longer-term will require further uncomfortable decisions to be implemented over the medium-term, on top of delivering the fiscal retrenchment already planned for the next few years.

We know that (Figure 2.6) the increase in Government borrowing since the recent crisis began could not have been left unchecked. It would have left the UK's public finances in an unsustainable position with debt forecast to rise remorselessly throughout this century. The fiscal tightening outlined in the March 2010 Budget by then Chancellor Alistair Darling would, if it had been delivered and maintained, have been sufficient to avoid this situation. The swifter and larger fiscal tightening planned by Chancellor George Osborne will (again if delivered and maintained) see debt peaking sooner and at a lower level, and then falling faster (and therefore leading to lower debt interest payments) than under Mr Darling's plan.

However as Chart 1, taken from today's OBR report shows, even if the government manages successfully to implement the fiscal tightening it has planned for this parliament, in the longer run demographic pressures (particularly from the ageing of the population) will place upward pressure on public spending. If left unchecked these would lead to higher borrowing and, as shown in the top line in Chart 1, a rising stock of public sector net debt from the late 2020s. These are not new issues, but current and future governments will need to decide how to address these pressures if UK public finances are to become sustainable over the long run. If future Governments were able to maintain borrowing forevermore at the level currently forecast for 2015−16, debt would be on course to return to its pre-crisis level towards the end of the 2030s.

Chart 1: OBR long-term projections for public sector net debt

OBR long-term projections for public sector net debt

 

 

 

 

Assuming currently legislated policy, increasing longevity, along with changing fertility and net migration, are projected to increase public spending by 5.4% of national income between 2015−16 and 2060−61 - equivalent to £80 billion in today's terms. In other words, simple changes in population structure will require us to raise taxes or cut other spending by £80 billion (roughly 11% of the current level of annual public sector expenditure, or 14% of this year's tax receipts) just to deliver currently promised levels of pensions, healthcare and education if future Governments are to avoid an increase in borrowing.

The projected levels of spending for pensions, health, long-term care and education are illustrated in chart 2. The largest projected increases in spending are for spending on health and state pensions, which are both forecast to increase by 2.4% of national income between 2015−16 and 2060−61 on the OBR's central forecast. But one big risk to the public finances (highlighted by the OBR) is that productivity in health services could grow less quickly than in the rest of the economy. We would then need to spend an increasing share of national income in order to keep the output of the public health sector growing at the same rate as the rest of the economy. The OBR estimates that this could require health spending to increase by a further 5.3% of national income by 2060−61.

Chart 2: Age-related public spending projected to rise, if left unchecked

Age-related public spending projected to rise, if left unchecked

But the public finances will not only be under pressure on the spending side. Some taxes will also deliver less revenue in the future than they do now. In particular this will be the case for revenues derived from the extraction and consumption of oil and gas, both of which are relatively highly taxed activities. Revenues from these taxes will fall as oil resources are exhausted and motor vehicles become more fuel-efficient and eventually shift towards being electrically powered (which will also reduce receipts of vehicle excise duties). Slightly offsetting these declining trends, revenues from income tax could increase if income growth over the next few decades is skewed towards the top of the income distribution as it has been over the last few decades.

Between them these pressures lead the OBR to estimate that the ratio of tax to national income could be lower by around 2 percentage points by 2029−30, or around £29 billion in today's terms. This is not factored into the OBR's central forecast for revenues, and therefore borrowing, over the next 50 years. There are a number of ways the tax system could be reformed in light of these trends, such as a shift towards a system of national road pricing, as we have discussed in the Mirrlees Review.

The Government is undertaking radical, and painful, surgery over the course of this parliament that is intended to return the public finances to financial sustainability in the short term. But today's OBR report is a timely and salutary reminder that, all else equal, significant further fiscal retrenchment will be required over the medium term to offset the estimated detrimental impact of changing demographics, and other factors, on the public finances.

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http://www.ifs.org.uk/publications/5630 Wed, 13 Jul 2011 00:00:00 +0000
<![CDATA[Hyping hypothecation: should green tax revenues be earmarked?]]> Today the Environmental Audit Committee published a report focusing on the implications of Budget 2011 for environmental taxes. One of the key recommendations was that in order to "... build trust and acceptance of environmental taxes", consideration should be given to "... greater use of at least partial hypothecation of revenues from environmental taxes [for environmental ends]." What does this mean, and is this a good idea?

'Hypothecation' means earmarking tax revenues for specific, identified purposes. 'Pure hypothecation' would see spending on a particular programme linked directly to the revenue raised by a particular tax or set of taxes: the licence fund used to finance the BBC is perhaps the best example of this. 'Incremental hypothecation' would see revenues raised from tax increases used to raise spending on a particular public service: net revenues from London's congestion charge, for example, are spent on public transport in London. A related concept is that of a 'tax switch', where revenues from new or increased taxes in one area are used to pay for cuts in other taxes. When the Climate Change Levy (CCL) was introduced in 2001, a 0.3 percentage point reduction in employer National Insurance Contributions (NICs) was also implemented with the idea that the overall package would on average be 'revenue neutral' for businesses.

But hypothecation has significant problems. In particular:

  1. With pure hypothecation, it is highly unlikely that the optimal amount to spend on a particular programme will be the same as the optimal amount of money raised from a particular tax. The tax base may also be volatile, which would lead to inappropriately volatile spending, and (particularly for environmental taxes) may even erode away over the long term if behaviour changes. Governments should be seeking to raise revenue in the most efficient way possible and to spend that revenue in the most efficient way possible. It is highly unlikely these objectives will marry up neatly in a way that justifies pure hypothecation.

     

  2. With incremental hypothecation, it is usually impossible to verify that the government's promises have actually led to any changes in the allocation of spending. Suppose, for example, the government took the advice of the Environmental Audit Committee to use higher fuel duties to raise spending on public transport. Without detailed plans for expenditures in the absence of the tax increase - which certainly do not exist beyond the current Spending Review period - it would be impossible to verify that this is actually how the extra receipts had been spent.

     

  3. In the past some promises of hypothecation have turned out to be meaningless. Revenues from the Aggregates Levy, introduced in 2002, were earmarked for a 0.1 percentage point cut in employer NICs and a "Sustainability Fund" which paid for projects to reduce the local impacts of extracting aggregates. This fund, however, was abolished in the 2010 Spending Review without any commensurate cut in the Levy. Similarly the 'revenue neutral' cut in NICs following the CCL introduction has been anything but: the cost of lower NICs has significantly outweighed the receipts from the CCL. For example, in 2011-12 the CCL is forecast to raise £0.7 billion. However, increasing employer NICs by 0.3 percentage points would raise around £1.3 billion.

What about the benefits of hypothecating green taxes for environmental spending as a means to increase public support for green taxes? While winning public support is clearly an important consideration for policy makers, it should not be an excuse for poor policy making. It may well be true that there is a clear rationale both to raise green taxes and to spend more on environmental objectives. But if so the case for each should be made on its own merits rather than making one contingent on the other. It is hard to disagree with the Committee's conclusion that the Government needs to take "... a more coherent and clearly articulated approach to environmental taxes ... setting out their objectives and rationale, the basis on which rates are set and how their impact will be evaluated." Doing so could in itself help instil public support for green taxes, rather than relying on hypothecation which at best would be meaningless and therefore misleading, and at worst inefficient.

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http://www.ifs.org.uk/publications/5622 Thu, 07 Jul 2011 00:00:00 +0000
<![CDATA[How could the government perform a gender impact assessment of tax and benefit changes?]]> The Equalities Act 2010 places an obligation on the government to give 'due consideration' to the effects of its policies on gender inequalities. The IFS was asked by the Fawcett society to consider ways in which our tax and benefit microsimulation model, TAXBEN (which we use for our distributional analysis of tax and benefit changes after each Budget) could be used as part of an assessment of the separate impact of Budget measures on men and women. We have today published some simple analysis that does this.

It is straightforward to compare the effects of tax and benefit changes on single men and single women living in households without other adults. The budget measures hit single women somewhat harder than single men, largely because lone parents were net losers from the changes, and most lone parents are women.

It is harder to distinguish the effects of changes on men and women living as couples or in bigger households in part because we don't know how much sharing of resource there is in households, and in part because it is slightly harder to allocate benefit eligibility between individuals in households.

TAXBEN calculates households' tax liabilities and benefit entitlements for each household under different tax and benefit systems, enabling us to calculate how much each household would gain or lose from a particular set of tax and benefit changes. This means that the comparison between men and women is straightforward for single people not living with any other adults. In Figure 1 we compare the average loss from the austerity measures that are being introduced between 2010-11 and 2014-15 as part of the government's deficit reduction package for single adult households according to the sex of the adult.

Figure 1: Impact of tax and benefit reforms on household incomes for single adult households by sex of adult, with average loss for couple and multi-family households for comparison

Impact of tax and benefit reforms - multi family

We find that overall, single women lose more as a percentage of their income than single men largely because the more than 90% of lone parents are women. In fact, single women without children lose less than single men without children, but because lone parents are a group that loses a particularly large amount from tax and benefit changes to be introduced after 2012-13, the average loss for single women as a whole is larger than that for single men.

Figure 2: Impact of tax and benefit reforms on household incomes for single adult households by sex of adult, couple households and multi-family households by presence of children

Impact of tax and benefit reforms - children

 

What can we do about people in couples? One option would be to examine the income of individuals rather than households and examine how this is affected for men and women by changes to direct taxes and benefits. Although such an analysis may not give us an accurate view of the effect of tax and benefit changes on the welfare of individuals, as we would expect at least some degree of income sharing within households, it might still be of interest in itself. Unfortunately, TAXBEN is not currently set up to give entitlements to benefits to the correct member of each couple and it was beyond the scope of this project to carry out the modifications that would have been necessary. Nevertheless, this is something that the government could consider doing as part of an assessment of the effect of tax and benefit changes on men and women.

Any gender impact assessment should also consider behavioural responses to tax and benefit changes. Since taxes and benefits clearly affect the incentives of individuals to do paid work and to increase their earnings, of particular importance here are changes in labour market behaviour. The paper published today also considers how these incentives are affected for men and women by the tax and benefit changes being introduced between 2010-11 and 2014-15. While women, on average, tend to have stronger incentives to do paid work and increase their earnings than men we find that this is little affected by the tax and benefit changes coming that are being introduced between 2010-11 and 2014-15.

In short, there are some simple ways in which the government could have chosen to show that it had undertaken its statutory duty to consider the impacts of its policies on gender inequalities. Performing this analysis need not require large additional resources - all of the charts in the report could be produced by HM Treasury using the data underlying the charts it presents in Annex A of the Budget document. Administrative data available to various government departments may also provide larger sample sizes to examine more robustly the impact of individual policies on smaller groups. That said, what is possible falls a long way short of a full gender impact assessment. Because most people live in households with others, and we don't know how incomes are shared, it is very hard to look at effects separately for many men and women. Furthermore understanding the impact of cuts to public service spending could be at least as important as the changes to personal taxes and benefits that I have considered, but doing this is even more fraught with difficulty.

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http://www.ifs.org.uk/publications/5611 Thu, 23 Jun 2011 00:00:00 +0000
<![CDATA[Top income growth drives rise in income inequality under Labour]]> Official figures released yesterday told us a lot about what happened to living standards, to poverty and to inequality over Labour's 13 years in office.

  • Average incomes rose by around 2% a year on average, but by only about 1% a year between 2002-03 and 2009-10;
  • Child poverty fell from 27% to 21% of children between 1996-97 and 2004-2005, and then barely at all in Labour's third term. The target to halve child poverty by 2010 will be missed by a considerable margin;
  • Inequality rose over the period as a whole.

Further detailed examination of the underlying data allows us to unpick the forces shaping this rise in income inequality. Much of the explanation can be found in the fast growth in the incomes of the very richest, and in particular of the incomes of just the top one or two percent. These very high earners have seen their incomes pull away from those of the large majority. Across most of the rest of the distribution inequality, if anything, actually fell a bit.

This is illustrated in the figure which shows how income grew between 1996-97 and 2009-10 at each percentile of the income distribution (100 equally sized groups of individuals ordered from poor to rich). Across the middle 80% of the distribution income growth was quite even, with slightly higher growth at the lower end. If this pattern had been repeated at the very top and very bottom of the distribution inequality would in fact have fallen.

Figure - Real income growth by percentile point in Great Britain, 1996-97 to 2009-10

Average income gain

 

But the top and the bottom are different. The poorest 10% experienced lower-than-average growth, and the richest 10% saw very strong income growth. The very top saw the fastest growth of all. On standard measures of inequality (for example, as measured by the Gini coefficient) these changes at the extremes of the distribution more than cancelled out the inequality-reducing trends among the bulk of the income distribution. (The Gini rose from 0.33 to 0.36).

What has happened at the top is particularly important. Whilst median income (income at the middle of the distribution) rose by a total of 23% in real-terms over the period of Labour government, and mean income rose by 28%, income at 95th percentile rose by 29% and at the 99th percentile by a phenomenal 56%. In 1979 the person at the 99th percentile would have had income 3.0 times that of the median person, that had risen to 4.4 times by 1996-97 and then further to 5.6 times by 2009-10.

The good fortune of the top 1% in 2009-10 is particularly remarkable. Methodological changes make it difficult to be definitive about the precise scale of that good fortune but it is clear that this group did far better than any other and saw income increases as big as at any time in more than a decade. Using the government's new, preferred, measure the incomes of the top 1% rose by a full 13% in 2009-10 - much more than in any other year since 1997. The previous methodology would suggest an 8% increase - and even that is the biggest for nearly a decade.

Overall this increase in inequality since 1996/97 came about in spite of reforms to the tax and benefit system which mitigated underlying increases in inequality. Recall that inequality measured by the Gini rose from 0.33 to 0.36. Had there been no tax and benefit changes we estimate it would have risen to over 0.39 (if the 1997 tax and benefit system had simply been uprated in line with prices). Under Labour, spending on benefits and tax credits rose from 12% to 14% of national income. This extra spending slowed the growth in inequality - and was the main reason for the cuts in child poverty. But it could not halt inequality growth altogether, nor was it enough to meet child poverty targets.

Going forward we know with a rather depressing degree of certainty that average incomes are likely to have fallen in 2010-11 and are likely to fall further in 2011-12. Real earnings are falling, cuts to benefits and tax credits are likely to hit those on low incomes and those on high incomes will be hit by the 50p tax rate and other tax changes. It looks as though we will all share in this fall in living standards. Given the way that tax increases will affect them, it will take some really extraordinary increase in other incomes for the very richest to continue to pull away from everyone else at least in the short term. But the pressures towards increasing inequality are unlikely to halt over the medium term.

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http://www.ifs.org.uk/publications/5585 Fri, 13 May 2011 00:00:00 +0000
<![CDATA[Reforming microfinance, what is the evidence?]]> Last week, Nobel laureate Muhammad Yunus lost his final court appeal to the Bangladesh Supreme Court to stay as managing director of the pioneering microlender the Grameen Bank. Regardless of whether or not his removal was politically motivated the criticism that his bank diverted aid cash to cover big losses, and any accompanying loss of faith in microfinance (the extension of very small loans to those in poverty designed to spur entrepreneurship), threaten the whole concept as a development tool. Especially exposed is India, where the sector has been in a deep crisis since 2010. In this observation we highlight new evidence from IFS researchers on how microfinance initiatives can be best designed.

One of the drivers of this crisis is said to be an irresponsibly fast growth of microfinance institutions, partly out of pursuit of profit (culminating in the IPO by SKS, of the largest microfinance institutions in India). In 2008 IFS research cautioned against the consequences of the overwhelming drive for microfinance institutions to become financially self-sustainable (subsequent journal article published in 2010). This argued that severe consequences could result, ranging from a mission drift to questionable practices employed by institutions.

In India it is argued that the growth and rise of private microfinance competes with the well-established, government-sponsored Self-Help Group (SHG) movement, which drives government intervention in Indian microfinance, culminating in an ordinance on October 14th 2010, which requires microfinance institutions (MFIs) to register with the state government and gives the state government the power to shut down MFI activity at its own cognizance.

In direct response, the Reserve Bank of India (RBI), released in January 2011 a report of the so-called Malegam committee appointed to study the regulation of microcredit in India.

Two key proposals of the report are:

  • banning "individual liability lending" (where each household is responsible for its own debts) in favour of "group lending" (where several households are collectively responsible for their debts);

 

  • introducing a ceiling on the annual family income for a household to be able to take out a loan from a microfinance institution.

 

What can we say about these proposals?

Recent research findings at IFS indicate that group lending delivers more benefits to borrowers than individual lending, giving support for the recommendation to ban individual liability in favour of group liability loans. IFS researchers recently analysed a randomised field experiment, which was conducted in collaboration with the European Bank for Reconstruction and Development (EBRD) and a leading Mongolian microfinance institution, XacBank, which wanted to expand its outreach to indigent rural borrowers, in particular women. As XacBank was unsure whether to deliver its services through group lending ('joint-liability') or individual lending the trial was set up to test which worked best. While no clear 'winner' stands out, the impact results indicate that overall, group liability lending results in greater benefits to borrowers. The study for example find a more sustained and more generalised increase in consumption in group loan villages, which seems to indicate that these loans are more effective than individual loan villages loans at increasing the permanent income of the households involved.

Banning individual liability loans may also not cause too much harm to lenders. In a recent study, for example, Gine and Karlan (2009) find no measureable difference in repayment rates between group and individual liability loans.

Nevertheless, the empirical evidence on the issue is so far scarce and inconclusive. More research is needed to justify the Malegam proposal.

More generally, until recently the debate on microfinance has been based on precious little rigorous empirical evidence. A flurry of new studies, however, are starting to provide more solid grounds for discussion (see for instance Banerjee et al for a study based in Hyderabad, India, 2010, Karlan et al, 2009 for one based in the Philippines). Researchers in EDepO at IFS are now adding to this debate with research on microfinance in Mongolia, Bosnia i Herzegovina and India.

Other findings of IFS researchers give input on the Malegam's proposal for an income ceiling. Their work suggests that there are possible benefits to this - but there are also risks. Using education as a proxy for income IFS researchers are able to show that the main beneficiaries of a Mongolian microfinance intervention, whether exposed to group or individual lending, are women that have only low education. Almost all outcome indicators looked at reflect this finding, suggesting that targeting microfinance at the poor may be sensible. However, the size of the suggested ceiling is not based on empirical evidence and in a country as diverse as India, with income as volatile, setting one income ceiling for all is highly questionable.

Furthermore, other work by IFS researchers shows possible negative effects of offering microfinance to poorer, less educated clients (in Bosnia). Our findings suggest that children just out of mandatory schooling age (16-19 years) of these microfinance clients are less likely to attend school and more spend more hours working on the business due to the loan made available.

Much additional work is needed to understand the impacts of micro finance institution and how these impacts are obtained. No single answer probably exists, which maybe should not be surprising as the contexts in which micro finance institutions operate are very diverse.

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http://www.ifs.org.uk/publications/5549 Tue, 12 Apr 2011 00:00:00 +0000
<![CDATA[A simple flat rate pension, but not anytime soon]]> On Monday the Government published its long advertised Green Paper on pension reform. Much press speculation has suggested that this would lead to a flat rate pension of £140 a week for all new pensioners from 2015. But to introduce such a scheme on anything like this timetable would involve either significantly more public spending or not honouring pension rights that have already been accrued, both of which have been ruled out by the Government. This means that introducing such a pension by 2015 would not be possible. Indeed the date 2015 does not, in fact, appear in the Green Paper.

The Green Paper did contain two options for reforming the current system of state pensions in the UK:

  • Option 1: an acceleration of already legislated changes to the state second pension such that it would become a flat-rate benefit more quickly;
  • Option 2: essentially scrapping the state second pension and increasing the level of the basic state pension above the Pension Credit guarantee level.

The Government has stated that its intention is that "any reform will not increase public spending dedicated to state pensions in any year", while Pensions Minister Steve Webb told the House of Commons "we would also continue to honour the contributions that people have built up to the date of reform".

The UK state pension system is extremely complicated and efforts to make it easier to understand are welcome. However achieving this is no mean feat. The complexity of the current system is the result of frequent past reforms. These have had merits, but have usually left (for understandable reasons) accrued rights untouched, and have therefore come at the cost of additional complexity in all but the very long run.

Existing legislation already implies a long-run transition to a flat rate state pension, albeit one made up of two components: the flat-rate basic state pension, and a flat-rate state second pension. This flat rate pension would significantly reduce entitlement to Pension Credit, although it would not eliminate it and many pensioners would still be subjected to means-testing for other benefits such as Housing Benefit and Council Tax Benefit. The current system will therefore eventually be simpler, making it easier for individuals to understand what pensions they can expect from the state in future and make their savings decisions accordingly. The reduction in means testing would also increase the reward for saving among those likely to be on low incomes in retirement.

Under current policies however, flat-rate accrual to the state pension will not start until the 2030s, and so the first individuals to retire on a flat rate pension would be reaching the SPA some 52 years later (when 16 year olds in the 2030s reach their SPA of 68 under current legislation). Given the advantages of the eventual flat-rate system, having simplicity sooner clearly has merits.

The first option for reform proposed by the Government basically keeps the current system as it is, but speeds up the transition to flat rate accrual. Going flat rate on accrual from 2015 would mean that the first individuals to retire on a flat rate pension would be 16 year olds in 2015 reaching the SPA around 2067. This move to flat-rate accrual sooner would lead to those on lower earnings and those receiving credits accruing greater state pension entitlement and those on higher earnings accruing less. This reform would bring about welcome simplicity sooner than under current policy, but still not for many decades to come.

A more radical reform for achieving simplicity would be to give a higher flat rate State Pension to all new retirees much sooner than 2067. This is what the Government is considering in its Option 2. This would result in significantly higher state pensions for many, but would also lead to some accruing lower state pension. The biggest gainers would be those who under the current system would not receive the Pension Credit and would also receive a lower State Pension than the proposed new flat-rate amount. This includes those who would not take up their Pension Credit entitlement, and those not eligible on grounds of their partner's income. The losers would be those with relatively high lifetime earnings who would have otherwise gone on to accrue state pension rights above £140 per week. But given that these losses would only come from future accrual it is not possible that they would be sufficient to finance significant winners from as soon as 2015.

In essence therefore, while the government has reaffirmed existing commitments to a simple flat-rate pension in future, it has met the same problem with actual reforms as its many predecessors. As stated in the Green Paper: "Major change such as this could not be introduced without taking into account the contributions people have made under the current system. Recognising these contributions would inevitably mean that some of the complexity of the current system, particularly related to contracting out, would continue during the transition to the single-tier pension."

Fully honouring past accrued rights - combined with the commitment not to increase spending on pensions in any year - by definition means that we will not be seeing a simple flat-rate pension any time soon.

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http://www.ifs.org.uk/publications/5543 Wed, 06 Apr 2011 00:00:00 +0000
<![CDATA[Pitfalls on the path to social mobility]]> This government, alongside most of its predecessors, is concerned about social mobility. A society in which one's prospects are largely or wholly determined by chance of birth is not one with which many will feel comfortable. But any strategy to increase social mobility must be long term, multi-faceted and cautious in its claims.

As the coalition government prepares to launch its own strategy for tackling social mobility, recent work at IFS exploring the literature on social mobility has highlighted some important conclusions that the government would be wise to bear in mind.

First, countries with higher income inequality tend to have lower social mobility (at least when using income-based definitions of mobility). In an unequal society there is further to travel to get from the bottom to the middle or the top. The UK has relatively high income inequality and low social mobility. It is therefore likely to be very hard to increase social mobility without tackling inequality.

Particularly in a context of high levels of inequality such as that in the UK it is important to be clear what one is trying to achieve through increased social mobility. It is obvious that pursuing relative social mobility implies downward mobility for individuals from rich/middle income families. In a world in which the consequences of downward social mobility are significant, there will be many who find this mobility very uncomfortable.

It also matters whether the government is more concerned about improving the mobility of the most disadvantaged or those somewhat further up the social spectrum. Policies aimed at improving the mobility of the most disadvantaged or the least skilled can be very costly. In part this is because the UK labour market appears to be "hollowing out", by which we mean there are increasing numbers of high skill and low skill jobs, and fewer in the middle. So it may be harder and more costly to help those at the very bottom than it will be to help those somewhat above the bottom. Any comprehensive social mobility strategy is likely to want to deal with both of these groups and may need to treat them quite differently.

One set of interventions which we know are important are those aimed at very young children, as the recent Field Review and Allen Review have highlighted. But it is equally important to understand that they will never be enough by themselves. The evidence is clear that early investments are most productive if they are followed up with later investments. Important findings in this area are that:

  • Continuing to increase the supply of graduates and highly skilled workers has the potential to reduce wage inequality (or at least slow down increases) and therefore help (in relative terms) those at the bottom.

 

  • Cognitive skills are highly valued in the labour market, and basic skills such as literacy and numeracy have higher economic returns in the UK than in many other countries. But effective interventions in adulthood that improve cognitive skills are not easily found.

 

 

  • There is emerging evidence that later inventions targeted at improving non cognitive skills (such as time management, teamwork, leadership skills, self-awareness and even self-control) may be more effective. Certainly there is clear evidence that such non cognitive skills are highly valued in the labour market.

 

 

  • Finally, interventions that change students' decisions at key points (e.g. the decision about whether to stay in full-time education beyond age 16), rather than their skills directly, could still have a positive impact on education outcomes and hence social mobility. These will be most productive where they also increase subsequent educational attainment.

 

 

 

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http://www.ifs.org.uk/publications/5541 Mon, 04 Apr 2011 00:00:00 +0000
<![CDATA[Many unanswered questions over EMA successor]]> Yesterday, the Government announced the details of a new bursary scheme to replace the Education Maintenance Allowance (EMA). The funding for this will total £180m, of which £15m is reserved for a £1,200 annual grant for vulnerable children (children in care, care leavers and those receiving income support in their own right). The remaining £165m will form a discretionary fund that schools and colleges will distribute to students deemed to have the greatest need. In this observation, we analyse how this fund could be structured and its potential impact on students.

Schools and colleges will be responsible for distributing the new discretionary bursary scheme. Exactly how this scheme will operate is now the subject of an 8-week consultation. A key question for this consultation is how the fund will be distributed to schools and colleges. If it is allocated on a flat-rate for the total number of students at the school or college, then disadvantaged schools or colleges will be able to offer less generous bursaries. So it seems likely that the bursary will be allocated to institutions on the basis of some formula incorporating the number of disadvantaged students enrolled. Another key consideration is whether this bursary fund will be ring-fenced for bursaries only; if not, then schools and colleges may face a financial disincentive to attract disadvantaged students.

How will the new fund change the incentives for students to stay in full-time education? This will clearly depend on how - and to whom -the new bursary is allocated. Firstly, it is clear that with the total pot reduced from £560m to £180m, many existing EMA recipients will get less money than at the moment. Secondly, if students must apply for the bursary after enrolment, then they will not know, when applying for a place in post-16 education, whether they will receive a bursary - and if so, how much. This could have an impact on their decision to stay on in the first place.

The discretion that schools and colleges will have could enable them to distribute the bursary in order to attract or reward certain types of student. For example, it could be given to high-achieving, low-income students - perhaps the type of students who would have stayed in full-time education anyway. Given that high deadweight cost was the reason given for scrapping the bursary's predecessor, one presumes that the government would want to avoid this outcome.

Given this uncertainty, we can't say in advance which students would receive more or less under the new scheme. Schools could choose to allocate more to some students than they receive at the moment, and less to others. However the Secretary of State for Education, Michael Gove, said that the new bursary scheme "would allow £800 for every child eligible for free school meals who chose to stay on - more than many receive under the current arrangements." Under the current arrangements, children with household incomes less than £20,817 are entitled to a full EMA payment of £30 per week (or £1,170 per year). By comparison, to be eligible for free school meals, their household income cannot total more than £16,190. In other words, any children on free school meals are currently entitled to the full £1,170 for EMA, if their circumstances do not change. It must be the case that most such students would be worse off under the bursary scheme that they would have been under the EMA - on average, to the tune of £370 a year. Furthermore, allocating the bursary fund in this way implies that other EMA recipients not currently eligible for free school meals would in future receive nothing.

The government as ever will be facing a dilemma in looking to provide more discretion to front-line providers over how they allocate the money made available. This could allow (the smaller amount of) money available to be better targeted at those who would benefit most. But if the discretion is used, it could reduce transparency and certainty for students. The system will also need to be carefully designed to avoid perverse incentives.

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http://www.ifs.org.uk/publications/5529 Tue, 29 Mar 2011 00:00:00 +0000
<![CDATA[Public service pension reforms: an improved structure, but impact on generosity and cost as yet unknown]]> Lord Hutton's review of public service pensions contains a number of recommendations. Perhaps the three most important for both the taxpayer and the members of these schemes are:

  • Rights employees have already accrued should be honoured in full;
  • Future accrual should continue to operate on a defined benefit basis but this accrual should be based on the individual's average earnings rather than their final salary;
  • The age at which a full pension should be paid (Normal Pension Age, NPA) should be equal to the State Pension Age (SPA), with the notable exception of the armed forces, police and fire fighters.

What would the impact of a shift from final salary to career average and the planned increases to NPAs be, and what would the whole package do to the overall generosity of public service pension schemes?

Much commentary on Lord Hutton's report has asserted that career average schemes are necessarily less generous than final salary schemes. But how the generosity of a career average scheme compares to a final salary scheme will depend on how that average is calculated. Lord Hutton has proposed that earnings in each year of an individual's active membership of a public service pension scheme should be revalued in line with average earnings growth. This reform certainly makes the scheme less generous than a final salary scheme to high flyers who would see their salaries increase by more than average earnings, but it will also make the scheme more generous than a final salary scheme to those whose salary grows by less than average earnings. This change might well be deemed sensible: as Lord Hutton's interim report showed public sector workers who experience high salary growth can currently benefit from almost twice as much pension per £1 of pension contributions than those who experience low salary growth. Where these reforms would change the level of remuneration significantly the Pay Review Bodies should consider carefully whether offsetting changes in pay would be appropriate.

The proposal to set the NPA equal to the SPA for most public sector workers does reduce the generosity of the schemes: those affected would typically have to contribute for longer to receive the same pension for fewer years. There are at least two good arguments in favour of such an increase. First, many new members of public service pension schemes already have an NPA of 65 while those who were members of such schemes before the last set of reforms came into force often have an NPA of 60. Aligning these would mean that individuals who were doing the same job, with the same pay, also accrued the same pension regardless of whether they happened to have joined the pension scheme before or after the cut off date set out in the previous reforms. Second, rising longevity led Lord Turner's Pensions Commission to recommend that the SPA should increase in future from 65 to 68 and this proposal was accepted with cross party support. Increasing the NPA in public service pension schemes would seem consistent with this decision, and there is also an attraction in aligning the ages at which an individual can start to receive their state pension and the age at which a full public service pension is available. In addition a formal link between the NPA in public service pension schemes and the SPA would mean that were future Governments to decide to increase the SPA further (presumably in the light of further increases in longevity) then the default would be that this led to an increase in the NPA in public service pensions.

Those in the uniformed services - the armed forces, police and fire fighters - are to have an NPA of 60 for future accrual rather than an NPA equal to the SPA. In some cases this also represents a substantial reduction in the generosity of these schemes (although not in the case of recent entrants to the fire fighters scheme who already face an NPA of 60) although significantly less than had their NPA been increased to the SPA. The desire to provide generous support to these individuals after they leave these careers - in particular where these careers typically can only be pursued up to a relatively young age - is understandable. What is less clear is whether more generous pensions, presumably with an expectation of early retirement, is the best way to provide such support. An alternative that might be more attractive would be to increase the NPA to the SPA for all public sector workers including those in the uniformed services and instead offer some of those leaving the uniformed services specific payments to support a transition into alterative careers. Careful targeting of such payments - for example for retraining and relocation - could offer better value for money for the taxpayer than using universally more generous pension arrangements, and were it deemed appropriate would also allow the payments to some individuals to be significantly more generous.

Overall many features of these reforms recommended by Lord Hutton are welcome. But what these reforms would do overall to the generosity of these schemes to public sector workers will not be known until a decision on other key parameters is announced. This will also affect the cost to the taxpayer of these schemes. In particular, Lord Hutton's report leaves open the choice of accrual rate in these schemes and the level of employee contributions. Once these are known we will be able to assess the extent to which the reforms are leading to an average reduction in the generosity of public service pensions (if that is the case). In addition it will be possible to calculate whether there are likely to be any overall winners - such as low flyers - from the reforms.

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http://www.ifs.org.uk/publications/5505 Thu, 10 Mar 2011 00:00:00 +0000
<![CDATA[Fuel duties and a fair fuel stabiliser: fuel for thought]]> Rapid increases in pump prices have sparked renewed debate on the level of fuel duties, with calls for the Chancellor to cancel April's planned real-terms increase in the forthcoming Budget. There is also continued speculation about the prospect of a "fair fuel stabiliser" (FFS) - a formal mechanism to cut duties at times of high oil prices (and to raise duties when oil prices fall). During Prime Minister's Questions on March 2, David Cameron made it clear the FFS was still under consideration, saying: "...we will look at the fact that extra revenue comes to the Treasury when there is a higher oil price, and see if we can share some of the benefit of that with the motorist. That is something that Labour never did in all its time in government." What are the facts and how should we assess these proposals?

Day-to-day changes in fuel prices are highly visible and fuel is an important share of spending for many households, so the salience of the issue is unsurprising. In 2009, vehicle fuel made up on average 4.9% of household spending, and more than one in five households spent over 9% of their budget on fuel. As prices have risen since 2009, fuel's prominence in household budgets has probably grown further.

In real terms, fuel prices are now about 17% higher than they were in autumn 2000, the period of the fuel price protests. Taxes now make up around 61% of the price of a litre of diesel and 63% of the price of petrol (for petrol, 46% of the price is duty and 17% VAT). The total tax paid for a litre of petrol amounted to around 80.2p in January 2011 following rises in both duty and VAT, though this is below the real-terms peak of 82.5p/litre seen in July 2000.

 

Fuel duties are set to rise by one penny above inflation each April up to 2014-15 as part of a duty escalator introduced by Labour in the 2009 Budget and extended in the March 2010 Budget. Even with no real increase, duties would rise by just over 2p/litre to reflect inflation (the inflation rate used is the expected RPI in the third quarter following the Budget , currently forecast at 3.5% by the Office for Budget Responsibility, OBR). Cancelling the one penny real increase would cost about £500 million. Freezing duties in cash terms would cost just over £1.5 billion. The latter figure would be higher if inflation forecasts for the third quarter are revised upwards in the Budget (RPI inflation was 5.1% in January 2011). If oil prices remain high, future planned increases in duties would also come under pressure. Cancelling all the real rises to 2014-15 would leave revenues about £2 billion lower each year from then. Cancelling all inflation-adjustments as well would leave revenues about £6 billion lower.

Given the scale of the deficit, the government has little room for manoeuvre to make any concessions on tax that are not paid for through tax rises elsewhere, or deeper than planned spending cuts. One particular consideration for fuel taxes must be that reductions in fuel duties would also make the government less likely to meet its objective to raise the share of total receipts generated from environmental taxes.

Beyond the fiscal issues, there are two particular problems with a FFS:

  1. In order to stabilise fuel prices around their long-run trend, the government will need to distinguish between short-term blips in prices around the trend and shifts in the trend itself. This is likely to be difficult, and large adjustments to duties may be needed if mistakes were apparent only with a significant lag. There could also be a political 'ratchet effect', in which popular cuts to duty when prices were high were easier to implement than unpopular increases when oil prices fell again. If the government decides to adopt a FFS, it should have a clearly proposed mechanism for how and when duties would be adjusted, how the assumed trend in oil prices is determined and updated, and what the target trajectory for pump prices will be.
  2. The claim that the Treasury receives a windfall gain when oil prices rise that it can "share" with motorists is incorrect. Estimates published by the OBR last September suggested that a temporary £10 increase in oil prices would generate a revenue gain of £100 million in the year of the shock, and a net revenue loss of £700 million in the year after. This need not prevent a FFS being adopted, but it could only be done so by injecting more uncertainty into the public finances rather than less. If the Treasury disagrees with the OBR's analysis, it should provide robust evidence to back up its view.

That said, one could argue that while no formal fuel stabiliser policy has been in place before, the previous Labour government did informally help to stabilise pump prices with their fuel taxation policy. The chart shows real-terms petrol pump prices and duty rates between January 1990 and January 2011. Aside from the autumn 2000 protest period, there was a relatively steady upward trend in pump prices throughout much of the 1990s and 2000s. This was caused first by the previous duty escalator introduced in 1993.During this period oil prices were relatively low and stable and so higher prices were driven by higher taxes. The escalator was abandoned in 1999 as oil prices began to rise, and duties were frozen in cash terms for a number of years, meaning higher prices were driven by the pre-tax cost of fuel.

Fuel Prices

Source: Calculated from DECC energy price statistics (http://www.decc.gov.uk/assets/decc/statistics/source/prices/qep411.xls)

It may be that a formal stabiliser policy would be preferable to ad-hoc adjustments to duty rates made Budget by Budget, adding (hopefully) more transparency and predictability to the process. But it should not be sold on the basis that it would stabilise the public finances: a formal stabiliser would - at least according to the OBR's estimates - lock in even more uncertainty to the overall fiscal position.

 

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http://www.ifs.org.uk/publications/5503 Tue, 08 Mar 2011 00:00:00 +0000
<![CDATA[Pupil premium: simple and transparent financial incentive]]> On Monday, the Department for Education announced the financial settlement for schools in England in 2011-12, including the new pupil premium. It announced a cash-terms freeze (or real-terms cut) in existing funding per pupil , on top of which there will be a pupil premium worth £430 for every child registered for free school meals as of January 2011. It also announced that children in care will receive a similar premium in 2011-12, and children of parents serving in the military will receive a smaller premium of £200 to assist with their pastoral care. Here we discuss the implications of the pupil premium for children eligible for free school meals, which accounts for about 95% of the estimated £625 million cost of the pupil premium in 2011-12.

The Government's chosen pupil premium is simple, amounting to £430 per pupil eligible for free school meals no matter which local authority children live in. The Government originally proposed a pupil premium that would have varied in generosity across local authorities, been relatively complex to understand, and gone against the Government's stated aim of evening out differences in funding for deprived pupils. In a welcome move, the actual pupil premium announced this week will be much simpler and more transparent, potentially sharpening the financial incentives generated by the pupil premium.

It is noteworthy that the pupil premium is lower than expected. The main reason given is that the Department for Education are now expecting a large increase in the number of children registered for free school meals, from 17.4% of pupils in January 2010 to about 20% in January 2011 (it is the number of pupils registered with their school for free school meals on 20 January 2011 that will determine precise allocations of pupil premium funding in 2011-12). This 15% increase in children registered for free school meals is significantly larger than has taken place in recent years, and is expected to arise through the stronger financial incentive generated by the pupil premium for schools to ensure all pupils entitled to free school meals are indeed registered as such with the school (i.e. the increase is amongst children in households with incomes low enough to qualify for free school meals, but who are simply not registered at present). Existing deprivation funding from local authorities already provides financial incentives to ensure all children are registered for free school meals, but the pupil premium increases the level of the financial incentive, and may make it more transparent to schools; it may also help parents realise that registering their children as eligible for free school meals could directly benefit their children's education.

Without such an increase in the number of children registered for free school meals, the pupil premium could have been at least £100 per eligible pupil larger. However, the financial consequences of a higher pupil premium and no increase in free school meal registrations would be very similar to that of the proposed pupil premium with the 15% rise in the number of children registered for free school meals. However, whether the increase in free school meal registrations transpires does matter for school funding allocations. With a 15% increase in registrations for free school meals, the schools settlement for 2011 implies a 0.75% real-terms cut in funding per pupil, on average, across schools. But if the increase does not take place, there would instead be a 1% real-terms cut, on average. In either case, less deprived schools will see larger cuts, with one-in-six pupils in schools seeing real-terms cuts of 2% or more with the increase in registrations (or one-in-five pupils if there is no rise in registrations). Thanks to the pupil premium, more deprived schools will see smaller cuts, and some will even see an increase in funding, with one-in-four pupils in schools seeing real-terms increases in 2011 (or one-in-five pupils if there is no rise in registrations). A few very deprived schools will see real-terms increases of 2% or more, with one-in-twenty-five pupils in schools seeing increases of this level or more with the increase in registrations (falling to one-in-fifty pupils if there is no rise in registrations). Actual changes to school budgets will, however, depend on decisions made by local authorities, and on which schools can increase free school meal registrations by the most (here we have assumed it is proportional to the current number).

Whether schools can register this extra number of pupils for free school meals by 20th January 2011 is an open question. If the increase in free school meal registrations is lower than the Government expects, then spending on the pupil premium will come in lower than expected. If this occurs, then the Government could choose to increase the value of the pupil premium in future years in response. In 2014-15 spending on the pupil premium is due to reach £2.5 billion and by then the Government will have already observed changes in free school meal registrations in response to the pupil premium up to 2013.

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http://www.ifs.org.uk/publications/5371 Wed, 15 Dec 2010 00:00:00 +0000
<![CDATA[An efficient maintenance allowance?]]> The Government announced in the Spending Review 2010 that it would withdraw the Education Maintenance Allowance (EMA), a payment of up to £30 a week to children from poorer families who remain in post-16 education, from September 2011. The Government defends its intention to scrap EMA - and replace it with a smaller payment - on the grounds that the EMA is expensive and fails to deliver enough bang for its buck. But what does the evidence on the effectiveness of the EMA show?

What impact has the EMA had?

Previous work by IFS researchers found that the EMA significantly increased participation rates in post-16 education among young adults who were eligible to receive it. In particular, it increased the proportion of eligible 16-year-olds staying in education from 65% to 69%, and increased the proportion of eligible 17-year-olds in education from 54% to 61%. Based on these impacts, and on estimates of the financial benefits of additional education taken from elsewhere in the economics literature, the study concluded that the costs of providing EMA were likely to be exceeded in the long run by the higher wages that its recipients would go on to enjoy in future.

This study was not able to examine the impact of the EMA on the likelihood of getting qualifications, but a subsequent report by IFS researchers found that in areas where EMA was available, students as a whole were around 2 percentage points more likely to reach the thresholds for Levels 2 and 3 of the National Qualifications Framework; they also had A Level grades around 4 points higher (on the UCAS tariff) on average.

Is the EMA an effective use of public money?

The Government argues that the impact generated by the EMA does not justify the £560 million spent on this policy in England. Underpinning this argument is a finding from some qualitative research. One of the questions asked those who were in receipt of EMA what they would do in its absence: only 12% reported that they would not be in education. The Government infers from this that the EMA policy carries a 'deadweight' of 88%, i.e. 88 out of every 100 students receiving EMA would still have been in education if EMA did not exist and are therefore being paid to do something they would have done anyway. The estimates from the IFS research reports above imply a level of deadweight that is consistent with this: 65 out of every 69 individuals aged 16 who are eligible for the EMA would have stayed in education without the payment. But does this mean that the money spent on EMA has been wasted?

If the purpose of EMA is to increase participation in education, then the higher the deadweight, the less valuable it will be. The question is: to what extent does the "wasted" spending on those whose behaviour was unaffected offset the beneficial effect of the spending on those whose behaviour was affected? The simple cost-benefit analysis mentioned above suggests that even taking into account the level of deadweight that was found, the costs of EMA are completely offset.

Furthermore, the key assumption behind the Government's methodology for calculating the deadweight is that the impact on participation is the only outcome that matters. But the EMA may have other benefits: those who receive EMA and would have stayed in education regardless of it might still benefit educationally through other channels: for example through better attendance, or more study time as a result of not having to take on a part-time job. Moreover, even if the EMA had no impact on educational outcomes it would still represent a transfer of resources to low-income households with children, which may in its own right represent a valuable policy objective.

Many public policies involve a high amount of deadweight. For example, the coalition Government announced in its June 2010 Budget the temporary relief of Employer National Insurance Contributions (NICs) for new businesses located outside the South East and Eastern England, in order to stimulate private sector growth across the rest of the UK. The Treasury's costing of this policy implies that 96% of the foregone revenue from this tax cut will go to employers who would have set up anyway (given the natural rate of business turnover) and that 4% will go to employers who have set up in response to the incentives created by the policy. If the sole aim of the policy is stimulate new business then this would be regarded as 96% deadweight. (But if the objective of the policy were to support new businesses in these regions regardless of whether or not they had started up anyway then the assumption underpinning the deadweight calculation would not be valid.)

Another example - more similar to the EMA - is the payment of Child Benefit to households with children over 16 who are in full-time education; EMA was initially conceived as a replacement for this. If the objective of this payment is to encourage 16-year-olds to stay in full-time education then it almost certainly has greater deadweight than EMA (it is also paid to higher income households, whose children are even more likely to remain in education anyway). But in the Spending Review the Government decided to protect this benefit: one might argue that a consistent approach would mean removing this as well as EMA.

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http://www.ifs.org.uk/publications/5370 Tue, 14 Dec 2010 00:00:00 +0000
<![CDATA[The UK will introduce a Patent Box, but to whose benefit?]]> The Chancellor of the Exchequer, George Osborne, yesterday confirmed that a Patent Box will be introduced in the UK in 2013. This policy will reduce the rate of corporation tax on the income derived from patents to 10%. Our analysis suggests that the policy will lead to a large reduction in UK tax receipts from the income derived from patents, is poorly targeted at promoting research, will add complexity to the tax system, and it is far from clear that any additional research resulting from the policy will take place in the UK.

The announcement of a UK Patent Box has been widely welcomed by the corporate sector and notably by a small number of large patenting firms for which the tax savings will be greatest. However, we are today publishing new research which simulates the impact of the introduction of a Patent Box and questions whether the UK will in fact benefit from such a policy.

In the document released yesterday, the Government suggests that the UK will benefit from the "additional tax on the consequential profits" associated with patents. However, we find that the introduction of a UK Patent Box would lead to a substantial reduction in government revenues: even though the UK would become a more attractive location for patents, the boost to revenue this would provide would be outweighed by the lower tax rate. The Government's own forecasts in the June 2010 Budget predicted a revenue loss of £1.1 billion a year. The largest share of the tax savings entailed in a UK Patent Box will accrue to a small number of firms that account for the majority of patents and are likely to generate large associated revenue streams.

There is a clear rationale for the government to enhance the incentives for firms to engage in research; some of the benefits of research accrue to third parties and because of this firms tend to under invest in research, especially basic research. But this rationale is currently explicitly recognised in the corporate tax system through R&D tax credits.

The Government has highlighted that the focus on patents, as opposed to other forms of intellectual property, is a result of patents having "a particularly strong link to ongoing high-tech R&D". However, a Patent Box is poorly targeted at research as the policy targets the income which results from patented technology, not the research itself. Once a patent is in place, a firm has a monopoly on the use of those ideas, and so can capture all of the returns and therefore faces the correct incentives to maximise the related income stream. In addition, to the extent that a Patent Box reduces the tax rate for activity that would have occurred in the absence of government intervention, the policy includes a large deadweight cost.

The Patent Box policy will also add complexity to the tax system and require policing to ensure that both income and costs are being appropriately assigned to patents. While the Patent Box may spur some new innovation and incentivise firms to create more patentable technologies, the time lags and uncertainty inherent in creating a patentable technology will likely mute these incentives. Moreover, it is not clear that any additional research resulting from a Patent Box will take place in the UK. Under European law, eligibility criteria for inclusion in the Patent Box could not include restrictions that patentable technologies be created in the UK. It would therefore be possible to hold patent income in the UK without co-locating any associated real activity. Indeed, while patent ownership is frequently co-located with research, there is an increasing trend towards holding intellectual property separately from real activity. Looking forward, firms may be more likely to separate income from real activity in the face of greater tax incentives for mobile income.

The UK will not be the first country to introduce a Patent Box; the Netherlands, Belgium, Luxembourg and Spain have recently introduced similar policies. The income from intellectual property is highly mobile and the presence of other Patent Boxes gives UK firms the incentive to locate patents offshore. But our research shows that the introduction of a UK Patent Box, accounting for the current Benelux Patent Boxes, would see UK revenue from patent income halved. In addition while a Patent Box may initially be successful in attracting or retaining firms' patent holdings, such gains can be quickly eroded if other countries introduce similar policies. That is, tax competition attempting to attract mobile patent income using Patent Box policies could amount to governments engaging in a race to the bottom in which related government revenues fall.

The UK Government faces the challenge of preventing firms from holding patents offshore for the sole purpose of avoiding tax. Indeed, the Government is consulting on reforms to the Controlled Foreign Companies (CFC) regime, which sets out the rules that determine how offshore mobile income is taxed, in relation to income from intellectual property. Our research highlights the potential interactions between Patent Boxes and CFC regimes. In particular, a UK CFC regime that effectively captured patent income held in Patent Box countries could reduce the incentive for UK firms to hold patents offshore and therefore mitigate some of the negative impact on revenues.

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http://www.ifs.org.uk/publications/5362 Tue, 30 Nov 2010 00:00:00 +0000
<![CDATA[Government proposals for higher education would squeeze high earners less and cost the taxpayer more]]> Please Note: Third parties issued press releases about this analysis on 17 November 2010. We will be revising this document shortly and have detailed how and why here.

Last week, the Minister of State for Universities and Science, David Willetts, announced the Government's proposals for higher education funding in England, in response to last month's publication of the Browne Review. IFS released some initial reaction to these proposals last week. Here we quantify the main implications of that announcement. The key differences compared with Lord Browne's proposals are:

 

  • Tighter means testing of grants, which saves the taxpayer money;

 

 

  • A fee cap of £9,000 but with no levy on fees above £6,000. The levy was intended to recoup the cost to the Government of providing larger loans to cover these fees; without it, the cost to the taxpayer is significantly higher than under Lord Browne's recommendations;

 

 

  • Increasing the interest rate for higher earning graduates and reducing it for lower earning graduates, via the proposed interest rate taper. We calculate that this will actually cost the taxpayer money compared to the system proposed by Lord Browne;

 

 

  • Making the maintenance loan system more complex without any significant savings to the taxpayer compared to Lord Browne's proposals.

 

 

Who are the winners and losers from David Willetts's announcement?

Compared to the system proposed by Lord Browne, universities wanting to charge between £7,000 and £9,000 a year are the main winners, while the richest half of graduates would gain slightly. Universities gain because the absence of a levy enables them to keep 100% of any additional fee income above the basic £6,000 level, and graduates gain because the tapered interest rate - a sliding scale between 0% real at earnings of £21,000, and 3% real at £41,000 - provides an overall subsidy, relative to Lord Browne's proposal, to middle- and high-earning graduates.

The main loser of the Government's proposed system is the taxpayer: the reduction in maintenance grants is more than outweighed by the cost of not imposing a levy. At higher fee levels, this becomes an increasingly important factor: if all universities charged £9,000 a year, we calculate that total the taxpayer burden of higher education would only be slightly lower than it is at the moment (by around £770 per graduate) costing the government potentially billions of pounds of savings compared to Lord Browne's proposals.

Table 1 summarises the balance of contributions to the cost of higher education under the current system, the Browne Review recommendations and the Government's proposals. The figures presented are total amounts per graduate over the course of their degree.

Table 1. Balance of contributions to higher education under current, Browne, and Government systems (Click here for a larger table)

 

 

What are the implications for graduates?

The Government's own analysis of its proposals suggests that most graduates - those in the top eight deciles of lifetime earnings - would pay back more than under the Browne Review proposals, and that the top 30% would actually pay back more than they borrowed.

On these points, our conclusions differ from the Government's. We find that the poorest 40% of graduates would be unaffected. As shown in Figure 1 (using a £7,000 fee), we calculate that most graduates, particularly those between the sixth and eighth deciles of lifetime earnings, would be better off under the Government's proposal and that no decile group would be worse off. We also calculate that at most 1.0-1.65% of graduates would pay back the full value of their debt. Only the very highest earners are likely to pay "over the odds" for their degree; the top decile as a whole would pay, on average, around 95% of their debt (compared with around 97% under the Browne Review proposals).

Figure 1. Graduate repayments under current system, Browne proposals and Government proposals (£7,000 fee)

 

 

This discrepancy arises because of differences in the assumed levels of annual earnings across the distribution. As a result of differences in underlying data, the Government's analysis over-estimates annual earnings at the top of the distribution. Our profiles of lifetime earnings imply average annual earnings of £60,000 in the top decile over the period during which loans are repaid (and higher earnings thereafter as graduates' progress through their careers). As a result, the Government's analysis over-estimates the number of graduates at the top of the distribution who would earn enough to face the full 3% real interest rate while they are making repayments. In fact, a significant number of graduates in the top half of the distribution could face a lower average interest rate than under the Browne proposals.

The £41,000 threshold for the interest rate taper effectively provides a subsidy to high earning graduates and will penalise only a very small number of high-fliers at the very top of the distribution. Since most graduates are unlikely to breach this level early on in their careers while they are making loan repayments, the Government could both save money and extract revenue more revenue from the high-earners by opting for a lower threshold. If it were set at £31,000 a year, for example, we estimate that the richest quarter of graduates would all pay back slightly more than under these proposals (while other graduates would be unaffected), thereby costing the taxpayer less.

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http://www.ifs.org.uk/publications/5354 Thu, 11 Nov 2010 00:00:00 +0000
<![CDATA[Higher education reforms: progressive but too complicated]]> The Minister of State for Universities and Science, David Willetts, has today announced the Government's proposals for higher education funding in England, in response to last month's publication of the Browne Review. Here we outline our initial response to this release. While the Government accepts a substantial part of the review's recommendations, including a higher fee and repayment threshold, it has put forward alternative proposals for student support and interest charges that are more complex, which risk compromising transparency as well as increasing the administrative burden. The key differences compared with Lord Browne's proposals are:

  • Tighter means testing of grants (which saves the taxpayer money);
  • Increasing interest rates for higher earning gratuates and reducing them for lower earning graduates (which makes the system more progressive, more complicated and lower cost to the taxpayer than that proposed by Browne);
  • Making the maintenance loan system much more complex and more generous (which increases the taxpayer burden from Lord Browne);
  • Increasing the funding for universities charging fees above £6,000 a year (costing the taxpayer more money compared to Lord Browne).

IFS researchers will release a more comprehensive reaction to this announcement, including distributional analysis and the balance of contributions, in due course.

Fees

The biggest single announcement was a cap on annual tuition fees of £9,000 per year (which was not recommended by Lord Browne). In return for preventing universities from charging more than this, the Government will not impose a levy on fees above £6,000 per year. Instead, universities wishing to charge more than this will be required to intensify their efforts to widen participation in collaboration with the Office for Fair Access. Universities would be free to charge less than £6,000 a year, but are extremely unlikely to do so as on average, they would need to charge £7,000 a year just to replace the lost income from teaching grants.

Graduate Repayments

On the system of repayments, the Government agrees with Lord Browne on the idea of a 9% repayment rate on earnings above £21,000 a year, and in principle agrees with the idea of uprating this threshold to reflect real average earnings growth. While this form of indexation is more expensive to the taxpayer than the current indexation (by inflation), it is also more progressive as it prevents the number of low-earning graduates being liable for repayments from growing over time.

There are important changes elsewhere. The Government proposes a higher maximum interest rate and a different way of tapering it. Instead of a capped real interest rate for lower-earning graduates to ensure that their debt does not increase in real terms, there would be a real interest rate applied linearly over the salary scale, from 0% at £21,000 a year to a maximum of 3% at £41,000.

While the maximum interest rate is higher than under Lord Browne's proposals, this taper is more progressive: graduates earning between £21,000 and roughly £35,700 a year would face a lower rate of interest (assuming an initial debt of £30,000). However, an interest rate that explicitly depends on earnings is more complex and it is not clear how this would be implemented, nor which measure of earnings would be used to calculate a graduate's interest rate, which could add to administrative burdens.

The prospect of a real interest rate has led to concerns about whether graduates from wealthy families may repay their loans more rapidly in order to reduce their total interest payment. In response to this, the Government has proposed an early repayment levy to discourage individuals (particularly high-earners) from making extra payments. While higher interest rates will increase the incentive to make larger repayments, the terms of the loan remain more generous than alternative commercially available sources of finance. For those facing a 3% real interest rate, the Government benefits from ensuring that these graduates take longer to pay their debt back. Hence discouraging early repayment would save the taxpayer money.

Upfront Support for Students

Today's announcement included changes to the package of upfront support currently received by students. Students from the poorest families (with household income at or below £25,000) will be better off, in terms of upfront support, by around £700 per year compared with the current system. This is due to increases in the generosity of maintenance grants and loans. The government will save money by cutting maintenance grants back for those from higher income families - the maximum parental income at which a grant is payable has been reduced to £42,600 (currently £50,000 and proposed to be £60,000 by Browne). Overall, the total amount of upfront support is more generous than the Browne recommendations for student with household incomes below £37,500, and less generous for students with household incomes above this.

Contrary to Lord Browne's welcome recommendation of a universal maintenance loan, the current system of means-tested maintenance loans will continue, with a series of complicated tapers to determine the proportion of support payable in the form of grants and loans.

Maintenance grants of £3,250 a year and maintenance loans of £3,875 a year will be payable to all students from households with annual income up to £25,000. Those with household incomes above this amount will then see the loan element of their support package increase and the grant element decrease with income, until household income reaches £42,600. Then as household incomes increase above £42,600, the total amount of support payable (purely in the form of loans) decreases until household income reaches £62,125. At and beyond this household income level a universal maintenance loan of £3,575 will apply. These changes will significantly increase the administrative burden of applying for and administering loans compared to Lord Browne's proposal. While there is a strong case for making maintenance grants for students depend on parental income, it is much harder to argue that graduate debt and therefore future graduate contributions should be related to parental income rather than just the course chosen and how much the graduate subsequently earns. In particular it is hard to justify why students from households with incomes of £42,600 should face larger debts than all other students doing similar priced courses. We agree with Lord Browne's preference for a simpler and more transparent system involving a universal maintenance loan and means-tested grant; this would be easy to devise and merits reconsideration.

 

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http://www.ifs.org.uk/publications/5342 Wed, 03 Nov 2010 00:00:00 +0000
<![CDATA[How to keep warm in winter: winter fuel payments or cold weather payments?]]> The winter fuel payment (WFP) is a non-taxable and non-means tested benefit paid, usually in November or December, to all households where one member is older than the female state pension age (currently between 60 and 61 and rising). The payment is usually worth £200 to households where the oldest person is aged less than 80 and £300 where the oldest person is aged 80 or over, but has been supplemented by additional "one-off" payments of £50 and £100 respectively for the past three years. Total expenditure on the WFP in 2010-11 is forecast to be £2.7 billion, and is due to fall to £2.1billion in 2011-12 unless the "one-off" supplements are continued.

In recent months, there has been much speculation that the WFP will be abolished or restricted as part of the forthcoming programme of spending cuts. This debate has mostly set the expense of paying benefits to richer households against the cost and inefficiencies that arise when benefits are means-tested. Lacking from the debate has been evidence on what the WFP does, and does not, achieve. In this observation we draw on two research projects undertaken by IFS researchers, funded by the Nuffield Foundation** which attempt to provide precisely that.

The first new finding is that some households containing someone over the age of 60 spend less on food during unseasonably cold weather - suggesting that they face the so-called "heat or eat trade-off". This is evident only among the poorest quarter of older households and only when the temperature is substantially lower than would be expected (i.e. when there is a month where the average temperature is more than about 2 degrees Celsius lower than normal for that time of year). This suggests that the WFP, in conjunction with other government policies, does not fully protect all older households from the impact of very cold weather.

The second piece of research examines the extent to which recipients actually spend the WFP on fuel. As an unconditional cash transfer there is no obligation to spend all (or even any) of the payment on fuel: it is simply extra income to those households containing someone over the female state pension age. However, ongoing research at the IFS suggests that recipients spend more of the WFP on household fuel than they spend of other income: households with someone aged 60 or more spend on average a little less than 3p of each additional pound of income on fuel, but when that additional income is provided through the WFP this rises to between 20p and 63p. This discrepancy could indicate that the name of the benefit (possibly combined with the fact that it is paid in November or December) has some persuasive influence on how it is spent.

While the WFP does, therefore, seem to increase fuel expenditure among older households, it is not clear that the policy is successful at protecting those most likely to struggle to heat their homes adequately. Additionally, as a universal payment, much of the money spent on the WFP goes to those who have resources that are more than sufficient to purchase an adequate quantity of fuel. One implication of our research is that it might be sensible to scrap the WFP and replace it with a payment that provides targeted support to those most likely to need help with their fuel bills. Such a payment could be either more closely linked to household income - such as a compensating rise in the means-tested pension credit, or more closely linked to extreme cold weather, or more closely linked to both. One way to more closely link it to both weather and income would be to provide a compensating increase in the generosity of the existing cold weather payments. These are currently paid in weeks of particularly cold weather to households in receipt of certain means-tested benefits and which contains a pensioner, a child under the age of five or someone who is disabled. The cold weather payment (of £25 per week) is received when the average temperature is recorded as, or forecasted to be, less than zero degrees Celsius for seven consecutive days.

If the Spending Review does not announce the demise of the WFP, then it would be helpful to hear what the Government thinks is the purpose of the payment. If the aim of the payment is to encourage older individuals (regardless of their income) to increase their fuel consumption, then it seems to be a reasonably successful (albeit expensive) policy. If, though, the aim is to reduce hardship among those most likely to struggle with paying their winter fuel bills, then the policy is poorly targeted and a great deal more expensive than necessary.

** Please note: the views expressed here are those of the authors, not the Nuffield Foundation.

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http://www.ifs.org.uk/publications/5308 Mon, 18 Oct 2010 00:00:00 +0000
<![CDATA[A progressive graduate tax after all?]]> Lord Browne's recommendations for higher education funding have provoked controversy. The potential sharp increase in tuition fees has grabbed the headlines, but another proposed measure has also received considerable attention: increasing the interest rate on student loans to 2.2% above RPI inflation. There have also been criticisms of the review's alleged lack of focus on the potential for a graduate tax. In this Observation, we explore both issues in some detail.

When is a pound not a pound?

It has been claimed by the Social Market Foundation (SMF) that middle-earning graduates face the risk of paying more for their university experience than the highest earning graduates, as a result of 2.2% real interest rate. But our analysis suggests that graduates with higher earnings would repay unambiguously more than their lower-earning counterparts.

Under Lord Browne's recommendations, graduates on lower incomes would not face the 2.2% real interest rate. Assuming a typical debt of £30,000 upon graduation, an individual would need to earn around £28,500 in real terms to service the full amount of interest. For graduates earning between £21,000 and this level, the interest charged would be capped to match their repayment, while for graduates earning below £21,000 no interest above inflation would be levied. Not only does this mechanism limit how much interest lower-earning graduates must pay, but it also prevents the debt from growing in real terms because the interest is always covered: either by the graduate, or partly or fully by the Government.

It is also worth highlighting the arithmetic involved in assessing - and comparing - the total value of repayments that different graduates make over their lifetime. Payments that occur in future should be discounted more heavily as they are inherently less valuable, and the further away in the future a payment is, the lower its corresponding worth in today's terms.

The choice of discount rate is important because it affects one's conclusion about whether the spread of graduate repayments is progressive or not. This is shown clearly in Figure 1, which demonstrates the effect of different discounting scenarios on the NPV of repayments that come from each graduate income decile group. The underlying data are based on the IFS's own model of graduates' lifetime earnings.

Figure 1: Graduate repayments with a £7,000 fee, under different discount rate assumptions

Graduate Repayments

The analysis produced by the SMF discounts future repayments only by the rate of inflation. According to those figures, middle earners appear to pay more in inflation-adjusted terms than the highest earning graduates. As the discount rate assumed by the SMF is less than the proposed real interest rate, it necessarily means at some point higher earning graduates will pay less in inflation-adjusted terms than lower earning graduates. However, our analysis suggests that even with a zero real discount rate, this will be only be true for those in the top two deciles of lifetime graduate earnings, and not in the top six deciles as suggested by the SMF.

While inflation is one reason to put a lower value on payments made in future, there are many others, including uncertainty about the graduate's future and their access to credit. Indeed, a real discount rate of 0% (as assumed by the SMF) is uncommon: the Government's own accounts and economic forecasts sensibly use higher rates of discount to evaluate future liabilities and revenue streams. The analysis in the Browne Review, as well as IFS's own analysis, is based on a discount rate of inflation plus 2.2%. Under this assumption the spread of repayments is progressive right across the graduate earning distribution.

A graduate tax by another name

Ed Miliband, the new Leader of the Opposition, has voiced calls for a graduate tax to be introduced. In fact the present system of income-contingent repayments is for many effectively a temporary graduate tax. Graduates who do not pay off their debt in full under the current system face a 25-year graduate tax of 9% above £15,000 (with this threshold fixed in real terms). Under Lord Browne's proposals, this would for many become a 30-year graduate tax of 9% above £21,000 (with this threshold indexed in line with earnings). Indeed, for the lowest-earning 30% of graduates the actual level of fees makes no difference to how much they repay, as shown in Figure 2.

Figure 2. Total repayments under different fee levels

Total Repayments

Under Lord Browne's proposals, more than half of graduates would make repayments for the full 30 years, effectively paying a graduate tax over that period. With higher fee levels this proportion can only increase, as demonstrated in Table 1. Paradoxically, therefore, the more fees go up, the more the system approximates a graduate tax - indeed, a pure graduate tax would arise under the current system if fees were infinitely high. The key differences are that under a fee regime, there is a link between how much students pay and how much universities receive thereby helping a market to operate among universities.

Table 1: Proportion of students who have their debt written off after 30 years

Student Debt Table

A focus on headline fee levels is not very informative given that repayments depend only on future returns in the labour market. Potential students would be best advised not to concentrate on the notional debt attached to degree courses, and instead go the university of their choice regardless of the fees. Assuming they do not have a cheaper form of credit they should borrow from the government if they are prepared to pay a graduate tax of 9% for 30 years. They may be fortunate, of course, and earn enough to pay the tax for less than 30 years. Either way, those who oppose the fee regime and advocate a graduate tax would - perhaps ironically - have their demands met if fees continue to rise.

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http://www.ifs.org.uk/publications/5307 Fri, 15 Oct 2010 00:00:00 +0000
<![CDATA[A tale of 3 indices: further thoughts on benefit indexation]]> Today the September 2010 inflation numbers were published by the Office for National Statistics. The September inflation figures are particularly important because they are typically used for the annual inflation adjustments to many taxes, benefits and tax credits.

In the June Budget, the Chancellor announced that benefits, tax credits and public service pensions would be uprated with the Consumer Prices Index (CPI) rather than the Retail Prices Index (RPI) (which has been used to uprate universal benefits) or Rossi Index (which has been used to uprate means-tested benefits) from April 2011 (more generous increases are to apply to the Basic State Pension and the Pension Credit). This September, CPI inflation was 3.1% , the RPI inflation was 4.6%, and Rossi inflation was 4.8%.

The CPI tends to give a lower measure of inflation than both the RPI and Rossi indices. This change in indexation rules is forecast to save the government £5.8 billion in 2014-15 and increasing amounts thereafter. This was likely an important motive for the change, but the government has also claimed that the CPI provided a better measure of benefit recipients' "inflation experience".

In late August we published an evaluation of this claim. Today we publish an improved version of this analysis, in which we consider alternative assumptions, use the data more effectively and consider announced future changes to the benefit system rather than just looking at the benefit system as it currently stands. The full list of changes between this new version and our original report can be found in Appendix E of our report.

In comparing these indices there are two key considerations. First, when the prices of goods and services change, households can partially avoid price rises by substituting away from goods that have become relatively more expensive and towards goods that have become relatively cheaper. As we previously observed, the way the CPI is calculated is designed to attempt to take some account of this (given certain assumptions about the way consumers behave) whereas the RPI and Rossi indices are not. In this respect, the CPI is a superior measure. The ONS reports that this is the most important reason for the difference between the CPI and the RPI.

Second, the CPI also differs from the other indices in terms of the goods and services it includes. Most importantly, compared to the RPI, the CPI excludes mortgage interest and Council Tax costs, and compared to Rossi, which already excludes these items, the CPI includes rents.

Do the differences in the coverage of the CPI make it a better measure of inflation for benefit recipients than the current combination of the RPI and Rossi? To assess this we use household survey data to look at the proportion of recipient households who could be considered insulated from changes in both mortgage interest and Council Tax costs. In this exercise, we only look at working age households, as pensions are subject to different indexation rules.

At present, it appears that the vast majority of those on RPI-linked benefits are not insulated from mortgage interest and council tax changes. This group is largely made up of households receiving only Child Benefit, some of whom might be affluent households.

Those on means-tested benefits that have hitherto been indexed to the Rossi are largely insulated from changes in mortgage interest and Council Tax, but as both Rossi and the CPI exclude these costs, this does not favour one or the other. At present the exclusion of rents from Rossi - an item included in the CPI - does favour the Rossi, as the vast majority of those receiving Rossi-linked benefits appear insulated from rental costs (in most cases because they receive Housing Benefit).This means that under current benefit rules the coverage of the CPI does not look like an improvement over the status quo.

However, changes to the benefit system announced in the Budget, or since, alter this assessment going forward. From April 2013, for instance, Housing Benefit for those renting in the private sector (Local Housing Allowance) will no longer be linked to local rents but will instead be uprated using the CPI. This means that fewer households receiving means-tested benefits will be insulated from changes in rental costs than before (this is something we consider in our revised analysis). A cap on total benefit payments linked to average family earnings announced recently might have a similar effect. These changes may make the inclusion of rental costs in the index used to uprate means-tested benefits more appropriate, and so, given these changes, the case for the Rossi over the CPI - on a coverage basis - will weaken.

To summarise, the fact that it accounts for consumers' ability to substitute between goods and services favours the CPI. For those on universal benefits, the coverage of goods and services in the RPI is superior to the CPI. For those on means-tested benefits, with whom we may be more concerned, the Rossi's coverage of goods and services is superior to the CPI's given the current benefit system, but the case against the CPI may weaken, once currently announced changes to the system take full effect.

Our analysis here has been concerned solely with the technical question of which index is a better measure of the inflation experience of households receiving benefits. This is, of course, an entirely separate issue from the broader question of how generous one thinks benefits should be.

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http://www.ifs.org.uk/publications/5301 Tue, 12 Oct 2010 00:00:00 +0000
<![CDATA[Can we assess the distributional impact of cuts to spending on public services?]]> The Government is planning a fiscal correction that by 2014-15 comprises 26% tax increases, 10% welfare cuts, and 64% cuts to spending on public services. A comprehensive analysis of how the pain from this fiscal tightening will be shared across groups requires distributional analyses of the tax rises, the cuts to welfare benefits, and the cuts in the provision of public services which it will entail. It is difficult enough to quantify the impact of the first two of these items, as IFS researchers did most recently here. But quantifying the third is much harder. In this observation, we explain why this is, and conclude that the existing studies which have attempted to evaluate the progressivity or regressivity of spending cuts must be interpreted very cautiously. A fuller analysis of the issues discussed in this observation can be found here.

To estimate the distributional impact of public services, we need to express in cash terms the extent to which households value public services, and how that valuation varies according to household income. A number of recent studies (Barnard 2009, Volterra 2009, Horton & Reed 2010) have attempted to do just this. In estimating the distributional impact of public services, the key approach taken by these studies is to assume that the value of a public service to a household is equal to the cost of providing it. The studies then allocate spending on public services - and hence the benefit of that spending - to households in proportion to the size of the household, correcting, where possible, for the fact that some public services (such as health, education, transport and housing) are used more heavily by some types of household than others. The general conclusion of these studies is that there is no reason to doubt the redistributive influence of public spending in general, and transfers in kind in particular.

This approach can be very useful, but there are some important caveats that must be borne in mind in interpreting any results. In particular, the cost of a particular service will not typically be the same as its value to the user. Supplying a household with a publicly-provided service that costs £100 is not the same as giving them £100 since purchasing that service is not necessarily how they would have chosen or have been able to spend the money themselves. This key difference between the cost of public services and their value to households means that different households might place very different values on a public service even if they made the same use of it. For example, while one family with children might be quite content with provision of, for example, an improvement to a local school in return for the £100 it cost to provide, another family with a child at the same school might have preferred half that amount spent, and a third might have preferred twice that amount. The second of these certainly values the service provided less and whether or not the third does depends on what options are available for further private spending on schooling. This variation in value is really important when analysing how the benefits of public services vary over the income distribution because one of the main things that affects valuations is precisely people's incomes.

The challenge of quantifying the benefits of spending on public services is even greater for spending on goods that are consumed collectively (known as pure public goods). Leading examples of these include national defence and environmental protection. Two recent publications (Volterra 2009, Horton & Reed 2010) allocate the spending on such items in proportion to the size of the households (and then assume that the value of the service equals its cost, as we explained above). While it is tempting to assume that the service provided by, the Ministry of Defence for example, is equally beneficial to all, this is far too simple. The services provided by Ministry of Defence spending are complex, involving protection of borders but also the ability to project military power abroad in pursuit of foreign policy interests and a means to defend in extreme circumstances the established political order. Not only are those with lower incomes probably less willing to afford these benefits, but the benefits themselves are not likely to be felt with equal keenness across the distribution of income. If military spending tends to benefit the well-off better than the less well-off, then allocating the benefit equally in cash terms will exaggerate the progressivity of military spending (and therefore the regressivity of cuts to military spending).

Even if all households feel similarly enthusiastic about the services provided by the Ministry of Defence, allocating an identical valuation in cash terms can still overstate the progressivity of military expenditure. To see this, consider an expansion in spending on defence. If the cash benefit is shared equally across all households the resulting quantity represents a greater proportion of the total income of the poor than it does the rich - implying that the expansion in military expenditure is a progressive move. Indeed, the expansion in spending on any pure public good will appear progressive, if the benefit is assumed to be equal to the cost and is spread evenly over households. This uneasy implication of the method of allocating the benefit across households highlights the fact that the underlying assumption is open to question. If an attempt is to be made to quantify the value of spending on public services, it is important to recognise that the cash valuation is likely to vary according to the income of the household in question. This discussion, abstract though it may seem, is a vital reminder of both the complexity of converting the benefit of public expenditure into a cash figure, and the potentially misleading implications of apparently innocuous assumptions.

It is worth emphasising one further point on the how the results from the papers listed above can - or cannot - be used to evaluate the distributional impacts of changes in public expenditure. It may be possible to determine a reasonable estimate of the distributional impacts of aggregate spending on a particular public service. However, the distribution of the change in spending on that public service might look very different. Simply because health spending tends to be progressive does not mean that every conceivable reduction in health spending is regressive; the fact that spending on higher education arguably benefits the rich more than the poor does not mean that every cut to higher education spending would be progressive. The devil will be in the detail; the precise composition and manner of implementation of the package of impending spending cuts will crucially determine the extent to which they are progressive or regressive.

Given the difficulties, conceptual and empirical, involved in the valuation of the benefits of public services, producing a single set of numbers that represent the distributional impact of the entire package of cuts to spending on public services necessarily involves making a series of contentious assumptions which may crucially impact the outcome; an alternative and no less plausible set of assumptions could yield quite a different outcome. For this reason, we suggest such exercises are interpreted with caution. The best approach is perhaps to put bounds on what constitutes a reasonable opinion about what the distributional effects may be rather than trying to tie things down to a single answer.

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http://www.ifs.org.uk/publications/5299 Fri, 08 Oct 2010 00:00:00 +0000
<![CDATA[Public-service pensions: more reform needed]]> In the interim report of the Independent Public Service Pensions Commission, published this morning, Lord Hutton argues for an increase employee contributions (with the exception of those in the armed forces) with longer-term reform recommendations to follow in next year's final report. Even though the report's projections (chart 4.B) suggest that the current arrangements are affordable in the sense that pension payments are set to fall as a share of national income over the next fifty years, the case for further reform appears strong.

The short-term recommendation is for an increase in the amount that members of public service pension schemes have to contribute. Should the coalition Government concur, this could make a useful contribution towards the cuts to spending to be set out in the Spending Review on October 20th. Last year Ireland chose to do something similar with the introduction of a "pension levy" as part of their fiscal tightening. Today's report estimates (paragraph 8.15) that an across the board increase in employee contributions of one per cent of earnings would raise £1 billion, which is the same amount as intended to be saved by the planned cut to child benefit for higher rate taxpayers (announced by Chancellor George Osborne on Monday). Increasing contributions would be very similar to a cut in public sector pay, although it might help provide a better guide to members of the value of the pensions they are accruing. Lord Hutton's report does not indicate how large any increase in contributions should be, instead leaving this decision to the Government.

Today's report does not detail Lord Hutton's recommendations for more fundamental reform to public-service pensions; these will follow in his final report to be published before next spring's Budget. Any such recommendations should consider how cost effectively public service pensions fulfil the role of attracting and retaining the desired calibre of staff in the public sector. In addition to these issues, Lord Hutton has also said that he will consider whether the pensions provide an adequate level of retirement income and whether the distribution of contributions and benefits is "fair". The following features of the current schemes are difficult to justify and reform could potentially enhance value for money for the taxpayer:

  • Final salary schemes benefit long-stayers more than short-stayers and are much more generous to those who receive pay increases towards the end of their career than those who do not;
  • Reforms introduced in 2007 mean that many who joined before that date are accruing substantially more generous pension entitlements than those who have joined since;
  • A fixed Normal Pension Age (NPA) of 65 (or lower) seems inconsistent with continued rising life expectancy and the planned increase in the State Pension Age to 68.

Pension cuts could either be made in such a way as to maintain their average generosity to members or in a way that reduced the overall generosity.

An example of a possible improvement to the structure of defined benefit pensions that could retain the average generosity would be a shift from final salary to career average earnings and an equalisation of NPAs with the SPA, combined with an offsetting increase in accrual rates. Alternatively, compensation for pension cuts could be provided through pay increases. Unfortunately this latter option might prove unattractive in the current circumstances: the unfunded nature of most public-service pension schemes (the most notable exception being the Local Government Pension Scheme) means that pension cuts leads to lower spending (and therefore borrowing) in the future, while increases in public sector pay would increase spending (and therefore borrowing) immediately.

Only pension cuts without full compensation would strengthen the public finances. But this would require the judgment that not only was the structure of public-sector pensions inappropriate but also that the total remuneration package on offer (pay and pensions) was unnecessarily generous to attract and retain the requisite public sector workers. Addressing what level of compensation for any pension cuts is appropriate will be one of the most important and difficult questions Lord Hutton should address in his final report.

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http://www.ifs.org.uk/publications/5298 Thu, 07 Oct 2010 00:00:00 +0000
<![CDATA[Child benefit withdrawal will mean some worse off after a pay rise]]> Chancellor George Osborne announced today that child benefit will be withdrawn from families containing a higher-rate taxpayer from April 2013. This move is expected to affect around one-in-six (1.2 million) families with children, and save the Government £1 billion per year.

The Government intends to claw back the amount of child benefit paid to a family from higher-rate taxpayers through the income tax system. Higher-rate taxpayers who receive child benefit, or whose partner receives child benefit, will have to make additional payments through income tax self-assessment equal to the amount of child benefit they receive.

This form of means-testing has a number of implications.

First, child benefit will continue to be paid in full to all who claim it. Instead of reducing the payment of child benefit, the Government's proposed reform would increase tax payments by those on high-incomes; in a stereotypical couple with children where the higher-rate tax-payer is a man, and the woman receives child benefit, then the Government's proposed reform would mean that the father effectively pays for the mother's child benefit.

Second, some may think the proposed scheme is unfair because child benefit is withdrawn where an individual in a couple is a higher-rate taxpayer, regardless of the joint income of the couple. To give an extreme example, the Government's proposed reform implies that a one-earner couple with an income of £45,000 would lose all their child benefit, but a much better-off couple where each has an income of £40,000 would keep all their child benefit.

A third implication, and the most serious from an economic point of view, is that this reform seriously distorts incentives for some families with children. In particular, adults with children whose income places them below the higher-rate income tax threshold might be find themselves considerably worse off from a small rise in income. This is because such a family would effectively lose all their child benefit as soon as the adult's income rose just above the higher-rate income tax threshold.

A family with two children currently receives £1,750 a year in child benefit, so a one-earner couple with two children with a gross income between £43,876 and £46,850 would be worse off than if their income were £43,875. Equivalently, a one-earner couple with an income of £43,875 would need a pay rise of £2,975 or more to ensure they were no worse off after paying income tax and national insurance and losing child benefit.

The Government might argue that using the income tax system to means-test child benefit is cheaper for it to administer than devising a brand-new means-test, and can be done more quickly. But there is already a system of means-testing support for families with children through the tax credit system, and the Government could have straightforwardly reduced spending on child benefit by combining it with the child tax credit in some way. Using the means-test in tax credits could be considered fairer to single earner couples, and would not distort incentives so dramatically. But this proposed means-test of child benefit might be just a stop-gap measure; Iain Duncan Smith, the Secretary of State for Work and Pensions, said today that his proposed universal credit system - which he hopes will be fully in place by the end of the next Parliament, and would replace all existing benefits - would taper away child benefit 'more fairly' from higher income families.

 

 

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http://www.ifs.org.uk/publications/5297 Mon, 04 Oct 2010 00:00:00 +0000
<![CDATA[Reforming welfare: less haste, more detail please]]> In July, the Department of Work and Pensions published a consultation paper, 21st Century Welfare, which sought views on its ideas for fundamental reforms to the benefits and tax credits system. We wrote about the document when it was published, and today we are publishing our formal response. The Government has also set an ambitious timetable for these reforms: it would like to bring forward legislation early in 2011, which would presumably require a White Paper later this year, after October's Spending Review.

The DWP consultation document argues that there are substantial attractions to a more integrated benefits and tax credits system: it would reduce the government's administration costs and the amount of money lost to fraud and error, and be simpler for claimants to understand, which might in itself encourage some to enter paid work. We agree with this assessment, and consider there to be a strong case for integrating all benefits and tax credits into a single benefit. Such a substantial upheaval would come with risks, of course; if those risks look too daunting, then the Government must seek integration or alignment on a smaller scale wherever possible. We urge the Government to improve the way that housing benefit and council tax benefit interact with tax credits for those in work, reduce the number of distinct out-of-work benefits, and have a single government department - presumably the DWP - responsible for policy and administration of all benefits and tax credits.

The DWP consultation document also suggests that work incentives need to be strengthened. This is a separate issue from simplification and integration: benefits and tax credits could be integrated without altering anyone's entitlement or their financial work incentives, and work incentives could be strengthened within the current set of benefits and tax credits. The DWP document does not specify which groups it is most concerned about, and so it is not possible to suggest what direction reforms might take.

There are countless different ways to design an integrated benefit. The Government has a preferred option which it refers to as a Universal Credit and which is based on a proposal of the Centre for Social Justice. Its unique selling point is that it would have a single rate of withdrawal, which would be lower than some of the effective rates of withdrawal that can exist at present when benefits and tax credits overlap; such a system would be more transparent and should be simpler for recipients to understand. But there may be other designs which are just as good at achieving the Government's objectives. The Government will need to do a great deal more explaining of how a Universal Credit would work and how much different groups of recipients will get if we are to have an informed debate on its merits. We are reminded of a remark we made in 2001, when the previous government was consulting on its intention to introduce the child and working tax credit: "A recent consultation document provided some detail of how the credits would work, but said little on the most important features. Although it invited views on key issues, it provided no quantitative evidence on which one might base a sensible response." We hope that the current Government will do better, by ensuring that any forthcoming White Paper on welfare reform provides enough information to facilitate public debate on what could be one of the most important changes brought about by this Government. In this respect, the planned short period of time between now and legislation is not a good omen.

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http://www.ifs.org.uk/publications/5293 Thu, 30 Sep 2010 00:00:00 +0000
<![CDATA[Welfare reform paper sets out sensible ideas for simplification, but ducks difficult decisions]]> The Department of Work and Pensions today published a consultation paper called 21st Century Welfare which sets out ideas for fundamental reforms to the benefits system.

The report presents a number of options for integrating different existing benefits. This has a number of potential attractions: the system could be made simpler for claimants to understand and navigate, cheaper for the government to administer, and provide a more seamless transition when family circumstances change. It could also put an end to the very highest effective tax rates that arise in the current system when people face several benefits being withdrawn at once - though perhaps at the cost of increasing effective tax rates for others. Devils will no doubt lurk in the detail, and the transition to a radically different system is bound to be hazardous. But the existing system is unnecessarily complicated and piecemeal; there are clear improvements available and the approach outlined in the report is promising.

But the report is much weaker in facing up to the age-old trade-offs between redistribution, work incentives and affordability. It is difficult to strengthen work incentives without either spending more money or hurting the poor - neither of which seems likely to be an attractive proposition to the government. In some cases the pursuit of conflicting objectives leads the paper to make proposals that seem to contradict each other. The report concludes that the government could 'improve work incentives by reforming the way benefits are tapered as incomes rise and allow people to keep more of their earnings' (implying less rapid withdrawal of benefits) and, in the next bullet point, that the reforms could be 'targeted to those most in need through tapers which focus payments on those with lowest incomes' (implying more rapid withdrawal of benefits).

More often, the report simply ducks difficult issues, putting them off for future consideration. It says that 'a balance between incentives and affordability would need to be struck', that 'reforms will need to consider the balance between contributory benefits and targeting support on those with the lowest incomes', and that 'at the appropriate stage, we will assess the impact of our proposals on vulnerable groups'. The multi-billion pound question is what the appropriate balance between competing objectives should be, and this is left unanswered.

The trade-off between objectives would be less severe if the government could throw money at the problem. But, come the spending review this autumn, George Osborne will be looking to take billions more out of the welfare budget, not to put billions more into it. This means that any promising structural reforms of the type identified in this paper are likely to be accompanied by financial losses for significant numbers of families now in receipt of benefits.

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http://www.ifs.org.uk/publications/5217 Fri, 30 Jul 2010 00:00:00 +0000
<![CDATA[Graduate tax: remedy, reform or rebrand?]]> Last week the Secretary of State for Business, Innovation and Skills, Vince Cable, suggested a graduate tax as a 'fairer' replacement for tuition fees in higher education. All the Labour leadership candidates - with the exception of David Miliband - have expressed support for this idea, as has the National Union of Students; the leading universities, meanwhile, have opposed it. This Observation examines whether the rationale for such a policy and the practical implications of it have been fully considered.

As Dr Cable acknowledges, the current system of income-contingent loan repayments already constitutes an implicit graduate tax. Students face a notional stock of debt upon graduation, reflecting the total fee and maintenance loans taken out over their degree. However, this debt merely determines the amount of time that a graduate will spend making repayments. The actual repayments depend only on income, being equal to 9% of earnings above £15,000 for a maximum of 25 years following graduation. After this point, any remaining debt is written off.

The system is already progressive, insofar as lower-earning graduates: (i) make smaller monthly repayments (both in cash terms and as a proportion of their income); (ii) benefit more from a subsidised interest rate; and (iii) are more likely to have some of their debt written off.

A graduate tax in its purest form is simply a variant of this with an infinite loan and without a debt write-off point. Whereas a current graduate's repayments stop at some point, their payments under a pure graduate tax would not, creating the possibility for high-earning graduates to pay substantially more over their working life than what it cost to educate them. We understand that a time limit is has been considered as a central feature of the policy, which would mitigate this issue - and, in so doing, come closer to the present repayment schedule -but it would still be possible for the highest-earning graduates to pay back significantly more than the cost of their degree.

At the other end of the spectrum, it may be possible for lower-earning graduates to pay less over their career than they do now, making the spread of contributions more progressive than under the current system. However, the greater progressivity comes with the risk of inducing unintended behaviour, such studying abroad - and thereby avoiding liability for the tax - if the fees abroad are less than the net present value of a student's expected future graduate tax bill. An incentive could also be created for students to work abroad after university, in order to avoid paying the tax.

Part of the Business Secretary's aim in mooting the idea of a graduate tax is to increase the contribution to higher education provided by graduates while reducing the contribution from general taxation. But if cuts are made, it is unlikely that the revenue from a graduate tax would fill the hole quickly. If high-earning graduates respond to the above incentives, the loss of tax revenue would have negative implications for the public finances - particularly as these individuals would be relied upon to effectively subsidise lower-earning graduates. Also, behavioural responses notwithstanding, any revenue from the tax would arrive in Treasury coffers at a slow rate, and a question then arises over how universities are to be funded in the interim.

Introducing an alternative system of funding may be politically expedient, but it raises additional issues. Tuition fees provide a transparent source of income which follows the individual, giving universities an incentive to attract and retain students. Under a graduate tax, it is not clear how allocations to individual institutions would be determined, and whether this incentive would remain. There would also be no obvious, transparent way of allowing contributions to vary according to the university attended or course studied. Furthermore, fees enable students to make judgements about the effectiveness or value for money that universities offer; under a graduate tax, this not possible.

Finally, the tax would replace fee loans only - maintenance loans would continue to be repaid under the current arrangements. While this seems more sensible than using a graduate tax as the only method of repayment, operating two separate repayment systems in parallel would increase the complexity of a funding regime that is already poorly understood.

A graduate tax is the latest in a series of options under consideration by the Browne Review as it explores ways to reform university funding. Alternative possible measures include increasing tuition fees, introducing a real interest rate on student loans or tweaking some other aspects of the current funding system. An IFS Commentary, Future arrangements for funding higher education, published earlier this year, has considered such options in detail, examining their likely effects on graduates and the public finances.

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http://www.ifs.org.uk/publications/5204 Wed, 21 Jul 2010 00:00:00 +0000
<![CDATA[It's not easy being green: raising the share of environmental taxes in total receipts]]> The Coalition agreement reiterated the Conservative's manifesto pledge to "increase the proportion of tax revenue accounted for by environmental taxes". Past experience suggests that this is easier said than done. On coming to power in 1997, the previous Labour Government indicated a general ambition to shift taxation from 'goods' such as income to 'bads' such as pollution. Despite this, our Election Briefing Note showed that between 1997 and 2009 revenues from environmental taxes fell sharply as a share of total receipts.

In an earlier observation, we pointed out that in the absence of any significant increases in environmental taxes, their share of total tax revenue was likely to fall still further. This is for two main reasons. Firstly, as the economy recovers, growth in non-environmental revenues such as VAT, income tax and corporation tax is likely to outpace growth in environmental revenues such as fuel duty. Secondly, to the extent that environmental taxes encourage people to consume less of the taxed goods like energy and vehicle fuel, revenues will tend to be eroded over time.

Although the Coalition has not stated an explicit timetable over which the desire to increase the green tax share of total revenues should be judged, it seems that as a minimum we would expect the share to be at least as high at the end of the current Parliament (assumed to be 2014/15) as it was at end of the last one (2009/10). Using the most recent estimates for future receipts from the Office for Budget Responsibility following the June emergency Budget, green taxes are forecast to fall from 6.9% of total receipts in 2009/10 to 6.5% in 2014/15. As the chart below shows, simply to get the share in 2014/15 back to the 2009/10 estimate would require additional green tax revenues of £2.5 billion on top of the £45.8 billion forecast for 2014/15 (an increase of around 5%), assuming that those extra receipts were offset by cuts in non-environmental taxes. If the Coalition wanted to go further, perhaps raising the share of green taxes to 7.5% by 2014/15, they would need to raise an extra £6.7 billion, almost 15% more than currently forecast.

Green Taxes

Source: Authors' calculations from OBR forecasts and historical data. Note: Bars show share of environmental taxes out of total revenue. Figures from 2009/10 are forecasts based on latest OBR data. Dashed line is 2009/10 share of 6.9%. Cash figures are the nominal amounts of additional green tax revenue needed each year from 2010/11 to maintain 2009/10 share, assuming offsetting reductions in non-environmental taxes. Environmental taxes include fuel duty, Vehicle Excise Duty, Air Passenger Duty, Landfill Tax, Climate Change Levy and Aggregates Levy. VAT charged on Fuel Duty, the Fossil Fuel Levy, Hydro Benefit and Gas Levy are not included in these figures.

This 'green tax gap' is essentially the same as was inherited from Labour based on forecasts at the time of Alistair Darling's last Budget in March. That so little has altered following George Osborne's first Budget simply reflects the lack of any new policy announcements on environmental taxes. Given the scale of the fiscal retrenchment required over the coming years, and the pledge made in the Coalition agreement, it is perhaps surprising that the Government did not take the opportunity to spell out any firm increases in green taxes in the Budget. They did however suggest there would be a consultation on reformulating Air Passenger Duty (APD) into a charge per-plane rather than per-passenger. A similar reform was consulted on by the previous Government, but was ultimately rejected in favour of reforming the APD system. In their manifesto, the Liberal Democrats proposed to go ahead with this reform, to raise an additional £3 billion per year. If this were to happen, this would raise just more than enough (based on current forecasts) by the end of the Parliament for the Government to meet the pledge to raise the share of green taxes in total revenues, but with little margin for error. Raising the share substantially above that which it inherited would require bolder action from the Coalition. If it wanted to raise much more revenue from the existing system of green taxes, it would be hard to do so without further increases in fuel duty over and above those already planned, since fuel duty makes up almost three-quarters of green tax receipts. Alternatives may include new taxes, perhaps on carbon emissions or congestion but as yet there is no concrete evidence that these will come soon.

 

 

 

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http://www.ifs.org.uk/publications/5189 Mon, 12 Jul 2010 00:00:00 +0000
<![CDATA[Tax increases: quality, not just quantity]]> Now that the Office for Budget Responsibility has delivered its judgement that the structural hole in the public finances is slightly larger than Alistair Darling claimed in his final Budget in March, attention turns to how George Osborne might go about filling it in his first Budget next week.

The Coalition partners have agreed that the "main burden" of the fiscal repair job should fall upon public spending cuts. But this clearly leaves open the possibility that the Chancellor will choose to announce fresh tax increases on top of those left in the pipeline by Labour - not just to help bring down the deficit, but also to pay for the other tax cuts that the Coalition partners have agreed to deliver (such as increasing the income tax personal allowance).

Much attention will focus of the quantity of any such tax increases, but we should be just as concerned by their quality. Will they exacerbate the weaknesses of the current tax system or begin to eliminate them? And will the Coalition demonstrate a commitment to tax reform that goes beyond the design of any revenue raising measures? IFS researcher Paul Johnson has explored some of the "do's and don'ts" in a talk at the London School of Economics, which you can find here. It draws on lessons from the Mirrlees Review of the UK tax system, which is being carried out under the auspices of the IFS, of which Paul is one of the editors, and which is now being finalised for publication in the autumn.

Paul lists the main defects in the tax system that the Review has identified and argues that the Coalition should make its Budget decisions with a long-term vision for the reform of the tax system in mind. A guiding principle of the Review is that the tax system and much of the benefit system needs to be viewed as a whole when we think about how taxes influence people's behaviour (for good and ill) and how they redistribute resources within the population and across generations.

He previews a number of the Review's recommendations, among them:

  • Taking a consistent approach to the treatment of savings, when deciding how to tax income and capital gains.
  • Improving work incentives for lower income groups, mothers with older children and people around retirement age.
  • Simplifying the benefit system and integrating income tax and National Insurance.
  • Broadening the base of VAT, so that people can consume more of the goods and services they want for every pound they spend.
  • Reforming the taxation of housing, to make it fairer and more efficient.

More details of the Mirrlees Review can be found here.

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http://www.ifs.org.uk/publications/5081 Thu, 17 Jun 2010 00:00:00 +0000
<![CDATA[Australia and the UK: different experiences of private schooling]]> As part of an international collaboration funded by the Economic and Social Research Council and the Australian Research Council, researchers at the IFS and the Australian National University have sought to compare the nature of private schooling in both Australia and the UK.

The experience of the two countries has been very different over the recent past. Whilst private school attendance has remained largely flat in the UK at around 6-7% of children, it has risen sharply in Australia with about a third of children currently attending a school outside the government sector. The level of public subsidies is also very different, with large public subsidies on offer in Australia and no direct subsidies in the UK.

Grants to private schools in Australia were introduced as small per capita, flat rate payments to all schools in 1970. They have increased substantially in real terms since then and effectively provide a weighted subsidy (voucher) for all students to attend the school of their choice in the private sector. Since the introduction of these subsidies, the proportion attending an independent school in Australia has risen strongly, though less so at the bottom of the income distribution (especially in elite schools). However, it seems as if these per-capita grants have not generally been used by schools to lower fees, but rather to improve the 'quality' of the education they provide their existing student base by reducing pupil-teacher ratios.

In Australia, the fastest student growth area in private schooling, low-fee private schools, also receive the highest levels of grants, so this growth has led to substantial growth in government expenditure on such subsides. There has been growing concern about the relative funding of public and private schools in Australia, including among senior educators. The Australian government announced a review of funding arrangements for all schools in April 2010.

With no direct government subsidies, the UK provides a very different experience of private schooling than that of Australia. In the UK, private schools seem to occupy a niche market. They have high fees, low pupil-teacher ratios and account for a relatively small percentage of the pupil population (6-7% in recent times). The families who make up this small percentage tend to be high income households, more highly educated and highly likely to have attended a private school themselves.

The proportion attending a private school has been subject to only small changes in recent history. It increased slightly during the 1980s. This was a time of rising income inequalities, which our research suggests could have driven some of the increase in regions with the fastest rises in income inequality. Changes since the early 1990s have been very small. This is despite a large rise in fees relative to both top and average incomes since 2000. This fits with findings from our research, which suggests that increases in fees do reduce private school attendance but at a relatively low rate.

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http://www.ifs.org.uk/publications/5080 Thu, 17 Jun 2010 00:00:00 +0000
<![CDATA[New schools nice, but at what price?]]> The coalition government has announced ambitious plans for a new generation of schools inspired by the Swedish model of "free schools", set up and managed by parents and other non-state providers. Creating these new schools will clearly involve a capital cost: acquiring land, building the facilities, and so on. However, under the previous Labour Government's budget plans, net capital investment was due to be halved in real terms across the public sector between 2010-11 and 2014-15, so the coalition already faces tough choices on investment in school buildings - existing or otherwise. Unless the new schools programme is to be very modest, these plans for overall capital spending will have to be revised upwards or the cuts to investment spending elsewhere will be extremely deep.

According to the most recent statistics, the previous government planned to spend £6.5 billion on investment in school buildings in 2009-10, across various programmes including Building Schools for the Future (BSF) and the Primary Capital Programme. This was set to fall to £5.8 billion in 2010-11 as the fiscal stimulus was withdrawn. Labour did not announce departmental spending plans beyond April 2011, but as part of its strategy to reduce the deficit, it did announce a planned reduction in overall investment spending. This reduction, from 2.7% to 1.3% of national income between 2010-11 and 2014-15, represents a cut of roughly 50% in real terms.

Although the coalition government has yet to say whether it will adhere to these plans, neither the Conservatives nor the Liberal Democrats stated that they would accelerate or reduce the planned cuts to capital spending in their election manifestos. To avoid such large cuts to capital spending would require difficult decisions elsewhere, such as new tax-raising measures or even larger cuts to non-capital spending (which are already likely to be significant). The planned reduction over the next four years may therefore be difficult to avoid. How the eventual burden would be shared across departments is unknown, but most departments will come under pressure to make significant cuts to capital spending, education included.

The coalition's plans for new schools therefore seem to add further pressure onto what is likely to be a tight schools capital budget. These plans were put forward by the Conservatives in the run up to May's general election, but neither the coalition programme for government nor the Conservative manifesto explained how many new schools would be created or how the capital costs would be met. A Conservative Party policy paper from 2008 suggested that 220,000 new school places would be created using 15% of the BSF fund. However, this paper was written before the financial crisis in late 2008 and subsequent rise in the deficit; it was also written before the previous government announced plans to cut capital spending over the next four years. If the coalition was to keep to these plans, then 15% of the BSF budget from April 2011 is highly unlikely to be sufficient to create 220,000 new school places.

In response to such funding challenges, the government is likely to try to keep the capital costs of these new schools down. For instance, many of the Swedish free schools used refurbished office blocks and commercial premises, and the coalition government could choose to do likewise. However, while such a move would reduce capital costs, converted premises may struggle to offer the same breadth and quality of facilities as a newly built school. Alternatively, the government could limit capital costs by establishing free schools on the site of the small number of schools that would otherwise have closed, or it could replace existing schools, though the latter would clearly not add any new capacity to the system.

Therefore, the coalition government will probably need to be very modest in its plans for new schools, or use an even greater proportion of the shrinking schools capital budget to fund them, or increase schools capital spending at the expense of other departments already facing a tight squeeze. We will need to wait for further details in the spending review due in the autumn, or the upcoming Budget, to see how the coalition government plans to respond to these challenges.

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http://www.ifs.org.uk/publications/4998 Thu, 03 Jun 2010 00:00:00 +0000
<![CDATA[What can be done to simplify benefits and strengthen work incentives?]]> Iain Duncan Smith, the Secretary of State for Work and Pensions, today gave a little more detail on the Government's plans for welfare reform, suggesting that the benefit system needed simplifying, incentives to work strengthening, and welfare-to-work programmes reforming . But what can actually be done?

The fact that the Government wants a simpler benefits system should not be a surprise: when was the last time you heard a Secretary of State calling for the benefit system to be made more complicated? The problem that confounds any government holding these worthy ambitions is that simplifying benefits is usually difficult, and often costly unless there are to be many people made worse off: the current benefit system is complicated because it targets money in very precise ways.

An easy route to a simpler system is to keep the existing set of benefits, but make them operate as a more seamless whole. For example, some benefit recipients have to give information to three authorities at present when circumstances change, and it would clearly be simpler for recipients if this information were given just once. These sorts of changes might involve governments having to spend more money themselves on administration, but could lead to savings if they reduced the money lost and administrative efforts wasted through the mistakes that can arise. There would be greater scope to make these sorts of changes, though, if the Department for Work and Pensions became the only authority administering benefits and tax credits: this would require taking responsibility for tax credits away from HMRC, and having local authorities pass the burden of administering housing and council tax benefit back to central government. The Conservative Party suggested such a change for tax credits when in opposition, but the coalition Government has so far remained silent on this issue. However, the benefit simplification suggested by the Centre for Social Justice would be much more dramatic, scrapping all existing benefits and tax credits, and replacing them with just two. Such a radical reform could substantially simplify the benefit system, but would pose considerable practical challenges.

Iain Duncan Smith also pointed to the weak work incentives that face some low-earning adults, a subject about which the IFS has done considerable research. The weakest work incentives - often characterised by the very high marginal withdrawal rates faced by some working adults - arise when benefits and tax credits are both withdrawn at the same time as individuals are paying income tax and national insurance on their earnings.

There are two broad approaches to addressing this problem, both with their disadvantages.

First, the problem can be reduced by means-testing benefits or tax credits less aggressively, but this leads to higher welfare spending, and will usually bring more families into the reach of means-testing. In general, this was the approach taken by the previous government, and, interestingly enough, also by a report published last year by the Centre for Social Justice. Given the priority accorded to reducing the size of the fiscal deficit, it is hard to believe, though, that the current Government feels this is the right time to increase spending on welfare benefits.

Alternatively, one can address this problem without spending more by limiting the reach of means-testing benefits, or by increasing taxes to pay for more generous benefits for low earners: this was the approach I took when contributing to the Mirrlees review of the tax system, where I proposed a reform to strengthen incentives to take low-earning jobs, and suggested this be paid for by cutting benefits for those who do not work, scrapping child benefit, and increasing most people's income tax bills; such a reform can strengthen incentives to work for some, and be made revenue neutral, but makes many people worse off.

Finally, the Secretary of State repeated the Government's intention to combine welfare-to-work programmes into a single Work Programme, with greater use of the private and voluntary sector, and more payment by results. In opposition, the Conservative Party made a similar proposal which they thought would cost £600m more over three years than the previous government's plans, but there is no indication yet what the Government's actual proposals might cost.

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http://www.ifs.org.uk/publications/4945 Thu, 27 May 2010 00:00:00 +0000
<![CDATA[The first cut]]> The new coalition Government has announced a £6.2 billion headline cut to public spending in the current year. Since £500 million is being recycled into additional spending or tax cuts, and the £704 million earmarked for devolved administrations does not have to be found until next year, the likely reduction in borrowing in 2010-11 is around £5 billion. This is less than a tenth of the fiscal repair job that Alistair Darling's March 2010 Budget forecast suggested will be needed over the next few years.

Of the £5 billion reduction in borrowing £4.8 billion is to come from reduced spending by central government on public services and their administration (Departmental Expenditure Limits, DELs). The rest is from cuts to the Child Trust Fund, offset by a small cut in business rates. This is a fall in these budgets of 1.2% relative to the level departments were told they could budget for under the previous Labour Government's plans. Labour had planned to cut these budgets by 0.5% after economy-wide inflation between 2009-10 and 2010-11: the 1.2% cut in plans for 2010-11 announced today increases this cut to 1.7%.

As promised the new coalition Government is keeping to Labour's planned increases in spending in the NHS, MoD and overseas aid. In addition they have decided not to cut spending on schools, Sure Start and education for 16-19 year olds. Our calculations - largely based on spending figures made available from the Treasury -suggest that on average the areas of spending that have not been protected from cuts in today's announcement will see their budgets fall by an extra 3.7%. This brings the total cut in these areas relative those planned for last year up from 4.7% to 8.2%. (An earlier version of this observation contained slightly different numbers as it was produced before any figures were made available from the Treasury.)

The Table below shows our estimate of the cuts to each department as a share of the previous Labour Government's plans, and the change in budget compared to last year.

    % change relative to Labour's plans for 2010-11   % change relative to spending in 2009-2010  
Total DEL   -1.2   -1.7  
Total protected DEL   0.0   +1.7  
Total unprotected DEL   -3.7   -8.2  
of which          
Education (not schools, Sure Start and 16-19 education)   -6.0   -6.4  
CLG Communities   -5.8   -27.4  
Work and Pensions   -5.7   -5.6  
Environment, Food and Rural Affairs   -5.6   -12.3  
Transport   -5.1   -10.8  
Culture, Media and Sport   -4.3   -5.4  
Home Office   -3.5   -5.4  
Justice   -3.4   -8.5  
Cabinet Office   -3.3   -3.7  
Chancellor's Departments   -3.1   -13.2  
Business, Innovation and Skills   -2.9   -6.5  
Energy and Climate Change   -2.7   -2.2  
Law Officers' Departments   -2.6   -6.8  
Foreign and Commonwealth Office   -2.5   -7.9  
CLG Local Government   -1.5   -1.2  

 

Note: Figures take account of increases in spending in the CLG Communities and the Business, Innovation and Skills departments. Chancellor's Departments ignores the cut to the Child Trust Fund.

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http://www.ifs.org.uk/publications/4924 Tue, 25 May 2010 00:00:00 +0000
<![CDATA[Conservatives and Liberal Democrats would extend Labour's tax credit cuts for middle-income families]]> The Labour party is pointing to the fact that the Conservative Party and Liberal Democrats are proposing cuts to child tax credit for middle- to high-income families with children. I and colleagues have written about these cuts before in the 2010 Green Budget and our election analysis, and I summarise that work here.

Both opposition parties want to save money by paying the family element of the child tax credit to fewer families with children. The child tax credit has two elements: a small family element, worth £545 a year for a family with children, and much larger child elements, worth up to £2,300 a year per child. The child elements are withdrawn as income rises, so that roughly the richer half of families with children do not receive them, and no party is proposing to make cuts to these. The family element does not start to be withdrawn until family income reaches £50,000 a year, and it is this here that the two parties are looking for cuts. Both cuts are small compared to total spending on tax credits (forecast to be £29 billion in 2010-11).

The Conservative Party's manifesto says that they want to "stop paying tax credits to families with incomes over £50,000". But this does not describe their policy in full, leading us to call that description "incomplete at best and misleading at worst". The Conservative Party want to lower the £50,000 threshold to £40,000, so families with a combined income above £40,000 currently receiving child tax credit would lose some or all of that entitlement. As we have explained before, we are not able to estimate precisely how much this would save, but it would be between £45 million and £400 million a year.

The Liberal Democrats want to make larger cuts by withdrawing the family element as soon as the child element has been withdrawn. For a 1-child family, this would mean that tax credits would not be paid to families with a combined income of around £25,500 if implemented today; each additional child would increase this value by around £6,080. We estimate this would save around £900 million a year, a little lower than £1.3 billion stated by the Liberal Democrats, which is based on a previous costing produced by IFS researchers which (unrealistically) assumed full take-up.

Given the strength of Gordon Brown's recent rhetoric about these potential cuts, you may be surprised to hear that the family element of the child tax credit has been cut by 19% in real -terms by the current government over the past seven years. Since its introduction in 2003, its value has always been £545 a year, and the upper threshold always been £50,000; had these values been increased by inflation - as is normal for benefits and tax allowance - the family element would now be worth £670 a year, and be paid to families with incomes up to £61,500 a year.

The bigger picture, though, is that many people consider that social security benefits and tax credits will be cut during the next Parliament by far more than is being admitted by the parties' manifestos. IFS analysis of the public spending plans set out by Alistair Darling in his last Budget suggest that departmental spending will fall by 11.9 per cent by 2014-15 in real-terms, but spending on welfare benefits and tax credits grow by 4.5 per cent over the same period. Obviously it is up to the next government to decide how much it wants to spend on public services and welfare benefits, but these diverging trends look unbalanced, and possibly unsustainable.

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http://www.ifs.org.uk/publications/4862 Tue, 04 May 2010 00:00:00 +0000
<![CDATA[The parties' policies for families and children: rhetoric vs reality?]]> All the main UK political parties claim to have put the needs of families at the heart of their campaigns. On launching the Labour Party's manifesto for families, Yvette Cooper, Secretary of State for Work and Pensions said that "We've always made helping families a central part of Labour's campaigns - and we are doing so again in this election". For the Conservatives, David Cameron has stated that "Above all, we will be the most family-friendly Government you've ever seen in this country, because I believe that the family is the crucible of responsibility". The Liberal Democrat manifesto states that "Liberal Democrats believe every family should get the support it needs to thrive". The Conservative Party has also pledged to end the couple penalty for all couples in the tax credit system, stating that "the tax and benefits system actually rewards couples who split up". A new election briefing note from IFS examines whether this rhetoric matches the reality of specific policy pledges; it concludes that there is a conspicuous absence of policy pledges with large price tags attached in all three parties' manifestos, and a rowing back from past aspirations, presumably because of the deep cuts that will have to be made to spending on public services over the next Parliament.

One particular policy area prone to sweeping statements is the issue of whether the tax and benefit system treats people differently depending on whether they are in a couple or single. In past years, the issue of so-called 'couple penalties' - situations where the government pays out more support to a couple if they split up than if they stay together - has been highlighted by the Liberal Democrats and the Conservative Party, and has become an increasingly debated issue.

New IFS research, funded by the Nuffield Foundation, has carefully examined these couple penalties and premiums in the tax and benefit system, explaining why they arise, whether we ought to be concerned by them, and how one could have fewer couple penalties should one wish to do so. Two adults can almost certainly save on living costs by living together, but this research simply measures how net state support varies by family situation, not whether couples would be better off living apart than living as a couple.

Whether by accident or design, all parties' proposals for reforms to taxes and benefits will alter couple penalties and premiums in the tax and benefit system, but by very small amounts. New analysis shows that the fraction of couples facing a couple penalty in the tax and benefit system would not change under government plans, and would fall very slightly under Conservative and Liberal Democrat plans (by 1 and 2 percentage points respectively). The average penalty would fall very slightly (by 0.2%) under the Conservative plans, rise very slightly (by 0.4%) under Labour's plans, and rise by a little more (by 3.1%) under the Liberal Democrats' plans.

Uniquely amongst the parties, the Conservative Party has an ambition to "end the couple penalty for all couples in the tax credit system" because "the tax and benefits system actually rewards couples who split up". A perhaps unkind, but literal, interpretation of this ambition would require assessing tax credits on an individual's own income, and cost at least £18 billion a year, vastly extending the scope of means-tested tax credits. Why is this? A woman with no income of her own who lives with a millionaire and their children would, in general, be entitled to state support for her and her children if he left her. The only ways of preventing the tax and benefit apparently "rewarding" this couple for splitting up are to not pay her benefits as a lone parent, or to pay her benefits when living with a millionaire. We cannot imagine that the Conservative Party has either of these in mind. It is more likely that the Conservative Party favour a higher working tax credit for couples with children, which currently pays lone parents and couples with children the same rate if they have the same earnings. Our analysis shows that this would reduce couple penalties in the tax and benefit system for couples with children, but would introduce new couple premiums - where couples get less state support if they split up - and would still leave the vast majority of couples with children facing a couple penalty in the tax and benefit system. Whether this would be a good idea depends, though, on one's priorities and view of fairness. There is some evidence that the existing couple penalties do distort behaviour in harmful ways, encouraging some single adults to live apart but not together, and encouraging others to live together but conceal this from the authorities. But any such impacts are small, and a more important consideration, which economic analysis alone can't answer, is whether the system would be any fairer if we paid relatively more to couples and relatively less to single adults.

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http://www.ifs.org.uk/publications/4859 Thu, 29 Apr 2010 00:00:00 +0000
<![CDATA[Conservatives' green tax pledge unlikely to be met]]> The Conservatives have pledged in their manifesto to "increase the proportion of tax revenues accounted for by environmental taxes, ensuring that any additional revenues from new green taxes that are principally designed as an environmental measure to change behaviour are used to reduce the burden of taxation elsewhere". In a briefing note released today we analyse this pledge, along with other environmental policy proposals put forward by each of the main UK political parties.

The idea of shifting taxation from 'goods' to 'bads' in this way is not new. Indeed, the Labour Party indicated similar intentions upon coming to office in 1997. The Liberal Democrats also talked of a 'green switch' in the tax system in 2006 (although no mention is made of this in their 2010 manifesto).

Recent history suggests that this is, however, a difficult ambition to achieve in practice. Since 1997 revenues from environmental taxes have in fact decreased both as a proportion of total revenue (from 9.5% in 1997 to 7.9% in 2009) and as a proportion of national income (from 3.3% to 2.8% over the same period).

There is also of course the question of whether using the share of revenues from environmental taxes as a measure of a government's "greenness" is sensible. We address this in our briefing note on Environmental Policy Since 1997. Effective environmental taxes will reduce the prevalence of the activities being taxed, and thus potentially reduce tax revenues. Despite these problems, it seems to be a popular ambition.

The reason it has proved a difficult ambition to fulfil is straightforward. Over 90% of the revenue from taxes that are considered "environmental" is raised from motorists in the form of fuel duty, the VAT paid on that duty and Vehicle Excise Duty (VED). And revenue from these taxes has barely budged in real terms since 1997. (Revenues from the other green taxes haven't increased much either.)

The real level of fuel duty has in fact risen by 10% since 1997 - mostly as a result of big increases before 2000, and despite a failure even to increase duty in line with inflation for most of the period between 2000 and 2008. But real revenues have not increased, in spite of an increase in total miles driven, because of a general improvement in the fuel efficiency of the UK's vehicle stock -implying lower revenues per vehicle mile. In part this reflects the long term effectiveness of fuel duties as a spur to reducing consumption through greater efficiency. This trend towards more fuel efficient cars is likely to continue, meaning that government has to run to stand still in terms of increasing duties to maintain revenue. Indeed in the medium term government climate change objectives are predicated on a wholesale move to the use of vehicles that don't use petrol at all.

Meanwhile the average payment of VED - the annual tax paid by car owners - has actually fallen on average in real terms since 1997. VED has been restructured so that levels relate to the fuel efficiency of cars, but the overall effect of changes has been to make owning a car cheaper.

In the absence of any new green taxes, or increases in other existing taxes, meeting the Conservative pledge to increase environmental taxes as a proportion of the total will be largely dependent on what happens to taxes on motorists. The Conservatives do propose changes to existing green taxes - including a reform of the climate change levy, and a "fair fuel stabiliser" for fuel duty - but both of these are supposed to be revenue neutral.

Even with the current fuel duty escalator intended to raise duties by 1 pence per litre per year in real terms until at least 2014-15, the most recent budget forecast is for environmental taxes to fall further as a proportion of all taxes - from 7% to 6.6% between 2009-10 and 2014-15.This in part reflects the fact that other revenue sources such as VAT, income tax and corporation tax are likely to bounce back more strongly as a result of economic growth. As a matter of arithmetic this will depress the proportion of total revenue accounted for by environmental taxes. So just to maintain the share of revenues from green taxes, the next government will have to raise an additional £2.5 billion from environmental sources in 2014-15. This would be, for instance, equivalent to roughly a 7% increase in revenues from fuel duty above what is currently forecast (that is, on top of the government's current fuel escalator).

Currently fuel duty is set a rate of 57.19p per litre and this is scheduled to increase to 61.57p (in 2010 prices) by September 2014. In order to raise revenues from fuel duty by 7% (assuming no changes in fuel efficiency or in total miles driven), the duty would need to be over 65p a litre by that date. With continued increases in vehicle efficiency even this is unlikely to be enough to meet the pledge.

There are other ways of ensuring that environmental taxes as a whole rise. The fact that VAT is imposed at a reduced rate on domestic energy is an effective subsidy to energy consumption - not the greenest of tax policies. Imposing VAT at the full rate on domestic energy would raise £3 billion annually - more than enough to meet the Conservative environmental tax pledge. But despite the environmental rhetoric no party seems to be willing to grasp this particular nettle. Which is perhaps one indication of why it is so much easier to say that environmental taxes will rise than it is to deliver on that pledge.

Read more in our election briefing note no. 14, Environmental Policy Proposals

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http://www.ifs.org.uk/publications/4854 Wed, 28 Apr 2010 00:00:00 +0000
<![CDATA[Radical or just radically vague? Manifesto proposals for education reform]]> On the face of it, there appears to be much agreement between the three main UK parties on education policy: they all propose the creation of new schools or academies, and all plan to introduce a 'pupil premium' that is intended to provide more funds to schools with disadvantaged pupils. On closer examination, however, this apparent consensus fades away - there are real and significant differences between the parties' approaches to the education system. Moreover, in many cases the details of their proposals remain decidedly vague. Today, the IFS launches an election briefing note examining Labour's record on education policy and the manifesto proposals of the three main parties.

The last thirteen years have seen a surge in education spending, with annual increases more than twice as generous as under the Conservatives. However, given the fragile state of the public finances, the years of munificent public spending increases are almost certainly behind us. The two key questions for voters, then, are: Did we get our money's worth, and what should we change in the future?

The government can certainly point to some concrete results from its largesse. From the expansion of free nursery places and the introduction of Sure Start, to the refurbishment of England's schools and the overall rise in higher education enrolment, the education system today is broader in scope and richer in resources than it was when Labour came to power. We have also seen a clear shift in funding priorities towards younger children, with the UK becoming one of the developed world's biggest spenders on early years programmes. This shift in emphasis continues higher up the education system: public spending on school-age children has caught up with (and is set to overtake) spending on college and university students. There appears to be a consensus on the importance of early years investment among all three main political parties.

However, the Government's progress should not be judged on the inputs to the system, but rather on the outputs - a population of skilled, literate and numerate children. Here Labour's record is mixed. Despite the introduction of national literacy and numeracy strategies, improvements in results have been slower than the government would have liked - as a slew of missed national targets attest. International comparisons suggest that England's pupils perform about as well as their peers in much of the developed world - providing little cause for panic, but also little cause for celebration.

Some of the parties' most radical manifesto proposals relate to England's school system, though for the moment these plans remain 'radically vague': they have potentially far-reaching consequences but frustratingly little detail. All parties propose a 'pupil premium' for the funding system, for example, yet only the Liberal Democrats have made clear how theirs would be structured and funded. All parties propose to expand and/or reform the Academies programme, but this apparent consensus disguises widely differing approaches. Liberal Democrat plans to return academies to local authority control could mark the effective abolition of the Academies programme (or at least the removal of one of its defining characteristics); Conservative plans to turn ever more schools into academies, and encourage parents to open academies in their area, could mark the effective abolition of local education authorities. Yet how these new schools' start-up costs would be funded, where the money would come from, and whether this would mark the end of collective wage-bargaining for teachers, has not been made clear.

Turning to higher education, Labour's time in office has seen an increase in participation (without reaching the infamous '50% of young people' participation target), as well as the introduction of the controversial top-up fees. Whether - and, if so, how - higher education funding will be reformed in future is a hugely important question, yet one which has received little discussion in the election debate. The Liberal Democrats have again proposed to scrap tuition fees; beyond that, however, all the parties are effectively 'waiting for the Browne review' before deciding further policy. In our view, this is unfortunate. An issue as important as university funding should be part of the electoral debate, not kicked into the long grass.

The next parliament may see some of the most radical reforms to the education system in decades. Despite (or perhaps because of) the enormous pressure on the public finances, virtually all aspects of England's education system could, in theory, see changes - from early years provision to the structure and funding of the school system, to higher education funding. But, with the possible exception of the Liberal Democrats, the parties' manifesto proposals are short of detail in certain key areas on what exactly they intend to do. On an issue of such fundamental importance to our nation's future prosperity, this is unfortunate.

Read more in our election briefing note no. 11, Education Policy

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http://www.ifs.org.uk/publications/4843 Mon, 26 Apr 2010 00:00:00 +0000
<![CDATA[After the recession giveaways; what next for output?]]> Today's GDP figures show that the economy grew by 0.2% in the first quarter of 2010, half the increase recorded in the previous quarter when the UK began to pull out of recession.

In the election campaign much has been made of the impact of the timing of spending cuts and tax increases on the ability of the UK economy to sustain this recovery. This is an important issue, but much less attention has been given to the equally important question of how UK growth is likely to fare in the medium term.

In the short term, output will be bolstered as demand strengthens, firms increase employment, and the spare capacity in economy is gradually eliminated. Thereafter, the most important drivers of growth will be the efficiency with which we produce goods and services (our productivity) and the extent to which we develop new ideas (our innovative output).

Today, the IFS publishes a briefing note analysing of productivity, innovation and the corporate tax environment in the UK, including how policy and outcomes have changed since 1997 and what the parties are proposing (or not) going forward. An additional briefing note looks at UK productivity in the recession.

Historically, the UK has performed well on measures that capture the outputs of basic science and universities. However, the UK consistently lags behind the US and other major European countries in terms of the proportion of national resources which are devoted to Research and Development (R&D) and has had a persistent productivity gap with the US going back to the 1980s. During the last few years the UK and US experiences have continued to diverge - while labour productivity fell over the course of the recession in the UK, US productivity continued to grow throughout.

Productivity and innovation are not areas on which election battle lines are drawn. While all the main parties agree on their importance and have made positive statements about the role of government support for science, research and higher education, they have set out very few specific policies. In particular, none has given details of the level of funding or elaborated on the extent and composition of inevitable cuts to science related budgets. Although Labour have pledged a ring-fenced science budget, the Conservatives have proposed a multi-year science budget and the Liberal Democrats have pledged to ensure that the allocated science budget is not used for other purposes, none of these pledges rule out deep cuts.

Cutting spending in these areas would arouse little protest from the electorate; voters tend not to get riled if the government announces cuts to science budgets or reductions in subsidies for research. However, large cuts in such spending would have long term consequences; we could expect both a fall in innovative outputs and a reduction in the extent to which the UK is seen as a desirable place for firms to conduct research. This would risk placing the UK in a weakened position from which to recover. Whichever party forms the next government, they will need to consider cuts with caution.

Where there is more disagreement among the parties - and where they have set out some policy details - is on corporate taxes. The corporate tax environment is important, since the private sector accounts for around two thirds of innovative activity and plays a large role in the UK's productivity performance.

Labour and the Conservatives agree how much revenue we should try to raise from corporation tax, while differing on how that should be achieved. The main point of difference is the planned short term trajectory of statutory corporate tax rates and capital allowances. A new Labour government says it would leave the main rate unchanged at 28% in 2010-11 and increase the small companies' rate to 22% in 2011-12. But Labour has been aiming to increase the small companies' rate since 2009 - and deferring it each year since. Having made regular changes to the small companies' rate since 1997, we cannot say with any certainty whether their aspirations now are more likely to delivered on in the future than in the past. In addition, Labour have set out a desire to 'protect and increase the size of capital allowances' which would operate to narrow the tax base, a break from the base broadening under Labour since 1997.

In contrast, the Conservatives have announced plans to reduce the main corporate tax rate to 25% and the small companies' rate to 20%, in both cases to be funded by reducing capital allowances and therefore broadening the base of the tax. Many high profit firms would gain from such a shift. The losers would be those firms with capital intensive operations - with long lasting equipment and machinery - that currently benefit most from the capital allowances. While this is likely to apply more to firms in the manufacturing and transport sectors it may also be true to for some capital intensive service sectors firms.

The Liberal Democrats, while stating a desire to reduce business regulation and clamp down on corporation tax avoidance, have not mentioned corporate taxes in their manifesto. In the past, though, they have expressed a desire to reduce corporation tax rates by eliminating some reliefs.

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http://www.ifs.org.uk/publications/4841 Fri, 23 Apr 2010 00:00:00 +0000
<![CDATA[Not much disagreement on welfare reform]]> Today's labour market figures show a slight rise in overall unemployment in the three months up to February 2010. Looking behind these figures, youth unemployment (amongst 18-24 year olds) has risen particularly strongly since the start of the recession, rising from 12.2% in the first quarter of 2008 to 17.7% in the latest data compared with a rise from 5.2% to 8.0% amongst all individuals. The number of people who have been unemployed for 12 months or more has risen from 400,000 at the start of the recession to reach 730,000 in the latest data.

Sensibly, there is general agreement between the three main parties on the need to tackle the large rise in youth and long-term unemployment caused by the recession, and all parties have policies to help deal with the high number of people who are out of work and receiving disability benefits. Today, the IFS publishes an analysis of the welfare and back-to-work policies proposed by the three main UK parties for welfare reform (the full report is available here).

For the under 25s who are unemployed, the Labour Party propose making work or training compulsory after 10 months, whilst the Conservatives would make it compulsory after 6 months. The Liberal Democrats would introduce voluntary work placements. Both Labour and the Conservatives are offering additional support for the long-term unemployed aged 25 or over and both have plans to make them partake in community work.

Labour has announced that it would move all recipients of incapacity benefits to employment and support allowance (ESA), which has a tougher medical test, by 2014, but the Conservative Party think they can do this by 2012. The Liberal Democrats are keen to stress that they would provide better "practical help" for people with disabilities to get to work, and that funding of disability-related equipment would be "already in place" when disabled people apply for a job, but without more detail it is impossible to assess the likely impact of this.

On top of these changes, the Conservative Party propose to replace all welfare-to-work programmes for the unemployed, lone parents and disabled people with a one mandatory Work Programme, delivered by private and voluntary sector organisations, with payment almost entirely by results. It is keen to present this as a "new welfare contract", but most of the ideas behind it merely go a little further in the direction of policy taken or planned by the current government.

The Conservative Party think the Work Programme and its plans for additional training places would cost £600 million over three years. It also claims that it would save £600 million over three years by moving IB recipients to ESA, providing a revenue neutral package. These savings seem odd given the Government has set out plans to implement the same policy. The Conservative Party has argued that these additional savings are credible because it does not believe that the Government would actually make savings from this reform, but the Government has set out a clear plan for moving recipients of incapacity benefits onto ESA, and announced how much it expects to save from this reform. Fundamentally, this is not a credible way of identifying 'savings' relative to the Government's plans, because any opposition party could identify alleged savings in this way at any time by simply asserting that the Government will not do things that it has publicly committed to.

None of the 3 main parties has proposed a substantial increase in the generosity of social security benefits (although government plans are for the pension credit guarantee and the state pension, from April 2012, to rise in line with average earnings, rather than inflation as is the case for most other benefits). On the other hand, the current state of the public finances may mean that the more likely scenario is for the next Government to implement more substantial cuts in social security spending than any of the 3 main parties have suggested in their manifestos. IFS researchers have found that on current policies the public spending plans set out by Alistair Darling in his last Budget imply departmental spending falling by 11.9 per cent by 2014-15, but social security spending growing by 4.4 per cent over the same period. Productivity improvements mean one might be able to squeeze more public services from a given level of departmental spending, whilst the same is not true for spending on cash benefits But, nonetheless, a post-election government may feel reluctant to allow public services spending to suffer this large a real squeeze while allowing benefit spending to grow that strongly.

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http://www.ifs.org.uk/publications/4831 Wed, 21 Apr 2010 00:00:00 +0000
<![CDATA[The Liberal Democrats: tighter or looser?]]> The Liberal Democrat manifesto contains more extensive and more detailed tax and spending proposals than those of the other main UK parties. But taking as given the Liberal Democrats' estimates of the amounts that their proposals will cost and raise, the document is less clear than it could be in setting out how these proposals fit into the party's overall plan to repair the public finances.

The Liberal Democrats propose a net tax increase that they think would raise £2.4 billion in 2011-12 and about 0.17% of national income (£2.5 billion in 2010-11 terms) in 2013-14. (A separate observation here discusses whether their numbers add up - and the short answer is that it is very hard to be sure.) The Liberal Democrats have also identified spending cuts that they claim would save 0.45% of national income (£6½ billion) in the same year.

Does this mean that the Liberal Democrats are planning to be more ambitious than Labour in reducing the deficit?

If anything the manifesto implies the opposite: it says that a Liberal Democrat government would carry out a Spending Review over the summer and autumn "with the objective of identifying the remaining [our italics] cuts needed to, at a minimum, halve the deficit by 2013-14". At face value this might suggest a less ambitious plan to reduce the deficit overall than that implied by the forecasts in the Budget. The Budget predicted that the deficit (total government borrowing) would be down to 5.2% of national income in 2013-14, whereas halving it means that it need not be reduced below 5.9% of national income (half the 11.8% forecast for 2009-10). But the Liberal Democrats tell us that this promise to "at a minimum, halve the deficit" should be taken as shorthand for matching the deficit reduction path set out in the Budget. So, overall, they are no more or less ambitious than the Government.

So the measures they have set out today tell us something about the composition of the tightening they propose rather than its size. In 2013-14 the Government is planning to deliver a tax increase of 1.0% of national income (thanks to measures already announced) and a spending cut of 2.2% of national income (to be detailed in a Spending Review after the election). The Liberal Democrats would increase the net tax increase to 1.2% of national income, thereby reducing slightly the overall size of the spending squeeze implied by the Government's Budget forecasts. Over the next three years at least, this now gives us a clear ranking. The three parties all want to rely more on spending cuts than tax increases to repair the public finances, but the Conservatives plan the biggest spending squeeze, then Labour and then (not far behind them) the Liberal Democrats.

Looking out over the whole fiscal tightening, which the Government expects to have to continue until 2016-17, the picture is somewhat different. The Liberal Democrats say that further net tax increases beyond those already announced by the Government (plus their bank profit levy) should only be a "last resort". The Government has pencilled in a fiscal tightening of 1.4% of national income in 2015-16 and 2016-17 that it has not allocated between spending cuts and tax increases, but which it would seem reasonable to assume they might split 2:1 between spending cuts and tax increases in line with the split over earlier years - requiring them to announce additional tax increases worth around 0.4% of national income (£6 billion). If the Liberal Democrats achieved all of this through spending cuts, they would end up using spending cuts to achieve a larger part of the total tightening than Labour, but still less than the Conservatives.

If they are costed correctly, the specific spending cuts set out by the Liberal Democrats in the manifesto would achieve a little under a quarter of the total discretionary spending cut as a share of national income that they need to match the Government's deficit forecast for 2013-14 - and a smaller proportion still of the eventual cut that would be necessary to complete the fiscal tightening in 2016-17.

Each of the three main parties has only filled in a small part of the deficit reduction plan jigsaw - in each case we would have to wait for a post-election Budget and/or Spending Review for a more complete picture to be filled in.

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http://www.ifs.org.uk/publications/4819 Wed, 14 Apr 2010 00:00:00 +0000
<![CDATA[Do the Liberal Democrats' tax plans add up?]]> The Liberal Democrats propose to increase the income tax personal allowance to £10,000 while keeping the level of income at which people start to pay the higher rate of tax unchanged. They say this giveaway would cost £16.8 billion in 2011-12. They also propose a set of significant tax-raising measures:

  • Reforming air passenger duty to operate per flight instead of per passenger and introducing additional tax for some domestic flights, to raise £3.3 billion
  • Introducing an annual 1% tax on domestic property values above £2m, to raise £1.7 billion
  • Introducing an additional 10% tax on the profits of UK banks (with no offset for losses) until bank regulation is fundamentally reformed, to raise £2.2 billion
  • Restricting tax relief on pension contributions to the basic rate, to raise £5.5 billion
  • Reducing the capital gains tax allowance from £10,100 to £1,000 and taxing capital gains above this at marginal income tax rates, to raise £1.9 billion
  • Introducing anti-avoidance and anti-evasion measures to raise £4.6 billion

In total, the Liberal Democrats estimate that these tax increases would raise £19.2 billion in 2011-12, £2.4 billion more than the cost of their income tax cut. We will be releasing a full analysis of this package - and all of the main parties' tax and benefit proposals - in the coming days. But what can we say by way of an initial assessment of whether the sums add up?

Increasing the personal allowance to £10,000 does indeed look like it would cost around £16.8 billion (or at most a billion or so more), assuming that people do not change their behaviour in response to the tax cut. In practice it would encourage more families to have someone in paid work (and paying taxes), thereby reducing the cost.

Whether the tax raising proposals would raise what the Liberal Democrats expect is much more uncertain. They could raise more or less.

For the reforms to aviation taxation, the Liberal Democrats suggest that they would set the rate as high as is necessary to achieve the £3.3 billion extra revenue they want. That is perfectly feasible.

On the taxation of 'mansions', banks, pensions and capital gains, the data that are publicly available do not allow us to give a definitive costing. To arrive at their figures, the Liberal Democrats have had to make numerous assumptions. Some of these assumptions are questionable, and there are some mistakes, but while in some cases that implies raising less revenue than the Liberal Democrats estimate, in other cases it implies raising more. Their estimates for the mansion tax, the bank tax and the restriction of pensions tax relief do not seem unduly optimistic, while the reforms to capital gains tax would probably raise substantially more than the £1.9 billion they suggest. But there is a great deal of uncertainty around all these costings, given the paucity of relevant data available.

The estimate that £4.6 billion would be raised from their anti-avoidance and anti-evasion measures looks highly speculative. The Liberal Democrats have not attempted to estimate directly the impact of most of the measures they specify; they simply assume particular proportions of the total 'tax gap' attributable to evasion and avoidance that they think they could fill. Whether their approach would really raise so much more than the Government's continuing strenuous efforts must be open to question. For example:

  • In estimating the revenue that a General Anti-Avoidance Principle (GAAP) would generate, they assume that they can recover a percentage of the revenue the Government thinks it loses from both 'avoidance' and differences in 'legal interpretation'. Yet a GAAP of the kind they describe would do little to address the latter, and so the fraction of 'avoidance' alone that a GAAP would need to eliminate to raise the same total is much larger than the Liberal Democrats assume.
  • Resources to tackle evasion are supposed to be freed up by the 'simplification' of the tax system implied by their other reforms and from a new commercial arm of HMRC set up to provide a pre-clearance service to underpin the GAAP. But it is not clear that their other reforms would reduce the cost of administering the tax system: there would be fewer income tax payers, but more capital gains tax payers, and it is far from clear that the pensions tax reform would reduce the demands on HMRC as the Liberal Democrats suggest. And the proposed new commercial arm of HMRC has to meet the costs of a pre-clearance mechanism before having anything left over to spend tackling evasion. To assume that a combination of profitable pre-clearance activities and 'simplification' would generate enough spare resources to stop £1.4 billion of evasion seems optimistic.

Beyond these concerns, the fractions of evasion and avoidance that the Liberal Democrats claim their measures would eliminate are assumed arbitrarily (though in fairness we have no way to estimate them more accurately). They may be too high or too low. The Liberal Democrats acknowledge this uncertainty and describe their £4.6 billion figure as a 'target', but they are relying on the revenue to fund their income tax cut.

So what is the overall picture?

We can be pretty confident that the Liberal Democrats' headline giveaway would cost roughly what they claim. Whether the revenue raising measures would yield what they expect is much more uncertain - and we cannot even say with confidence whether they are more likely to raise too much revenue or too little. On the one hand, their estimates of the revenue to be raised from tackling avoidance and evasion seem optimistic; on the other hand, the estimates of the revenue to be raised from the rest of the package if anything look pessimistic. The only way to find out for sure would be to suck it and see.

 

 

 

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http://www.ifs.org.uk/publications/4820 Wed, 14 Apr 2010 00:00:00 +0000
<![CDATA[No new taxes?]]> The Conservative manifesto did not tell us anything about their tax and spending plans we did not already know. In particular, it was no more explicit about how much more ambitious the Conservatives would be than the Government in reducing the budget deficit over the medium term. The Conservatives promised only "to eliminate the bulk of the structural deficit over the Parliament", a vague goal that the Government would argue that it is on course to achieve already.

The best clue to the Conservatives' fiscal ambition is their earlier commitment to balance the structural current budget deficit (i.e. that part of Government borrowing which is neither used to fund investment nor is the result of the temporary weakness of the economy) by the end of the forecasting horizon. Unfortunately, they refuse to say yet what their forecasting horizon would be, but it seems reasonable to assume that it would remain five years as under Labour now.

A five-year horizon implies that in 2015-16 the Conservatives would need to deliver the spending cuts and tax increases of 4.1% of national income (£60 billion in today's terms) that Labour is already intending for that year, plus an additional 0.6% of national income (£9 billion). (Labour would make that additional tightening too (plus an extra 0.1% of national income or £1 billion), but not until the following year.) This acceleration of the tightening timetable would be consistent with David Cameron's comment at the manifesto launch that the Conservatives want to go further than Labour in dealing with the deficit, and not just start earlier.

The Conservatives have also signalled that they would prefer to see deficit reduction measures split 4:1 between spending cuts and tax increases, rather than the 2:1 split implied by the Government's plans. If they aim for the same overall tightening of 4.8% of national income or £70 billion in today's terms as the Government, then a 4:1 split would imply an eventual spending cut of around 3.8% of national income (£56 billion) and a tax increase of around 1.0% of national income (£14 billion). If the Government was to stick with a 2:1 ratio throughout its planned tightening, it would be looking for eventual spending cuts of 3.2% of national income (£47 billion) and tax increases of 1.6% of national income (£23 billion).

The tax increases that the Government has already announced will deliver about 1.2% of national income (£17 billion) in the medium term, suggesting that they might need to announce further tax increases worth around 0.4% of national income (£6 billion). Of the 3.2% of national income spending cut (£47 billion) they need, their plans to 'protect' (but shrink as a share of national income) non-investment spending on the NHS and part of the education budget, offset by a rise in the share of national income spent on overseas aid, would get them only a small part of the way there. We would have to wait for a Labour Spending Review to see where much of the rest fell.

Under their desired 4:1 ratio, the Conservatives would need a tax increase of 1% of national income, smaller than the 1.2% of national income that the Government has already announced. But their National Insurance cut, marriage tax break and freezing of council tax in England (minus the proceeds of their bank bonus tax) would more than exhaust this cushion and so the Conservatives too would likely need to announce further tax raising measures to get the job done. We will address this issue more definitively when we compare the deficit reduction plans of all three parties in a few days' time.

All these calculations are based on the Treasury's latest forecasts in the Budget. And, of course, there are huge uncertainties surrounding them, especially over a period of five or six years. The necessary fiscal repair job could yet turn out be much larger or smaller than we now think.

Given the current forecasts, let alone the uncertainties surrounding them, the Conservatives were wise not to make a "read my lips, no new taxes" pledge in their manifesto. William Hague only went so far yesterday as to say: "We are not looking for tax rises", which does not rule anything out. The Conservatives also eschewed Labour's manifesto promise not to increase income tax rates or extend VAT, a pledge that leaves the door open to many other tax increases - just as similar pledges in Labour's last three manifestos left the door open to the substantial tax increases they have implemented since 1997.

Of course, the Conservatives are left having to identify an even bigger spending cut overall than Labour in the next Spending Review and beyond. And, like Labour, they have only identified where a small proportion of the cuts will come from.

An obvious question is whether it is really realistic to expect spending cuts to bear as much of the burden of the fiscal tightening as the Conservatives intend, given the likely consequences for public services and the generosity of the welfare system. Bear in mind that the ratio of discretionary spending cuts to tax increases in the last big fiscal tightening undertaken by a Conservative government, under Norman Lamont and Kenneth Clarke in the early 1990s, looks to us to have been around 1:1.

Whoever forms the next Government, it is hard to escape the conclusion that there are likely to be more tax increases to come.

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http://www.ifs.org.uk/publications/4818 Tue, 13 Apr 2010 00:00:00 +0000
<![CDATA[Labour leaves tax and spending questions unanswered]]> The key question for the next Government is what size and combination of public spending cuts and tax increases to implement to repair our public finances. Anyone looking for a more detailed answer from Labour in its manifesto will have been disappointed. The party listed plenty of new things it would like to do, but was no clearer about where the spending cuts would fall. And it listed a few tax increases that it promised not to implement, but left the door wide open to many others.

Specifically on tax, the manifesto promised that: "We will not raise the basic, higher and new top rates of tax in the next Parliament and we renew our pledge not to extend VAT to food, children's clothes, books, newspapers and public transport fares."

This is very similar to the promises Labour made in its previous three manifestos. Namely:

  • 2005: "We will not raise the basic or top rates of income tax in the next Parliament... We renew our pledge not to extend VAT to food, children's clothes, books, newspapers and public transport fares."
  • 2001: "We will not raise the basic or top rates of income tax in the next Parliament... We renew our pledge not to extend VAT to food, children's clothes, books, newspapers and public transport fares."
  • 1997: "To encourage work and reward effort, we are pledged not to raise the basic or top rates of income tax throughout the next Parliament... We renew our pledge not to extend VAT to food, children's clothes, books and newspapers and public transport fares."

But, as we show in an Election Briefing Note published today (The tax burden under Labour), these pledges have not stopped Labour from implementing net tax increases since 1997 that will cost families £31.1 billion this year (£970 per family) and almost half as much again - a total of £45.4 billion (£1,420 per family) in today's terms - by 2014-15, once the tax increases already announced in recent Budgets and Pre-Budget Reports for implementation during the coming Parliament take effect.

Among the largest of these tax increases are the rises in National Insurance Contributions (NICs) announced in the 2002 Budget, the 2008 Pre-Budget Report and the 2009 Pre-Budget Report. For the majority of people, who receive most of their income in wages and salaries, an increase in NICs is to all intents and purposes the same as a rise in income tax rates. And it is not obvious therefore why they should be reassured by a pledge on income tax that does not extend to National Insurance.

As it happens, Labour did of course breach the promise it made on income tax rates in the 2005 manifesto by announcing a new 50% income tax band to take effect from the current financial year. Even if the Treasury's potentially overoptimistic assessment of the revenue to be raised is correct, this will make only a modest contribution to the net tax increase announced since the financial crisis.

Labour has also raised revenue by failing to increase tax allowances and thresholds in line with rising real living standards - so, rather than raising the basic and 40p income tax rates, it has increased the number of people paying them. On current policy the number of people paying tax at the 40% and 50% rates is set to continue increasing significantly over the coming Parliament.

The analysis we publish today shows that the widest measure of the total tax burden (total government revenue as a share of national income) has risen since 1997, albeit by much less than the value of Labour's announced tax increases. This reflects the impact on revenues of factors such as the recession and the particular plight of the previously tax-rich financial sector.

In contrast, most industrial countries have reduced their tax burdens since 1997. On an internationally comparable definition, the UK has moved from having the 8th lowest tax burden of 28 OECD countries in 1997 to having the 13th lowest in 2010. If the UK had seen its tax burden fall by the same proportion of national income as the unweighted average of the other 27 countries, then in 2010 it would be 3.3% of national income below that forecast by the OECD for this year - a difference of £49 billion in today's terms or £1,520 per family.

The tax burden has risen in the UK partly because Labour has chosen to spend more on public services and on financial support for poorer families with children and pensioners. Spending has risen particularly sharply as a share of national income since the financial crisis, reflecting higher welfare bills, higher debt interest and a shrinking economy.

As we describe in a second Election Briefing Note published today (Public spending under Labour), the UK had the second largest increase in public spending as a share of national income of 28 industrial countries between 1997 and the eve of the financial crisis in 2007. Taking the period of the financial crisis into account as well, the UK recorded the largest increase from 1997 to 2010. This has moved the UK from being the 22nd highest spender of 28 in 1997 to the 6th highest in 2010.

Figures from the Office for National Statistics show that one result of the pre-crisis rise was a big increase in the quantity and quality of public services we enjoy. It estimates that public services output (adjusted for quality as best it can) had increased by more than 33% between 1997 and 2007. But the amount of inputs required - and the cost of those inputs -increased even more.

We therefore estimate that the "bang for each buck" that we get from public services spending has fallen by more than 13% over the same period. If Labour had managed to maintain the "bang" it inherited in 1997, it could have delivered the same quality and quantity of services that it delivered in 2007 for £42.5 billion less - or it could have provided 15.5% more or better services for the same money.

But this is not necessarily proof of unnecessary waste. The quality of public services may have improved in ways that the ONS does not measure. Some cost increases may have been unavoidable. And some increases in public sector inputs may only be fully reflected in the quantity and quality of service outputs after a significant lag - if so, we may not yet have seen the full benefit.

Whatever the case, the outlook for spending on public services looks much bleaker over the next few years, and it would futile to hope that the quality and quantity of services will be unaffected. Labour's manifesto has left us none the wiser as to where exactly the axe will fall, but fall it will.

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http://www.ifs.org.uk/publications/4816 Mon, 12 Apr 2010 00:00:00 +0000
<![CDATA[Do the poorest really pay the most in tax?]]> The Liberal Democrats have, once again, claimed that the poor pay more of their income in tax than the rich, and that this gap has got larger under Labour. But, by ignoring the fact that the poor get most of this income from the state in benefit and tax credit payments, and by overstating the extent to which indirect taxes are paid by the poor, this comparison is meaningless at best and misleading at worst.

The underlying figures come from the Office for National Statistics, and are not in dispute. As the Liberal Democrats say, in 2007-08, the poorest fifth of households had a gross annual income of £11,105 on average, and paid £4,302 a year in tax, a ratio of 38.7%. Meanwhile, at the other end of the scale, the richest fifth of households had an average gross annual income of £74,247, and paid £25,926 in tax, on average, a ratio of 34.9%. (See Table 1 of this article).

The first key point to note is that benefits and tax credits account for £6,453 of the £11,105 average gross income of the poorest fifth of households. Their original income - in other words, private income from sources such as earnings, private pensions and investments, but not that from benefits and tax credits - was an average of £4,651. So the poorest fifth of households were clearly net beneficiaries from the tax and benefit system, to the tune of £2,151 a year, on average. At the other end of the scale, the richest fifth of households received £1,666 a year in income from the state, and so they are net contributors to the Government's coffers, to the tune of £24,259 a year, on average.

If we define "net taxes" as "taxes paid less benefits received", then the net tax rate of the poorest fifth is -46% of their original income (or -32% of their after-tax income), with the negative number reflecting that they are net beneficiaries. At the other end, the richest fifth have a net tax rate of +33% of their original income (or +50% of their after-tax income). These figures show what one would expect: the tax and benefit system as a whole takes money from the rich, and gives it to the poor.

The combined impact of the tax and benefit system on the distribution of income seems much more enlightening than the impact of the tax system alone when talking about fairness. The Liberal Democrats' analysis does highlight, though, that benefits and tax credits do more to reduce income inequality in the UK than the tax system.

A second difficulty with the numbers relates to the way in which indirect taxes are treated, and this affects whether they appear to be regressive or not. People who are interviewed in the sort of surveys which underpin this analysis, and who report a low current income, tend to spend a lot relative to their current income, and therefore pay a lot of indirect tax relative to their current income. But this arises because the figures are a snapshot view of indirect taxes paid in a given period as a percentage of income in the same period. In reality, much low income is temporary, and people borrow and save to smooth out their living standards; over a lifetime, individuals cannot spend more than their income. As acknowledged by the ONS (see footnote 35 here), we get a different impression of the impact of indirect taxes by ranking people by their level of spending. That shows, for example, that VAT is progressive as a percentage of spending, since zero- and reduced-rated goods (such as food, children's clothes and domestic fuel) are necessities that are bought disproportionately by the poor. IFS researchers have written more about this issue here, although it must be noted that the ONS analysis suggests VAT is regressive even as a percentage of spending.

What about the Liberal Democrats' second claim: that the tax system has got less redistributive over time? Following the definition we introduce above, net tax rates on the poorest fifth have gone up since 1997-98, and those on the richest fifth have fallen very slightly (the 1997-98 figures which underpin this calculation are available in Table B here. But the poorest fifth have seen their own private income rise faster than the richest fifth (masking the opposite trend at the very extremes of the income distribution), so this may not be a particularly enlightening comparison: net tax rates should rise as incomes rise under a progressive tax and benefit system.

A more definitive answer is provided by analysis of the impact of Labour's tax and benefit reforms on the distribution of income, which have been strongly progressive, with the poorest households gaining, on average, and the richest households losing, on average (but with the precise amounts depending on what one considers to be a "change"). It is also clear that these changes acted to dampen down what would otherwise have been a large rise in inequality.

Even on the Liberal Democrats' peculiar definition, a natural follow-up is to wonder whether the tax system would get any less regressive over time under their policies? IFS researchers will provide a fuller assessment of that after their manifesto has been published. It is reasonably clear that the reforms to capital gains tax and the new mansions tax should increase the tax burden on the rich, but it is less clear that the proposal to increase the income tax personal allowance to £10,000 will help many of the poorest households, as the poorest fifth of households will contain those with incomes too low to pay income tax. (In any given year, one third of adults do not pay income tax and one quarter of adults live in a family where no-one pays income tax). The largest beneficiaries of the higher personal allowance will be families with two earners (where both earn less than £100,000).

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http://www.ifs.org.uk/publications/4813 Mon, 12 Apr 2010 00:00:00 +0000
<![CDATA[An efficient debate?]]> As we watch the parties squabble over how much can be achieved in efficiency savings this year, it is worth remembering that we will not be able to judge with confidence which was right even after the event.

 

The National Audit Office has been highly sceptical of the Government's claimed efficiency savings in the past. And, while the Office for National Statistics has improved its measurement of public services output, its estimates of the bang we get for our buck are nowhere near accurate enough to verify the claims the parties make.

 

For what it is worth, Labour said in the Budget that of the £35 billion in efficiency savings that it planned to deliver between April 2008 and March 2011, it had managed to achieve £10.8 billion by autumn 2009. Barely two weeks later, it now feels confident enough to assert that it has achieved £20 billion, leaving £15 billion to be achieved in 2010-11. They point out that for the Conservatives to achieve another £12 billion on top, within the current financial year, would be quite an ask.

 

Does this mean that if the Conservatives cannot achieve the efficiency savings they claim, they would not be able to use £5.6 billion to avoid the bulk of the planned National Insurance rise for April 2011? No. The key point is that the Conservatives have said that they will cut public services spending outside the NHS, the Ministry of Defence and overseas aid by £6 billion this year, compared to Labour's current plans. Whether they could achieve efficiency savings that would make this feel painless is, from the perspective of the management of the public finances, a second order question. The same was true when Labour announced a £5 billion cut in public services spending for 2010-11 in the November 2008 Pre-Budget Report and claimed that that would be painless too.

 

We will never know for sure if efficiency savings deliver the additional bang for the buck that is claimed for them. And if they do, we might hope that most of them would have been achievable even if we were not cutting spending.

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http://www.ifs.org.uk/publications/4810 Thu, 08 Apr 2010 00:00:00 +0000
<![CDATA[Taxes and elections: are they by any chance related?]]> Last week Chancellor Alistair Darling warned us not to expect a giveaway in next week's Budget, while his Chief Secretary to the Treasury, Liam Byrne, reassured us that the Government could halve the deficit by 2013-14 without announcing any further tax increases. If both statements prove correct - no pre-election tax giveaway and no new post-election tax takeaway - then this would break the pattern of the last four general elections.

The figure below shows the net long-run fiscal impact of tax measures announced in each Budget and Pre-Budget Report (PBR) since spring 1985. The shaded areas denote different Parliaments.

The clearest example of pre-election tax cuts followed by post election tax rises was around the April 1992 general election. In the pre-election Spring 1992 Budget the Conservative Government announced net tax cuts worth £5½ billion a year in today's terms. The then Chancellor Norman Lamont has conceded that this was "not a very good budget. But it did help us to win the 1992 election". In contrast the Spring 1993 Budget delivered a net tax rise of £23 billion a year. Lord Lamont described this as having "helped to lose the 1997 election for the Conservatives, but it was definitely my best budget". The November 1993 Budget - delivered by the now Shadow Business Secretary Ken Clarke - delivered a further £16 billion of tax raising measures.

Under Labour the pre-election Budget of Spring 2001 did contain a net tax cut, but the pre-election Budget of Spring 2005 did not. This difference reflects the apparent strength of the public finances at the time: in 2001 a pre-election giveaway appeared consistent with then Chancellor Gordon Brown's fiscal rules, whereas by 2005 the strength of the public finances had deteriorated and a breach of those rules seemed increasingly likely. Given the current far worse state of the public finances, a significant permanent pre election giveaway in next week's Budget would be tantamount to poking gilt investors with a sharp stick. And voters might well think it too good to be true.

That suspicion would certainly be justified by the experience of recent post-election tax decisions. Like the Conservatives after 1992, Labour has tended to announce relatively big net tax increases in the months following its general election victories. This can be seen in the Budgets of July 1997, March 1998, April 2002 and the PBR of 2005. We have also seen relatively large tax increases announced since the outbreak of the recent financial crisis (PBR 2008, Budget 2009 and PBR 2009). But with the exception of the increases in income tax from April 2010, which will only directly affect one adult in 50 (those fortunate enough to have an income above £100,000 a year), most of the pain will not be felt until after the 2010 general election. For example the forthcoming 1ppt rise in all rates of National Insurance Contributions is not scheduled to come into force until April 2011.

It is possible that we won't see further net tax rises after the 2010 general election. But recent history suggests we will. And so too does the need to reduce the deficit from its current post second World War high without eye-watering cuts in many areas of public spending. Whatever Mr Byrne may say now, most likely we will see a Chancellor - or Chancellors - announcing fresh net tax increases in 2010 and 2011, once the forthcoming general election is safely out of the way.

Figure. Net estimated long-run fiscal impact of tax changes by statement since Spring 1985.

Tax cuts

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http://www.ifs.org.uk/publications/4793 Mon, 15 Mar 2010 00:00:00 +0000
<![CDATA[The Conservative party's council tax freeze]]> In his 2008 Conservative party conference speech, Shadow Chancellor George Osborne announced that an incoming Conservative government would freeze Council Tax in England for two years. IFS researchers estimated at the time that if this policy was implemented in 2009-10 and 2010-11 it would cost have £1 billion in its second year, in 2008-09 prices. Over the past month, the parties have been disputing how much it would cost if an incoming Conservative government was to implement it in 2011-12 and 2012-13.

In its New Year assault on the Conservatives' tax and spending policies, the Labour Party cited a Treasury estimate that the policy would cost £1,320 million a year in its second year in 2011-12 prices - more than we originally estimated. Now that we have a preliminary estimate from the Chartered Institute of Public Finance and Accountancy that council tax will rise by an average of 1.8% in England in 2010-11, we have been able to update our own original costing. It has increased a little, reflecting inflation between 2008 and 2011, but remains at £1.0 billion (in 2011-12 prices) to the nearest tenth of a billion pounds.

In our costings, both we and the Treasury assumed that council tax bills would rise by 2.5% a year in the absence of the policy. Our estimate of the year two cost comprises a £1.3 billion increase in grants to English local authorities to offset the revenue they would forego, partially offset by a reduction in expected spending on Council Tax Benefit of £0.3 billion. Figure 1, below, shows how we think families in England across the income distribution would benefit, ignoring the impact on households of the central government spending cuts required to pay for the policy (of which more below). The average gain is about 75p per week, or 0.17% of average net weekly income. The biggest beneficiaries in proportional terms are those in the middle of the income distribution and those at the very bottom. Many poorer people gain little or not at all, because council tax benefit would have largely or entirely insulated them from the impact of the council tax increase that would have occurred in the absence of this policy.

Figure 1. Distributional Impact of the 2-year Council Tax Freeze

Council tax

At first glance, this suggests that our estimate of the cost of the policy is lower than the Treasury estimate cited by Labour. In fact that turns out not to be the case. At the time when Labour first cited the number, the Treasury said that it included the offsetting savings from lower council tax benefit. But they have now corrected this and said that the savings had not been included. So we and the Treasury probably both think that the net cost of the policy in England would be around £1 billion.

But the cost and impact of the policy in England is not the whole story. Under the infamous 'Barnett formula', a £1.3 billion increase in grants to English local authorities would be matched by a £0.3 billion increase in grants to the devolved administrations in Wales, Scotland and Northern Ireland. This increases our estimate of the total net cost of the policy to £1.4 billion after rounding - and would presumably increase the Treasury's estimate of the cost to roughly the same level if they were to net off the council tax benefit savings too.

The Conservative Party say that they would pay for the extra grants to English local authorities by cutting the 'consulting and advertising' budgets of central government (e.g. departments like the Department of Health) in England. If spending in England is reallocated from central departmental budgets to local government grants so that total spending in England remains unchanged, there would be no need to increase spending to increase grants to the devolved governments. So, these savings would need to amount to £1 billion (the net cost of the policy in England alone), right? Unfortunately, it's not that simple, again because of the intricacies of the Barnett formula. Because increased grants to local authorities are counted as additional "English" spending but savings on council tax benefit are counted as savings on the UK-wide benefits budget, the cuts would need to total £1.1 billion to pay for the cost of the policy in England plus a £60 million increase in grants to the devolved nations. These cuts would need to be genuinely additional to any currently planned by the government or any intended by the Conservatives as a way to reduce the deficit. Taking these spending cuts and the council tax pledge together means a net cut of spending by central government and the devolved national governments of £1.0 billion.

But, cuts in spending on advertising and consultancy could surely go ahead in the absence of any pledge on council tax with the savings instead used to reduce the deficit or cut other taxes. With this in mind we think the best way of thinking about the policy is as a rise in central government spending in England that needs to be matched by increased grants to the other nations in the UK giving a £1.4 billion total cost of the council tax pledge, once one takes account of the lower bill for council tax benefit.

But is the policy a good idea? It's easy to see the political attraction of freezing council tax given its apparent unpopularity. But it is noteworthy that the Conservative Party have not announced plans for long-term reform of Council Tax, whether that be scrapping it, or making it more proportional to house-prices, and they are also opposed to a revaluation, which would make the tax fairer by being more closely related to current house prices. The policy represents a small shift in the balance of funding away from local authorities and back towards the centre, which seems hard to reconcile with a desire for more localism in policy-making. The policy also adds yet more complexity to the English Local Government Finance system.

With a number of slightly different numbers floating around, you may be confused. Don't let that concern you. The answer to which party is right on the costing of the council tax pledge is quite subtle. Labour could rightly say that this pledge costs £1.4 billion (if we consider the pledge in isolation from the planned reductions in advertising and consultancy spending), whilst the Conservative Party can point to the £1.0 billion in net cuts in central government spending required to make the combined spending cuts and council tax pledge revenue-neutral. However, the couple of hundred million pounds involved is negligible compared to the multi-billion fiscal repair job needed over the next parliament (or two).

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http://www.ifs.org.uk/publications/4780 Wed, 03 Mar 2010 00:00:00 +0000
<![CDATA[Tougher than Thatcher?]]> "Whoever wins the election, Labour or Conservative, is going to have to cut spending. That is not something that Margaret Thatcher actually did. So tougher than Margaret Thatcher." So said George Osborne on the Today Programme this morning - and the numbers by and large bear him out.

Total public spending increased by an average of 1.1% a year in real terms over the Thatcher era. This is almost three times the increase of 0.4% a year that Alistair Darling pencilled into his Pre-Budget Report last November for the forthcoming Parliament. If the Conservatives wish to achieve a bigger fiscal tightening than Labour - and/or if they wish to achieve more of it through spending cuts rather than tax increases - then the gap would be even bigger.

While the PBR figures do show spending continuing to rise in real terms over the coming Parliament, if we subtract spending on welfare and debt interest then we estimate that the rest of public spending would be cut in real terms by an average of 1.4% a year compared to an average increase of 0.7% in the Thatcher era. We have not seen five years with an average annual real cut as big as this since the mid-1970s. The PBR figures also suggest that we will see real cuts not just on average over the Parliament but in every year of it - and we have not seen cuts for four or five years running since before the war.

Even this comparison flatters the likely outlook for public services, as it includes some spending on other areas (such as public sector pension bills) that are likely to continue rising in real terms. We estimate that if you look solely at what the Treasury calls "Department Expenditure Limits" - Whitehall spending on public services and administration - then the likely real cut implied by the PBR projections would be 2.4% a year over the Parliament.

Alas we don't have official estimates of what DELs would have been in the pre-Labour years. But the comparison would be pretty sobering. And if the Conservatives want to cut further and faster, all the more so.

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http://www.ifs.org.uk/publications/4772 Thu, 25 Feb 2010 00:00:00 +0000
<![CDATA[Marriage, children's outcomes and tax policy]]> The issue of marriage and family life looks set to be a key election battleground. In recent weeks, the Conservative Party's policy on supporting marriage in the tax system - re-stated in the family section of their Draft Manifesto published this week - has been under the spotlight. A Green Paper on family policy is due to be released by the Government next week. Recently-published IFS analysis, and two new projects funded by the Nuffield Foundation, hope to shed light on some of these issues.

The Conservative Party's wish to recognize marriage in the tax system, and many of the recommendations made by the Centre for Social Justice on family life, are justified by their proponents by the fact that in general children born to parents who are married do better on a wide range of outcomes than children born to cohabiting couples (and indeed to lone parents). But marriage itself may not be at the root of this difference, since cohabiting and married couples with children differ: for example, cohabiting parents are typically less educated, younger, and have a lower household income than married parents, and they may also differ in their relationship quality and stability. There has been remarkably little systematic work from the UK to date which investigates these important issues, and a new and substantial research project at the IFS will assess the impact that being born to non-married parents has on UK children's outcomes, trying to tease out how much of the observed differences might be genuinely attributed to the state of marriage.

The Conservative party have also said that they wish to reduce the couple penalty in tax credits, presumably by increasing the working tax credit for couples with children, and that funding for this policy would come from savings in the welfare budget. By "the couple penalty", we mean the change in entitlements - usually a fall - to benefits and tax credits that occurs when two single people (with or without children) start to cohabit. In theory, the existence of a couple penalty can give couples an incentive to live apart, rather than together, and to act fraudulently when claiming means-tested benefits or tax credits. In another new research project underway at IFS, which will produce results in a couple of months, we will provide a descriptive analysis of the "couple penalty" and how it has changed in recent years.

Finally, the IFS has recently published analysis, commissioned by Gingerbread, of the impact of three different tax and benefit policies on family incomes, work incentives and child poverty. The policies were a transferable personal allowance for married couples with children of certain ages (a policy which featured in the Conservative Party's 2001 election manifesto, and was recommended to the Conservative Party by Lord Forsyth's Tax Reform Commission, and Iain Duncan Smith's Centre for Social Justice), a higher working tax credit for couples with children, and higher child elements of the child tax credit for all families. It updates some previous work, which discusses what features of the tax and benefit system lead to couple penalties being present. The intention is that our new analysis of the couple penalty, described above, will allow a more complete comparison of these different policies.

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http://www.ifs.org.uk/publications/4725 Fri, 22 Jan 2010 00:00:00 +0000
<![CDATA[More unequal - but why?]]> It is widely known that income inequality has risen substantially over the past thirty years. During the 1980's, in particular, inequality rose dramatically - to levels from which it has never subsequently fallen. But what lies behind this increase in income inequality? In recent work, commissioned by the National Equality Panel, IFS researchers attempt to answer this question by 'decomposing' changes in inequality into the effects of various different forces.

For example, households' incomes derive from many different sources - earnings from employment, state benefits, pensions, investment income, and so on. By breaking income up into these constituent parts, we can investigate which income sources contributed most to changes in inequality. As the chart below shows, it appears that earnings from employment were the main culprit in driving up inequality, but that most sources of income - including investment income and income from self-employment - became more unequally distributed throughout the 1980's.

Income inequality by income source, 1968 to 2006-07

Income inequality

Our full report decomposes inequality according to many other factors (age, sex, region, occupation, etc.), in an effort to assess which contributed most strongly to changes in income inequality. Several factors which one might expect to be important drivers of inequality - Britain's ageing population, for example, or the inequality between the North and the South - turn out to explain very little of the changes in inequality over the past forty years. More surprisingly still, the earnings gap between men and women has actually acted to reduce inequality, as the relative earnings of women have 'caught up' with those of men.

The most important drivers of increased inequality appear to be occupation - with a widening earnings gap between unskilled workers and professional/managerial workers - and education, with increasing relative wages among better-educated members of the workforce throughout the 1980's. This finding is consistent with the idea that 'skills-biased technological change' was responsible for much of the increase in inequality - with new technologies complementing the work of skilled and educated workers, but substituting for the work of lower-skilled workers.

However, our analysis also provides grounds for humility - there is still much about inequality changes over the past four decades which remains unexplained. Individuals' observable characteristics (at least the ones we have in our data) account for only a fraction of total inequality - rarely as much as half. Indeed, the unexplained ('residual') portion of inequality increases over time, suggesting that incomes have become more dispersed even within tightly defined groups.

On the same day that our report was published, the Office for National Statistics announced the results of their Wealth and Assets Survey (WAS) - providing a snapshot of the wealth distribution in the UK between 2006 and 2008, and revealing stark disparities. The top 10% of wealth-holders have more than 44% of all wealth (compare this with the top 10% of income earners, who receive 'only' 29% of all income). Where the Gini coefficient for income inequality is currently around 0.36 (a higher Gini coefficient means more inequality), the Gini for net financial wealth is as high as 0.81. And education again appears important: households headed by an individual with a degree are nearly four times wealthier than households headed by an individual with no qualifications, on average. As striking as inequalities in income are, the WAS shows that inequalities in wealth are far greater.

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http://www.ifs.org.uk/publications/4713 Wed, 16 Dec 2009 00:00:00 +0000
<![CDATA[What's the point of the Child Poverty Bill?]]> One of the 13 bills in the recent Queens Speech was the Child Poverty Bill, carried over from the previous Parliamentary Session. The most eye-catching part of the Bill is the duty it would place on the Secretary of State for Work and Pensions to ensure that child poverty in 2020/21 is eradicated (how eradication is defined is discussed below). But it would also establish a Child Poverty Commission to advise the government on its strategy, require future governments to publish a strategy and report annually on progress, and place duties on local authorities and other "delivery partners" in England to work together to tackle child poverty, as the House of Commons Library explains.

It is hard to argue against most of the aspects of the Bill: if a government is seeking to eradicate child poverty, then it will clearly help to have annual reports on progress, an identifiable strategy, and for local authorities to work with, rather than against, central government. But critics of the Bill argue that all of these things can happen without a new Act of Parliament, and indeed have been happening: the current Government used to publish an annual report on its anti-poverty strategy, known as Opportunity for All , the Treasury has published several documents on its strategy to reduce child poverty, and local authorities can currently be assessed against their performance in reducing the number of children in workless families on benefits, teenage pregnancies and NEETs in their area. A official Child Poverty Commission is likely to help policy-making and enrich public debate, but groups including CPAG have argued that the Commission needs more independence, along the lines of the Climate Change Commission, and to be resourced adequately, perhaps in line with the Low Pay Commission. My very positive experience as a member of the National Equality Panel tells me that these sort of advisory bodies need strong support from a secretariat, and a budget with which to commission research, to be truly effective.

Those with a more cynical mind would accuse the Government of introducing this Bill to try to hide its predicted failure to meet its target for child poverty in 2010/11. As I argued to the Public Bill Committee, if the Government misses its target - which it almost certainly will unless the Chancellor announces an unprecedented rise in tax credits in December's Pre-Budget Report - then it will be because it was not able to find the money to make benefits and tax credits generous enough to lift enough children out of poverty. It is not clear why the Government is unwilling to meet its own target for 2010/11, but keen to bind its successors to more stringent targets. Furthermore, it is also unclear what consequences would follow if child poverty in 2020 was above the levels specified in the Bill, particularly as, given current delays in processing data, this might not be known until 2022.

But, in my mind, the worrying aspect of the Bill is that it highlights income-based measures of child poverty over all other possible measures of child well-being. Although the Bill says that a government strategy must tackle socio-economic disadvantage amongst children, the way we will know whether child poverty is eradicated in 2020 will be determined by four measures of income poverty. It is clearly ridiculous to argue that child poverty is not about income, but I have argued before that, by not including any other sort of measures or targets, but there is a risk that politicians will always favour policy responses with immediate and predictable impacts on the incomes of parents over responses which mitigate the impact of poverty on children, or improve poor children's well-being, or reduce the intergenerational transmission of child poverty (such as measures to tackle low achievement amongst white boys in receipt of free school meals, whose results at Key Stage 2 were recently revealed to be lower than all other ethnic groups) . An annual state-of-the-nation report on children, and a wider set of targets and indicators that covered all aspects of children's and parents' lives, would make it more likely that future governments' policy response was more balanced, and in the best interests of children in poverty.

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http://www.ifs.org.uk/publications/4661 Fri, 20 Nov 2009 00:00:00 +0000
<![CDATA[Have the poor got poorer under Labour?]]> One of David Cameron's key themes in his speech to the Conservative Party conference was that Labour has "made the poorest poorer", "left youth unemployment higher" and "made inequality greater". How fair are these accusations?

We reported earlier this year that, until 2007-08, the latest year for which we have data, the third term of this Government has seen a rise in income inequality, and a fall in the income of the poorest fifth of the population, justifying Cameron's claims. But Labour's record over their entire term in office is slightly different. Cameron's claim that income inequality has risen is still true over this longer period: income inequality was slightly higher in 2007-08 than in 1996-97. However, since 1996-97, there has been positive income growth, after allowing for inflation, at almost every part of the income distribution except amongst the poorest 3 per cent of the population. It is, therefore, technically true that those with the very lowest incomes now have lower incomes than in 1996-97, but we have argued that difficulties in recording income amongst some groups means that those with the lowest reported incomes can often have very high living standards . So the fall in income for those with the very lowest recorded incomes is probably not, therefore, a good guide to what has actually happened to the poorest in society.

How do overall trends in poverty and inequality compare with those observed under the last period of Conservative government between 1979 and 1997? As the figure below shows, income inequality rose substantially during the 1980s, dwarfing the small increase under Labour to date. And the incomes of the poorest 2 per cent of the population were lower in 1996-97 than they were in 1979, similar to what has happened under Labour. As can be seen in our annual report on poverty and inequality and our on-line inequality data resource, there was also a large rise in relative poverty during the 1980s, which compares with a small fall under Labour to date (although relative poverty amongst working-age adults without children has risen since 1997-98). Furthermore, we have found that direct tax and benefit changes made by the previous Conservative governments acted to increase income inequality, whereas those made by since 1997-98 have benefitted the poor by more than the rich.

Turning to youth unemployment, Cameron is correct to point out that youth unemployment was higher over this summer than any period since 1992, the start of official data. We have argued that the rise in youth unemployment during this recession is no different from what happened during the previous two. However, the level of unemployment is highly affected by the state of the economy, and the unemployment rate for 18 - 24 year olds was no higher before the current recession than when Labour came to power.

So it is fair to say that youth unemployment and income inequality have risen under Labour, and that, on a very narrow, and potentially uninformative, measure, the incomes of households with the lowest incomes are now lower than they were in 1996-97. But, although the performance of the last Conservative government is not necessarily a guide to a potential future administration, the record on youth unemployment was no better, and on poverty and inequality considerably worse, in the Thatcher and Major administrations than under Blair and Brown.

 

The Gini coefficient, 1979 to 2007-08 (GB)

Gini coefficient

Note: The Gini coefficient has been calculated using incomes before housing costs have been deducted. Source: Authors' calculations using Family Expenditure Survey and Family Resources Survey, various years. Taken from Figure 3.7 of http://www.ifs.org.uk/comms/c109.pdf.

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http://www.ifs.org.uk/publications/4637 Tue, 13 Oct 2009 00:00:00 +0000
<![CDATA[What can we learn from Labour's shift in childcare policy?]]> Gordon Brown's speech to the Labour party conference gave more detail about an existing ambition of this government to provide free early education and childcare places for 2 year old children in England.

The Prime Minister has now promised that this would be provided to young children in "modest and middle income" families by 2015, and would be paid for by "reforming tax relief" on childcare. This is widely reported as meaning that the Government intends to scrap the existing tax break on employer-provided childcare vouchers, something which it introduced in April 2005. If it is scrapped outright, the losers will be relatively well-off families in work and using formal childcare: low- to middle-income working families using childcare will continue to be able to get help with childcare costs from the tax credit system.

However, there is, we presume, more to this reform than just redistributing income by removing state support for well-off families with children and increasing it for the poorest, because the two policies also have different objectives.

The tax break on employer-provided childcare vouchers is mainly intended to reduce the cost of childcare for working parents, and so encourage them to work. The vouchers are flexible, in that they can be used to buy any form of childcare provided it is registered with Ofsted or otherwise approved, including day nurseries, playgroups, out-of-school clubs, childminders or nannies.

On the other hand, if the free places for two year olds are like the existing entitlement for three and four year-olds in England, then they will be limited to centre-based care, such as state-run Children's Centres, and private or voluntary sector nurseries or playgroups. These free places will, presumably, make it a little easier for the parents of these two year-olds to work if they want, but the Government may also be hoping that this policy might improve developmental outcomes for the children from low-income families. Recent work based on the Millenium Cohort Study, and currently the subject of further research at the IFS and the CMPO, has shown that children aged three from families in poverty have lower cognitive skills, lower achievement scores and more behavioural problems than those that do not, and it is argued by some that education and child care for such children can help to reduce these differences, especially if it is of sufficiently high quality.

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http://www.ifs.org.uk/publications/4630 Wed, 30 Sep 2009 00:00:00 +0000
<![CDATA[Conduct your own Spending Review]]> The leaked Treasury spending figures released by the Conservatives on Wednesday highlighted the extent to which spending on public services is set to be cut over coming years. Under current plans the Government would rely much more on spending cuts than tax increases to reduce public sector borrowing over the next parliament. Real total public spending is forecast to fall very slightly over the three years starting in April 2011. Spending on public services is set to fall more quickly with investment spending - that is spending on buildings and equipment - bearing the brunt. Investment spending is set to halve in cash terms over three years, as discussed in a previous IFS observation.

Alistair Darling has pointed out that current spending - that is public spending excluding investment spending - is set to continue growing in real terms by an average of 0.7% a year. But the outlook for current spending on public services is not as rosy as this suggests. The Figure below shows that once the Treasury's forecast for growth in current Annually Managed Expenditure (AME) - that is spending on items such as debt interest payments and welfare benefits - of 3.6% a year is taken into account, current spending by central Government on public services - known as current Departmental Expenditure Limits (DELs) - is to be cut in real terms by 1.9% a year. Once you add to this the large real terms to public sector investment spending, the outlook for departments is that total real terms DELs are set to be cut by 2.9% a year on average. Over three years this implies a cut in spending in 2013-14 of 8.6% compared to spending in 2010-11.

Planned growth in spending April 2011 to March 2014

Whoever is in Government after the next election will have to decide how big the spending cuts should be and how the pain should be shared out. George Osborne has said that he would not cut spending on the NHS and that he would continue Labour's policy of large increases in overseas aid spending. This would, under the Treasury's spending plans, leave other areas of spending facing a cut of at least 13.9% by 2013-14. On Tuesday Vince Cable said that investment spending should not bear the brunt of the cuts and that no area should be spared from the pain.

If you disagree with the Treasury over how much of the reduction in borrowing should come from cuts in spending as opposed to increases in tax, or if you disagree with Mr Osborne or Mr Cable about how the pain should be shared out, you can carry out your own "Spending Review 2010" using a new tool, DIY Spending Review, that can be downloaded as an Excel spreadsheet. This enables you to set your own spending envelope and decide how the cake is shared out. A health warning for NHS managers though: Secretary of State for Health Andy Burnham said yesterday that he doesn't want you carrying out your own "mini spending reviews".

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http://www.ifs.org.uk/publications/4621 Fri, 18 Sep 2009 00:00:00 +0000
<![CDATA[Encouraging work through benefit reform]]> The Centre for Social Justice have published a report in association with Oliver Wyman on how to reform the benefits and tax credits system, with the aim of reducing the number of families where no one is in work. The proposals are wide-ranging, and cover both how benefits and tax credits should vary as people move into work and increase their earnings, and the overall structure of the benefits system. I provided advice on how to model the impact of the reforms, but was not involved in producing the report's policy recommendations; some of the Centre for Social Justice's recommendations are, though, similar in spirit to those I and colleagues made last year in a study commissioned by the Mirrlees Review of the British tax system.

The most important recommendation of the Centre for Social Justice is that benefits should be withdrawn more slowly as people move into work, in order to encourage more people to work, particularly in low earnings or part-time jobs. The main beneficiaries would be people in work, or who want to work, but are not currently entitled to the working tax credit: these are adults under 25, or those without children who work part-time, or those with children working in so-called mini-jobs.

There would also be a stronger incentive to work for those receiving Housing Benefit. One drawback to the reform is that high marginal tax rates would apply over a longer range of earnings. This is an inescapable trade-off: if benefits are to withdrawn more slowly when someone moves into work, then they have to be withdrawn over a longer range of earnings. Another implication is that second earners in couples will have less incentive to work: this is because the reform continues the UK's high reliance on benefits assessed against joint family income. To save money, the report recommends withdrawing the family element of the child tax credit, and all of disability living allowance, once all other benefits have been withdrawn, and this would lead to some better-off families losing out.

The report also recommends merging all existing benefits into just two, and combining these with the existing tax credits. (The levels of benefit for those out of work would remain unchanged - calculated as they are today based on household need.) This would reduce the work disincentives and administrative problems that can occur when benefits and tax credits overlap, and should increase transparency, reduce administration costs and fraud, and cut the burdens imposed on benefit recipients. It also suggests that employers could be involved in withdrawing benefits from families, as an alternative to individuals repeatedly giving the government details of their earnings. Proposals to simplify and merge benefits and tax credits always look appealing in principle, and were part of my own recommendations to the Mirrlees review, but can often lead to some people losing out: sometimes, complexity in the benefit system exists because the government is trying to achieve complicated things.

The many things achieved by this reform package come at a price. The report itself presents a set of proposals with different costs and results. For the preferred option, there would be an immediate cost of 3.7 billion a year, which the report argues will fall to 2.7 billion a year, as more people move into work, and will fall further if savings can be made on administration costs and fraud in the benefits system, and even on spending on crime and health.

These savings may occur, but presumably not in the short-run, and in any case should not be relied upon. It is clear, then, that this reform is not intended as a way to solve the current crisis in the public finances; instead, it is an attempt to design a benefit system that will lead to higher employment.

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http://www.ifs.org.uk/publications/4613 Wed, 16 Sep 2009 00:00:00 +0000
<![CDATA[Tighter than thou]]> There is a lot we do not yet know about how Labour and the Conservatives would go about repairing Britain's battered public finances over the next few years. But yesterday's speeches by David Cameron and Alistair Darling at least highlight a sharp difference of opinion over what should be done next year. Yet the picture is quite not as straightforward as either makes out.

The Conservatives' latest line of attack is that the Government is planning to increase public spending by just over £30 billion next year, from £671.4 billion in 2009-10 to £701.7 billion in 2010-11. Mr Cameron said this was "reckless" and that spending cuts should begin next April to start bringing government borrowing back down to sustainable levels.

But it is worth remembering that two-thirds of the increase in spending next year can be accounted for by rising social security costs (which are forecast to go up by £6.2 billion) and increasing central government interest payments (which are forecast to rise by £15.7 billion). Neither is straightforward for the government to reduce sensibly in the short term.

Departmental Expenditure Limits - the amount Whitehall has to spend on public services and administration - are set to increase by only £3.2 billion next year (the Government already having cut them by £5 billion in last year's Pre-Budget Report, thanks to some conveniently identified "efficiency savings"). Once you take into account whole-economy inflation, this actually represents a 0.7% cut in real terms. If a Conservative government were to take office in May or June next year, it would be interesting to see where exactly they think they could make sensible and significant additional cuts in the remaining 10 months or so of a fiscal year that will already be underway.

Mr Darling meanwhile attacked the Conservatives for proposing early spending cuts on the grounds that this would withdraw support for the economy at a time when recovery is not yet firmly rooted: "At the weekend, G20 finance ministers agreed that we must continue to support our economies until recovery is established. To cut spending now would kill off the recovery."

But it is worth remembering that even the Government is currently planning to withdraw fiscal support for the economy next year. Its Budget plans show it ending the fiscal stimulus that is currently in place next year and beginning some modest tightening - a swing of around 2% of national income in total. Indeed, according to the International Monetary Fund, the UK is the only G20 country other than Argentina planning to withdraw its fiscal stimulus in calendar year 2010. The Conservatives are hardly likely to attack them on this front, as they opposed the stimulus in the first place. But there will be others of more Keynesian bent who think that the Government and the Conservatives alike are proposing to withdraw fiscal support for the economy prematurely.

The choices for 2010-11 are only a small part of the picture, of course. The parties will have to decide when and how quickly they would wish to reduce government borrowing over the longer-term - and through what combination of tax increases and spending cuts. On Wednesday 16th September we will be publishing a briefing note outlining some of the trade-offs.

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http://www.ifs.org.uk/publications/4612 Wed, 09 Sep 2009 00:00:00 +0000
<![CDATA[Should the Child Trust Fund be abolished?]]> The oldest children to receive a Child Trust Fund from the Government today celebrate their seventh birthdays. Alongside their other presents, the Government is making a further contribution to their accounts - those in families receiving a full Child Tax Credit award get £500 while everyone else will get £250. These are the first contributions that these children will have received from the Government since equivalent amounts were paid in when the account were opened, at which point thirty per cent qualified for the more generous award. The money is invested and, under normal circumstances, is locked away until the child reaches age 18.

The need, in the medium-term, to reduce public borrowing makes it natural to try to identify the areas of public spending that could be cut with the least pain. Might the Child Trust Fund be a potential candidate? Each year around 800,000 newborns receive an account at a cost - including the top-ups at age seven - of around £½ billion to the taxpayer. Abolishing it would make a small, but not insignificant, contribution to the total £26 billion spending cut estimated to be needed by 2013-14 under the Government's spending plans.

There are two benefits from the Child Trust Fund. First, most eighteen year olds will have no financial assets so even a modest amount - such as £500 - can have a major impact on the distribution of wealth at that age. For those individuals unable to access credit it could increase opportunities, such as to continue in education, to purchase a car, to become self-employed or to go travelling. Second, children could benefit from seeing their Child Trust Fund accruing over time and learning about the advantages - and costs - of investing in riskier and safer financial products. The FTSE-100 index is currently around the level it was at the start of 2005 when the first Child Trust Fund vouchers were issued having first risen steadily, then fallen sharply and then risen again during the intervening period. Proponents of the policy therefore argue that the Child Trust Fund complements existing spending on schools and cash transfers to families with children, and that it could help improve life chances by bringing about a stronger saving culture.

Abolishing the Child Trust Fund would make newborns worse off in eighteen years time. But spending cuts in other areas might leave them worse off. Cuts to benefits or tax credits would reduce the amount that their parents have available to spend on them during their childhood. Cutting spending on public-services - such as pre-school education - could reduce the quality and quantity of the services provided. Both could reduce the quality of life and the future life chances of children by more than the abolition of the Child Trust Fund. The now increased focus on personal financial education within schools might be a more cost-effective way of helping children to make appropriate saving decisions in the future. When the time for tough choices about public spending arrives abolishing the Child Trust Fund could be one of the less unattractive options.

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http://www.ifs.org.uk/publications/4602 Tue, 01 Sep 2009 00:00:00 +0000
<![CDATA[Unemployment mystery: not so mysterious...]]> Today's unemployment statistics showed an increase of 220,000 in the three months to June 2009, using the widely watched International Labour Organisation (ILO) measure of unemployment. Meanwhile, the number of people claiming unemployment benefits has risen more slowly, with the latest figures showing an increase of just 25,000 from June to July, following increases of 22,000 in June, 31,000 in May and 50,000 in April. Earlier this week, the Government announced an inquiry into the discrepancy between the two series for unemployment. But is there really a discrepancy?

We should bear in mind that the two series measure different things - the claimant count (as the name suggests) measures the number of people claiming unemployment benefits, while the wider ILO measure counts the number of people looking for work, regardless of whether or not they are claiming benefits. The ILO measure therefore tends to show higher levels of unemployment than the claimant count - but what about changes in the two series as we enter the recession? Should we expect the two measures increase by the same amount?

First of all, we must make sure that we are comparing like with like. The claimant count figure is a month-on-month increase (from June to July), while the ILO numbers give the increase from quarter to quarter (Q1 to Q2 2009). The 'latest' increases therefore cover different time periods, with the claimant count also slightly more up to date (as it includes July 2009, where the ILO measure only extends to June).

In order to compare the claimant count figures with the ILO measure of unemployment, we have a constructed a three-month rolling average for the claimant count. The graph below then shows the increase on the previous quarter for each of these series.

As we already knew, the latest ILO figures show an increase of 220,000 on the previous quarter. Defined on the same basis, the claimant count figures show an increase of 167,000. This is lower than the ILO numbers, but the discrepancy is certainly not as big as the initial numbers suggested.

Looking at the period as a whole, since Q1 2008 (just before the UK recession started), we calculate that the ILO measure of unemployment has increased by a total of 810,000. The claimant count has increased by 740,000. Put like this, there seems to be no mystery: the claimant count has increased by slightly less, but this is understandable, as some who are unemployed on the ILO measure choose not to claim unemployment benefits or are not entitled to them.

If anything, a case could be made that it is the ILO measure that is increasing slower than one might have expected. Before the recession began, for every two people unemployed on the ILO measure, one was claiming unemployment benefits, yet the two measures of unemployment have increased by very similar magnitudes, and the ratio has fallen to about 1.5 to 1.

The two measures have also increased sharply at different times. The ILO measure rose faster than the claimant count in mid-2008. They both then tick up following the financial crisis of autumn 2008, but the claimant count 'catches up' - rising faster than the ILO measure throughout late-2008 and early-2009. More recently, we seem to be seeing another period in which the ILO measure is accelerating away from the claimant count. But that really only leads us to expect the claimant count to play 'catch up' again in the autumn, as some of these newly unemployed people start claiming benefits - though both series will hopefully slow as the recession eases.

Therefore, there appears to be no mystery, the mismatch just leads us to expect the claimant count to increase faster than the ILO measure ('catching up' somewhat) in the future. It is also an important lesson in not placing too much emphasis on one or two months' worth of data.

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http://www.ifs.org.uk/publications/4593 Wed, 12 Aug 2009 00:00:00 +0000
<![CDATA[Chronic underinvestment?]]> In Prime Minister's Questions this week Gordon Brown and David Cameron clashed over the Government's plans for spending on investment in public services. Mr Cameron highlighted the fact that the Government plans to cut investment spending. Mr Brown responded that the Government had deliberately brought forward investment spending and that investment spending had in recent years been higher than under the previous Conservative Government. So how do the plans for investment spending going forwards compare to Labour's record to date and to that of previous Conservative Governments?

The figure below shows how much investment (as a share of national income) has taken place each year since 1978-79 and what the latest Budget plans imply for spending through to 2017-18. After Labour came to power in 1997 the Treasury stated that "public investment has fallen to low levels by historical and international standards, even allowing for factors such as the effects of privatisation, and there are maintenance backlogs". Despite this, investment spending remained low throughout Labour's first term in office, with the four years from 1997-98 to 2000-01 being the lowest four-year period of investment spending since the Second World War.

Since then investment spending has increased dramatically reaching 2.1 per cent of national income in 2007-08 (the last year before the financial crisis struck). The Comprehensive Spending Review (CSR) of October 2007 planned for investment spending to rise slightly before stabilising at 2.3 per cent of national income, which if delivered would have been higher than the level delivered in any year since 1980.

But these plans have been dramatically changed in response to the financial crisis. The decision to bring forward some investment spending previously planned for 2010-11 into 2008-09 and 2009-10 to help ease the severity of the recession, and the fact that national income is currently depressed, have led to a sharp increase in investment spending this year. In 2009-10 public sector net investment is now planned to be 0.9 per cent of national income higher than planned in the last CSR, with a £10 billion boost to investment spending plans (from £33.9 billion to £43.8 billion) explaining 70 per cent of this increase and the lower level of national income explaining the remaining 30 per cent. Both these factors will unwind, reducing investment spending as a share of national income. So Mr Brown is correct in pointing out that some of the planned decline in investment spending between this year and next simply reflects the Government's decision to bring spending forwards into the current year.

But, to help bring public sector net borrowing back down to sustainable levels, the Government has also substantially revised down its longer-term plans for investment spending. Rather than having public sector net investment stabilise at 2.3 per cent of national income a year it is now planned to be cut back to 1.3 per cent of national income. So under these plans investment in public services each year will be at just under 60 per cent of the level implied by the pre financial crisis plans. This level of investment spending would be about the same as that delivered during John Major's premiership (1990-91 to 1996-97), a level deemed by Mr Brown to be "chronic underinvestment" which if continued would "leave the country run-down and ill-equipped for the future".

Initially the impact of the reduced level of public sector investment from 2013-14 will be mitigated by the high levels of investment spending seen in recent years, although if Mr Brown's criticisms of investment under Mr Major are correct then maintenance backlogs would soon begin to re-emerge. Undoubtedly investing 1.3 per cent of national income will deliver a lower quality and/or quantity of public services relative to a scenario in which 2.3 per cent of national income was being invested each year. Which public services are affected - and to what extent - will not be known until the next Spending Review is announced. But areas that are relatively investment intensive - such as transport and housing which make up 40 per cent of all public sector investment - are set to be relative losers in a very tight spending settlement.

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http://www.ifs.org.uk/publications/4554 Fri, 26 Jun 2009 00:00:00 +0000
<![CDATA[Squeeze harder, says the IMF]]> Gordon Brown and Alistair Darling will be pleased to have won the International Monetary Fund's endorsement today for the £30 billion fiscal stimulus package for 2008-09 and 2009-10 that they announced in November's Pre-Budget Report and March's Budget - especially in light of the IMF Chief Economist's public criticism last year of the temporary VAT cut that accounts for two-fifths of the giveaway. While the IMF verdict that the stimulus package was "appropriate" is hardly effusive praise, it will provide useful ammunition the next time the Conservatives claim that it was pointless or counterproductive.

The Fund also praised the Government for having "commendably acknowledged the scale of deterioration of the fiscal position and included a cautious judgement on its structural nature". But it was less enthusiastic about the Budget plans to dig us out of the hole.

The Budget and PBR plans together imply a fiscal tightening that will build up steadily to around 6½% of national income (or £90 billion a year in today's money) over the eight years from 2010-11 to 2017-18. Over the first four years, 20% of the tightening would come from the tax increases that have been announced since November, 30% from cuts in planned public sector capital spending and 50% from cuts in planned current spending. The Treasury thinks this will be sufficient to keep public sector net debt below 80% of national income and have it falling from 2014-15 onwards.

But the Fund argues that "the success of the current policy package hinges on the continued trust in the sustainability of the fiscal position" and that the Government should therefore tighten fiscal policy more aggressively than it suggested in the Budget. This would get public sector debt on a downward path more quickly. There may also be some political attraction in this for an incoming Conservative government, which might prefer to concentrate the pain in its first parliament when it is easier to blame their predecessors.

The Fund thinks that it is right to load more of the pain on spending cuts than tax increases, because the tightening is more likely to stick as a result. But the Budget spending plans imply a very tough squeeze on departmental spending in the three years to be covered by the 2010 Comprehensive Spending Review (2011-12, 2012-13 and 2013-14). Reasonable estimates of social security and debt interest bills suggest that spending on public services may have to be cut by more than 2% a year in real terms - the biggest reduction since the last Labour Government had to negotiate its spending plans with the IMF in the late 1970s.

Veterans of past Whitehall spending squeezes hands fear it will be very difficult to achieve even the spending plans in the Budget, let alone more ambitious ones. If they are right, a Government wishing (or having) to get debt down more quickly may need to rely more on tax increases. That is unlikely to be what the Conservative backbenches want to hear.

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http://www.ifs.org.uk/publications/4531 Wed, 20 May 2009 00:00:00 +0000
<![CDATA[A bust without a boom?]]> If the picture painted by the Treasury in this year's Budget is correct, we are currently suffering a "bust" without having enjoyed a "boom". The official story is that after the dramatic ups and downs of the late 1980s and early 1990s, the current government kept activity in the economy impressively close to its "Goldilocks" level - neither too hot nor too cold - until a virulent strain of banking flu arrived unpredictably from the US and pushed us into recession, as well as sharply reducing the economy's long-term productive potential.

We can see this version of history in Chart 1. This shows the Treasury's estimates of the "output gap" - the difference between the actual level of economic activity and the Goldilocks level consistent with stable inflation. At the time of last year's Budget, activity in the economy was expected to remain pretty close to its sustainable level. In this year's Budget we see the Treasury permanently reducing its estimate of that sustainable level by 5% (or £70 billion in today's money) between mid 2007 and mid 2010, relative to the path assumed in last year's Budget. It then expects the actual level of activity to fall another 5% below even that reduced estimate of the economy's potential.

Chart 1

This picture helps the Treasury explain: first, why we are about to see such a dramatic increase in government borrowing, and; second, why a large proportion of that extra borrowing will not disappear without a policy squeeze as the economy returns to its Goldilocks state. But those of a cynical disposition may suspect that this particular depiction of history is also designed to avoid casting an unflattering light on the quality of macroeconomic management during Gordon Brown's decade as Chancellor of the Exchequer leading up to the crisis.

An alternative view of history is that the productive potential of the economy did not go into sudden and unpredictable decline in mid-2007, but rather that the Government - among many others - consistently overestimated the potential of the economy in the good years, lulled into a false sense of security by global disinflation.

We can see this version of history in Chart 2. As an alternative to the Treasury's belief that the productive potential of the economy grew by almost 3½% a year in Labour's first term and then by roughly 2¾% a year thereafter until the crisis hit and trend growth fell to 1% a year for three years, we can assume that the productive potential of the economy grew at 2.6% a year throughout. We would still expect to see economic activity running 5% below its potential in 2010, as the Budget predicts, but we would also see that it had been running roughly 3% to 4% above potential from 2000 to 2007.

Chart 2

If the considered view of history is that the Treasury missed a boom of this magnitude, it will cast a much less flattering light on Mr Brown's record as Chancellor. It would certainly suggest that he should have been running a much stronger fiscal position during this period. But it also poses much more awkward questions about the goals of monetary policy. During this period the Bank of England's Monetary Policy Committee was instructed to keep retail or consumer price inflation low and stable - and did a much better job that most people would have predicted beforehand. The Treasury's view that the economy was at its Goldilocks level in 2006-07 was also supported by a range of evidence that overall pressures on retail price inflation were subdued.

If the missing boom manifested itself in asset and credit markets - rather than those for labour, goods and services - then to do what we can to promote stability in the future the Bank will have to be given a rather more opaque and multi-faceted target to pursue than it has been required to pursue to date.

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http://www.ifs.org.uk/publications/4513 Thu, 30 Apr 2009 00:00:00 +0000
<![CDATA[Two parliaments of pain]]> Alistair Darling admitted yesterday that the underlying health of the public finances is much weaker than he thought in last year's Pre-Budget Report, and that it will take two full parliaments of intensifying austerity to get government borrowing back to acceptable levels.

 

The Chancellor's forecast that the Government would need to borrow £175 billion this year - almost 12½ per cent of national income - had been well trailed in advance. Much more surprising was the Treasury's assessment that four-fifths of this borrowing will be 'structural' and therefore impervious to economic recovery - whenever it comes and however strong it is.

 

The Treasury has revised up its estimate of the structural budget deficit for 2010-11 from 7.2 per cent of national income in the PBR to 9.8 per cent in the Budget, increasing the size of the hole that the Treasury thinks needs to be filled by around £35 billion since the PBR.

This reflects a number of factors. For example, the Treasury thinks that the economic crisis will punch a bigger hole in the productive potential of the economy. It also expects the level of prices in the economy to be lower over the long-term. It has also been hit by the growth of 'VAT debts'.

 

In response, the Chancellor announced cuts in capital spending plans, cuts in other government spending plans and increase in taxes that will each raise about £9 billion each by 2013-14, adding up to 1.6 per cent of national income. But this will still leave the government borrowing 3.2 per cent of national income more than it needs to invest in that year.

 

That means that whoever takes office in the general election after next will still have to find another £45 billion a year in today's money by the end of their parliament to eliminate this deficit, from tax increases and cuts in non-investment spending.

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http://www.ifs.org.uk/publications/4509 Thu, 23 Apr 2009 00:00:00 +0000
<![CDATA[Financing inheritance tax cuts]]> Some of today's papers suggest that the Conservatives have softened their inheritance tax policy while others have suggested that their promise to cut this tax remains. But is this pledge affordable given the state of the public finances?

In October 2007 George Osborne, the Conservative Shadow Chancellor, proposed a large increase in the inheritance tax threshold to £1 million, and an increase in the stamp duty threshold for first time house buyers to £250,000. He also proposed a new charge for UK residents not paying tax on any overseas income as a result of being domiciled outside the UK for tax purposes. The main redistribution achieved by this package of policies would be from those non-doms with foreign incomes to those wealthy enough to pay inheritance tax. First time house buyers - and those with homes worth between £125,000 and £250,000 - would also benefit.

After the November 2007 Pre-Budget Report (which reduced inheritance tax and introduced a new charge for those non-doms resident in the UK for seven years or more) Mr Osborne's inheritance tax cut was costed at an estimated £2.0 billion and the stamp duty cut an estimated £0.4 billion. The Conservatives assumed that the £2.4 billion cost of these policies could be met by their non-dom charge. In contrast the Treasury's costing implied this charge would raise less than £0.5 billion. Since the distribution of foreign income of non-doms is not known both these are necessarily guesses relying on strong assumptions.The recent economic turmoil has led to sharp falls in UK equity markets and house prices. This will reduce the cost of the Conservatives' tax cuts. However it will also reduce the overseas income of non-doms which will mean that their proposed charge will also raise less.

The Conservatives also have a number of other commitments to cut taxes: for example reducing council tax in England, exempting interest income from basic rate income tax, increasing the income tax personal allowance for those aged 65 and over, introducing new tax breaks for married couples, and reducing the headline rates of corporation tax. These measures are intended to be financed by a combination of tax increases and spending cuts.

Judging whether or not the Conservatives' plans "add up" would require an assessment of the costs of all of these policies - many of which we do not yet have in sufficient detail. But even this would miss the bigger picture. Public sector net borrowing in 2009-10 is forecast to be at the highest level since the Second World War. To reduce this, the 2008 Pre-Budget Report (PBR) contained a £4 billion net tax increase and a £19 billion net spending cut. Even this might not be enough - the January 2009 IFS Green Budget forecast implied that a further £20 billion of tax increases or spending cuts would be required to bring about the reduction in borrowing sought by the PBR. Any additional shortfall that needed to be met as a result of errors in the costing of the Conservatives' policies would, relative to these figures, be small beer.

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http://www.ifs.org.uk/publications/4465 Mon, 23 Mar 2009 00:00:00 +0000
<![CDATA[A minimum price for alcohol?]]> The publication yesterday of the annual report of the Chief Medical Officer, Sir Liam Donaldson, contains a controversial proposal to impose a minimum price of 50p per unit on alcohol, and follows close on the heels of similar ideas floated by the Scottish Government. At least in England, a minimum price looks unlikely to be imposed any time soon: Gordon Brown has indicated an unwillingness to cause "the responsible, sensible majority of moderate drinkers to have to pay more or suffer as a result of the excesses of a minority".

Sir Liam's proposals do merit some serious consideration: his report contains some compelling evidence on the impact that excessive alcohol consumption has not just on those who drink, but on other people. These 'externalities', to use economists' jargon, provide justification for Government intervention in the alcohol market as they are not taken into account when people make their private decisions about how much alcohol to consume, generating excessive consumption relative to the socially desirable level. In addition, consumers may not be fully rational in their alcohol consumption decisions (not taking into account the risk of addiction, say) which could provide more paternalistic reasons for intervention. If this is the case, it is not obvious that price represents the right policy instrument.

The "sensible majority of moderate drinkers" are already currently hit by existing alcohol taxes and plans to increase them. For typical strength drinks, these currently stand at 36p on a pint of beer, 157p on a bottle of wine and 622p on a bottle of spirits. The Government seems keener to use these taxes to raise alcohol prices than it is on introducing a floor price: Budget 2008 announced an increase in alcohol duties of 6% above RPI inflation, with a further 2% real increase in each year up to and including 2013. These tax increases will probably raise revenue for the Government at a time when the public finances are particularly stretched, unlike a floor price where the transfers involved are more complex.

One possible advantage of a minimum price is that in terms of the costs of alcohol abuse, the concern is presumably much greater for underage drinkers and those who binge drink than moderate drinkers, and these groups may be more likely to buy cheap alcohol. If this is the case, then a minimum price may be more directly targeted on these problem cases than a general increase in alcohol taxes for all drinkers. A report from Sheffield University commissioned by the Department of Health last year found that heavy drinkers also tended to be the most responsive to prices.

Would the "sensible majority of moderate drinkers" be affected by a minimum price as the government claims? If this group already purchases alcohol costing more than 50p/unit, then the policy would have no direct impact on them. There may even be indirect effects which reduce prices for some people. Retailers can use alcoholic drinks as 'loss-leaders', pricing aggressively below cost to attract customers into their stores. If this avenue is closed off by a minimum price, it is not clear how retailers would respond. They could choose to loss-lead on alcohol that currently costs slightly more than 50p/unit, bringing those prices down to the minimum: in this case, the policy becomes a transfer from those who currently pay, say, 40p/unit for alcohol to those who currently pay 60p/unit. Alternatively, the floor price could just act as a transfer from drinkers to alcohol retailers and manufacturers. Longer term, manufacturers who currently produce cheap alcohol may switch production to slightly higher quality drinks as a result of the change, further increasing competition and reducing the price of alcohol that currently retails just above the floor price.

There is, however, evidence that the majority of alcohol purchased from supermarkets and off-licences is currently bought at prices below 50p/unit, suggesting the impact on the priced faced by consumers would be quite strong. The Sheffield University study suggested that around 59% of off-licensed trade alcohol purchased was at a price of less than 40p/unit, compared to 14% of on-trade sales. This distinction between on- and off-trade is important. In recent years, real-terms alcohol prices (that is, prices relative to inflation in general) have been falling quite strongly, with this fall driven by off-trade sales. Since 1990, the price of beer and cider off-trade has fallen by around 30% and real terms, and of wines and spirits by around 20%, compared to increases in on-trade prices of 30% and 25% respectively. One effect of this shift in relative prices has been a decline in alcohol purchased in pubs and an increase of consumption at home which a minimum price may go some way to reversing.

Minimum alcohol prices are untried and their effects, relative to the impact of increasing existing tax rates, are unclear. The way in which consumers, retailers and manufacturers respond to higher taxes and price floors could be very different. Since it looks unlikely the Government will adopt Sir Liam's proposals south of the border, the UK could be set to embark on yet another public health policy experiment where Scotland and England try different approaches to a problem.

Click here to download 'Alcohol prices relative to allitems RPI inflation, 1990 - 2008'

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http://www.ifs.org.uk/publications/4462 Tue, 17 Mar 2009 00:00:00 +0000
<![CDATA[A disadvantaged pupil premium]]> This weekend, the Liberal Democrats will gather in Harrogate for their spring conference, which will focus on education. On Saturday, they will discuss a series of proposals designed to combat inequalities in Britain's education system. One is a "pupil premium [to] bring the funding levels [of] one million disadvantaged pupils immediately up to private school levels." How effective might this be?

A pupil premium would provide extra funding to state schools for each pupil from a disadvantaged background they admit. The current system of school funding in England already does this to some extent, albeit in a rather slow and unnecessarily complex way (see our previous school funding report). In economics, we usually talk about "getting the incentives right" and in principle this policy could simultaneously achieve two objectives: focus more resources on schools with poorer pupils; and partly counteract any incentive schools may have to "cream-skim" more affluent or easy to teach pupils.

However, research by the OECD implies there is, at best, a weak relationship between spending per pupil and educational performance across countries. Furthermore, to quote an example from a recent report by Policy Exchange, American researchers used estimates of the effect of spending on the attainment of black children to say that nine times as much needed to be spent on black children to get their attainment up to the national average. Closing ethnic gaps and gaps in attainment by socio-economic status are obviously not directly comparable, but if the cost for getting the attainment of poor children up to the national average were just five times the current spending per pupil, the pupil premium would need to be set at over £25,000. The Liberal Democrats propose a premium in the range of about £3,000.

As a further motivation for the policy, Nick Clegg has said that he is "determined to close the gap between the private and state schools." This is very similar to an aspiration espoused in Budget 2006 by Gordon Brown, but the Liberal Democrats claim they would achieve this target earlier than Mr Brown would. In practical terms, they both want to see the future level of state school spending per pupil rise to the current level in the private sector. By the time state school spending reaches this level, however, private school spending will have increased even more. Neither the government nor the Liberal Democrats are truly proposing for state school spending to 'catch up' with (contemporaneous) private school spending. Closing that gap would require a one-off injection of funds and increases in funding every year to at least match increases in school fees. But when one talks about 'educational inequality', it is surely the gap in any given year which one really means - not the inequality between today's state system and the private sector some years ago.

 

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http://www.ifs.org.uk/publications/4453 Fri, 06 Mar 2009 00:00:00 +0000
<![CDATA[The schools lottery]]> "It is not acceptable for children's futures to be decided on the roll of a dice." So said shadow schools minister Nick Gibb, criticising the use of lotteries to allocate places in oversubscribed schools. Schools Secretary Ed Balls has stated that he would be concerned if lotteries were used "other than as a last resort", and announced that the practice is to be reviewed by the Schools Adjudicator, to ensure that it is "fair for children."

The natural question to ask is: 'fair' compared to what? Oversubscribed schools can't take in every pupil who applies, so the places must be allocated somehow - and all systems for doing so create winners and losers.

The most common allocation mechanism is the 'catchment area' - whereby pupils living closest to the school are first in line for scarce school places. This system naturally favours children born to better-off parents, who can afford those (more expensive) houses near a good school. We might say that this system allocates school places according to a different lottery - the lottery of birth.

These affluent parents lose out under a lottery system, because they can no longer guarantee a place for their child at the state school of their choice (by buying the 'right' house). The gainers from a lottery system are the less-affluent parents, who could not afford to live right next to the popular school. Where before their child would have had no chance whatsoever of getting into the oversubscribed school, they now have a real (albeit possibly small) chance of a place.

Beyond the issue of what is fair, it is worth emphasising that a child's prospects for success in life are unlikely to hinge entirely on the outcome of a school place lottery. In his best-selling book, 'Freakonomics', Steven Levitt quotes one of his research findings from a school lottery in the Chicago Public System. Levitt and his co-authors found that children who won a place at an oversubscribed school via the lottery did no better at school than children who lost the lottery.

This finding does not mean that schools are irrelevant to a child's success in life. Some schools are clearly better than others. It is just that the impact of attending a "good" school may be much smaller than the effect of having a parent who wants the best for their children.

 

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http://www.ifs.org.uk/publications/4449 Mon, 02 Mar 2009 00:00:00 +0000
<![CDATA[Widening participation in higher education]]> The Public Accounts Committee published a report on widening participation in higher education last week, which highlights the big gap in university participation between young people from rich and poor backgrounds. The aim of the report is largely to question whether the £392 million of public money given to universities for widening participation over the past six years has been used wisely.

IFS' recent work on participation in higher education (HE) gives a strong indication of what sorts of spending might work and what won't. It shows plainly that outreach activities aimed primarily at A-level students cannot fix the problem - by the time poor children have reached 16, it's already too late for many. Their low attainment has already drastically reduced their chance of a university place.

Our research used newly linked administrative datasets following every state school student from one particular cohort through the school system, from age 11 to age 19, allowing us to observe the entire history of academic achievement and any resulting HE participation.

It found, for example, that only 12.7% of boys from the most deprived fifth of households attend HE at age 18 or 19, compared to 41.7% of boys from the most affluent fifth - a gap of 29 percentage points. The gap between the richest and poorest girls is even bigger, at 34.6 percentage points. However, we found that this 'socio-economic gap' in HE participation does not emerge at the point of entry into higher education. Instead it comes about because poorer pupils do not achieve as highly in secondary school as their more advantaged counterparts. In fact, the socio-economic gap that remains after controlling for prior attainment (that is, comparing individuals with similar records of academic achievement) is tiny, at just 1.0 percentage points for males and 2.1 percentage points for females.

The implication is that focusing policy interventions on disadvantaged pupils who are already in post-compulsory education is unlikely to have a serious impact on the socio-economic gap in HE participation. This is not to say that universities should not carry out outreach work to such students, but simply that it will not tackle the much larger problem, namely the underachievement of disadvantaged pupils in secondary school.

 

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http://www.ifs.org.uk/publications/4447 Sun, 01 Mar 2009 00:00:00 +0000
<![CDATA[IMF provides ammo for another Budget giveaway]]> Despite official figures showing that the public finances are weakening more sharply than the Treasury predicted in November's Pre-Budget Report (which we analyse here), Gordon Brown has been handed some useful ammunition if he wants to argue for a further short-term fiscal giveaway in April's Budget.

In a paper prepared for a meeting of finance ministry officials from the G20, leading industrial and emerging market economies earlier this month, the International Monetary Fund points out that most of these countries are planning to extend their fiscal stimulus packages for longer than the UK. We are unusual in not having announced tax and public spending measures to add to spending power in the economy in 2010.

The IMF estimates that the temporary VAT cut and the rest of the PBR stimulus package will increase growth by up to 1% in 2009. But these measures will then come to an end and so have no impact on national income in 2010. In contrast, the US and Germany are planning an additional fiscal stimulus in 2010, on top of the ones they are planning for this year. Specifically, the IMF estimates that the fiscal stimulus in the US will increase growth by up to 1.2% in 2010, following a boost of up to 1.4% in 2009. And it expects the German stimulus to increase growth by up to 0.9% in 2010, on top of a 1.2% boost in 2009.

Mr Brown may well argue that this shows that the UK should put in place a further fiscal giveaway to take effect next year, because the recession looks likely to be longer than the Treasury expected last year.

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http://www.ifs.org.uk/publications/4442 Thu, 19 Feb 2009 00:00:00 +0000
<![CDATA[Ministers suggest more realistic child poverty target]]> Abolishing child poverty by 2020 has been one of this Government's defining policy goals for almost a decade. Last week ministers tried to make it a little easier, suggesting that it would be enough to cut the proportion of children in poverty on the most familiar definition to 10% rather than the 5% they have so far aspired to.

Claiming to have abolished child poverty with 1 in 10 children still below the poverty line is not as daft as it sounds. Numerous studies have shown that many households with very low incomes enjoy high living standards, suggesting their incomes are mis-measured or that they are poor only temporarily. Historically, child poverty in Britain has never fallen as low as 10% since the consistent series began in 1961, so hitting the new target would hardly be a cinch.

In addition to loosening the relative income target, the Government has suggested looking at two other measures too. It will aim to remove all children from material deprivation and persistent poverty. These are sensible complementary measures, although the precise definitions have yet to be set. It is noteworthy that the Government still wants to equate poverty firmly with low household income, rather than a wider range of circumstances. Although this may fit with most people's understanding of poverty, it risks skewing the policy response towards redistribution through cash payments, rather than - for example - better public services to improve children's lives.

Cynics may suggest that the focus on child poverty in 2020 is to deflect attention from the Government's existing target to halve child poverty from its 1998 level by 2010. Despite considerable extra spending on families with children in the past two Budgets, we estimated last summer that the Government would miss this target, just as it missed its earlier target one for 2004.

New data on household incomes, and the dramatic change in the economic climate over the past year, have led us to update that forecast and our estimates of how much it would cost to meet the 2010 and 2020 targets. This work, funded by the Joseph Rowntree Foundation, was published and presented at an IFS briefing on 18th February 2009.

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http://www.ifs.org.uk/publications/4425 Fri, 06 Feb 2009 00:00:00 +0000
<![CDATA[Innovation in the recession: willing, but not necessarily able]]> The latest annual survey of Business Enterprise Research & Development, released by the Office for National Statistics this morning, shows another real increase in R&D spending during 2007, in line with growth in real national income. But will the recession throw this into reverse?

 

Not necessarily. During a recession the cost of investing in innovation is lower than in times of expansion. Labour and other inputs are less in demand, and likely to be cheaper. The firm's internal resources are also likely to be underutilised, so undertaking innovative activities will be less costly.

 

Imagine a retail firm thinking about implementing a new computer system to monitor stock flow. It may find that a recession a good time to do so. Shutting the store to install the new equipment, and diverting staff away from sales work to train them will be less costly when the firm is selling less. Managers will have more time to spend reorganising current practices, and workers are likely to be more willing to accept change when their job security is less certain. It may also be a good time to lay off workers and replace them with new ones with more appropriate skills. Tougher business conditions may also encourage Research and Development (R&D) into new products or processes, as the search for productivity gains intensifies.

 

The notion that downturns are not necessarily bad for innovation fits into to the 'pitstop' view of recessions, as being a period when firms can take the time and resources to reorganise their activities and invest in new ideas. Recessions may therefore spur activities which enhance long run growth.

 

However, although firms may wish to invest more in innovation, they may lack the finance to do so - especially given banks' current reluctance to lend. Reorganising management practices or retraining workers may be relatively cheap and not need external finance. But a firm wishing to introduce new technology may need credit to buy and install the new equipment.

 

So whether the recession turns out to be good or bad for innovation remains an open question. Firms may be keener to invest in it than you might imagine, but whether they are able to do so will depend in no small part on when the banks are happy to lend again.

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http://www.ifs.org.uk/publications/4420 Fri, 30 Jan 2009 00:00:00 +0000
<![CDATA[IFS celebrates 40th birthday]]>

Established in 1969, the IFS has come a long way since four financial professionals lamented the poor design of Capital Gains Tax and decided that fiscal policy in Britain needed more effective independent scrutiny.

Our work now covers public finances, tax and welfare policy, tax law, education, inequality and poverty, pensions, productivity and innovation, consumer behaviour and international development. As fate would have it, we celebrate our anniversary at a time when all these topics could not be more relevant to the policy debate.

We are grateful to all those who support our work - and in particular to the Economic and Social Research Council, whose core funding makes it possible to sustain our basic research and to respond flexibly to rapidly changing policy developments.

We begin our anniversary year with our annual Green Budget, which examines some of the many challenges that must be keeping Alistair Darling awake at nights as his Budget draws nearer. In February we will be casting our eye over the Government's progress in reducing child poverty. And later in the year we will be publishing our flagship review of tax reform, chaired for us by the Nobel laureate Sir James Mirrlees.

As I hope you have noticed, to celebrate our anniversary we have also given our website a spring clean. We hope this will make access to our analysis quicker and simpler for visitors, as well as easier on the eye. There is still plenty of work to do, so please let us know if you experience any difficulties. We have also introduced this "Observations" slot, which will provide an opportunity for our researchers to offer brief comments on current developments and debates. If you would like receive email alerts when these are posted, please contact Bonnie Brimstone.

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http://www.ifs.org.uk/publications/4416 Tue, 27 Jan 2009 00:00:00 +0000