On December 5, the Chancellor will present his annual ‘Pre-Budget’ Report. This is likely to include revised Treasury estimates for the economic outlook (particularly for this year). There are fears, particularly among industry groups, of tax increases, and despite there being no significant risks of imminent breaches of the government borrowing limits, revenue raising measures of some variety look rather likely.
The Treasury’s economic forecasts look optimistic
In this year’s Budget Report (March 16), the Treasury presented forecasts for the economy which looked sensible to us over the medium to longer term, but distinctly optimistic in the shorter term.
Having now had data on GDP growth for Q1-Q3 of this year, the Treasury’s growth forecasts look very unlikely to be met. For 2005, the Treasury expected real GDP to grow between 3.0% and 3.5% and by 2.5 to 3.0% in 2006.
If the preliminary estimate of Q3 GDP growth from the Office of National Statistics (ONS) was left unchanged (along with its estimates for Q1 and Q2), then in order to achieve 3.0% GDP growth (at the bottom of the Treasury’s range of forecasts) we would need Q4 GDP to have grown by around 6.0% on the quarter (non-annualised). Our central forecast is for GDP growth to be around 1.7% — about half the Treasury’s forecast.
Borrowing is tracking ahead of the Treasury’s forecasts
So far the key fiscal figures are on track to generate outcomes somewhat worse than the Treasury’s 2005 Budget forecast. But there is always uncertainty about the scale of tax revenue — particularly from corporations —in the last couple of months of the financial year.
Oil prices both hinder and help the fiscal finances
Although growth is coming in well below the Treasury’s expectations, the Treasury’s receipts are likely to receive something of an offsetting boost through oil-related revenues (corporation tax, petroleum revenue tax and VAT). But the offset is unlikely to offset more than a small part of the revenue shortfall if the level of GDP in 2005-06 is about 1% lower than the Treasury’s 2005 Budget forecast.
The Chancellor’s fiscal rules are likely to be met near term … just
Whether or not the Treasury meets the ‘golden rule’ this cycle (borrowing only to invest — that is, have a current budget of zero as a percentage of GDP or less when averaged over the whole cycle) is a close call.
If the cycle is deemed to have ended this year (as the Treasury had forecast), then the current budget as a percentage of GDP will likely be zero over the cycle. Having revised the estimate of the start of the current cycle by two years (thereby including more years when there was a surplus), the chance of breaking the golden rule this cycle is diminished.
However, whether the cycle has ended this year is open to question. While the debt rule (that public sector net debt as a percentage of GDP should not exceed 40%) looks likely to be met this year, this may be by a relatively small margin.
The press are highlighting the potential for tax rises
A number of UK newspapers have highlighted the possibility of an announcement of some sort of additional taxation on oil companies. The Chancellor is now widely perceived to have an underlying tax revenue-spending gap of around £10 billion a year to fill. But the government will want substantial new investment to develop the remaining oil fields in the North Sea. Any further change to the taxation of oil company profits risks undermining the incentives to develop UK oil reserves.
Revenue raising measures of some type look likely
We think that meeting the golden rule will likely be a close-run thing and that with its economic assumptions likely to be significantly lowered for this year, and possibly into next year, the Treasury may wish to try and carve out a bit more breathing space. Revenue raising measures of some description look rather likely to us and the corporate sector looks a more likely target than more immediately visible (to voters) alternative measures such as raising income taxes or national insurance contributions.
By David Miles, Melanie Baker and Vladimir Pillonca, Morgan Stanley economists, as published on the Global Economic Forum