An audit of the public finances
We expect the current budget surplus in 2001-02 to be ñ4.0bn compared to the ñ1.1bn forecast by the Treasury last November, mainly reflecting lower than planned public spending this year. In the medium term we expect receipts to be at a similar level to the November 2001 Pre-Budget Report forecast but expect public spending to be higher.
If the Government were to maintain the level of caution seen in recent years in the public finances, and pay for new measures which have been announced but not yet included in its costings, the Chancellor would need to announce new spending cuts or tax increases of õbn. Alternatively, the Chancellor could choose to increase borrowing and still meet the fiscal rules, but with increased risk of breaking them in future.
This assumes as a baseline that public spending in 2004-05 and 2005-06 grows in line with national income. In its last two spending reviews the Government decided to increase public spending as a share of national income. Increases in capital spending can be financed by increases in borrowing without breaching the fiscal rules. Increases in current spending as a share of national income require the Chancellor either to reduce the caution in his forecasts or to ensure that tax revenues rise. If the Government were to increase current spending by 2ޥ a year in real terms then this would require around an additional ñbn each year in borrowing or tax revenues. Therefore to increase current spending at 2ޥ a year in real terms in 2004-05 and 2005-06, to finance the new measures, and to restore the level of caution in its plans to the March 2001 Budget level, the Treasury would need new tax increases of around ÷bn in the Budget. This is made up of the õbn for restoring caution, paying for the new measures and keeping spending constant as a share of national income, and an extra ñbn for each year of increasing current public spending at 2ޥ.
Improving public services?
UK spending on health and schools is relatively low by international standards. But current increases in health and education spending are historically large, and are planned to continue at least until March 2004. If continued substantial spending increases in the health and education budgets are deemed necessary beyond 2003-04, then one option would be to try and fund them from savings out of other departments. But this does not look easy - it seems unlikely that falling unemployment will continue to provide significant savings on social security, and the claims of many other spending departments, for example, transport and defence, might be seen as relatively strong at the moment. It seems likely, therefore, that continued large increases in health and education spending beyond 2003-04 would need finance from either increased borrowing or taxation.
Options for raising tax
Possible sources of significant extra revenue in the 2002 Budget are National Insurance and VAT. But the decision to rule out increases in income tax rates might seem disadvantageous should the Government want to raise significant revenue. The pledge limits the potential to increase the single biggest tax, and it does so more severely now than it did in Labour's first term, as many of the means used to increase income tax revenue without changing the rates are now exhausted. It might also seem disingenuous to simulate tax rate rises using National Insurance. The National Insurance option would be less progressive than a rise in income tax: National Insurance increases leave untouched the unearned income of the wealthy, and would hit moderately high earners harder.
Personal tax reforms: the Child Tax Credit and the Working Tax Credit
The Government has promised to announce the rates of two new tax credits - the Child Tax Credit and the Working Tax Credit - in Budget 2002. These credits will be introduced in 2003-04, and are likely to have a full-year cost of ò-3bn a year. After a worrying lack of public discussion and openness, many of the operational details may be announced in the Budget: these details will determine whether people in the target group understand the credits and choose to claim them.
Tax policy and companies
The Government intends to introduce a further R&D tax credit open to larger firms in Budget 2002 and now looks likely to opt for a volume-based credit with relatively low compliance and administrative costs.
The 2001 Pre-Budget Report outlined proposals for a training tax credit. This represents another proposed reform to the provision of post-school education and training, following the introduction and subsequent withdrawal of Individual Learning Accounts. Few doubt that there is some role for government in the provision of training. But the Government should clearly identify, and consider evidence on the magnitude of the market failures that it is trying to tackle, and use this to develop an effective policy. It is not clear that the current proposals have followed this route. The planned piloting of the scheme, with plans for an evaluation of its effectiveness, is therefore welcome.
Developments in asset-based welfare policy
At the time of the Pre-Budget Report the Treasury published a consultation document discussing two proposed asset-based welfare policies, the Saving Gateway and the Child Trust Fund. It is not clear that spending on matched savings accounts (the Saving Gateway) represents a better way of supporting lower-income families than increasing benefit expenditures or funding more financial education. Equally, it is not clear that children will be better supported by the provision of an asset that matures at 18 (the Child Trust Fund) than by targeted increases in financial support to their families or by targeted education spending.
A graduate tax for the UK?
The recent interest in a graduate tax continues a long running, but unresolved debate about student finance in the UK. It is unclear whether there is to be a formal consultation on the issue, or whether concrete proposals will appear. We examine the potential impact of a graduate tax scheme. Graduates tend to be better off than the average, and to come from families with above average incomes. A graduate tax operating through increases in basic and higher rates of income tax would have progressive effects. But fundamental questions about whether it would be appropriate to use such a vehicle as a means of funding higher education remain unanswered, as do many questions about the design and implementation of such a tax.
Notes to Editors
- The IFS Green Budget: January 2002 was funded by the Economic and Social Research Council.
- The IFS Green Budget: January 2002, edited by Andrew Dilnot, Carl Emmerson and Helen Simpson, is published on 30th January 2002 and is available from the IFS, 7 Ridgmount Street, London, WC1E 7AE, price £40 (£15 to IFS members), telephone 020 7291 4800 or e-mail firstname.lastname@example.org
- The Green Budget will be launched on 30th January, 11am at Barber Surgeons' Hall, 1a Monkwell Square, London EC2Y 5BL. For press places, please telephone IFS on 020 7291 4800.