1. © Institute for Fiscal Studies Disease and cure in the UK: The fiscal impact of the crisis and the policy response Slides prepared by Carl Emmerson for SOLACE November 2010 http://www.ifs.org.uk/projects/346

2. Conclusions Permanent hit to public finances from financial crisis estimated at £86 billion a year (in today’s terms) Response is a £98 billion fiscal tightening by 2015–16, comprising a £24 billion tax rise and a £74 billion spending cut (in today’s terms) –OBR estimates 60% chance of hitting fiscal mandate on current policies Overall post crisis tax and benefit reforms regressive across most of the income distribution, although very focussed on richest 2% –cuts to welfare payments for working-age individuals Four years from next April will be the tightest sustained squeeze to public service spending since April 1976 to March 1980 –total DELs cut by 11% in real terms –overseas aid budget increased sharply –in England: NHS and schools relatively protected; largest cuts to: Communities and Local Government, DEFRA and BIS Would be sensible to review plans in 2012 © Institute for Fiscal Studies

3. Disease Outlook for the public finances dramatically weakened since Budget 2008 Much of deterioration expected to be impervious to economic recovery –‘structural’ rather than ‘cyclical’ increase in borrowing Forecasting borrowing difficult –estimates of the size of the structural hole have changed over time –latest (June 2010) forecasts are slightly worse than the forecast made before the general election (March 2010) © Institute for Fiscal Studies

4. Permanent damage = 5.8% of GDP (£86bn) Note: Author’s calculations comparing HM Treasury June 2010 Budget with HM Treasury March 2010 Budget. Disease: size of the problem

5. © Institute for Fiscal Studies Disease: change over time Sources: HM Treasury; IFS calculations.

6. Cure Labour (March 2010 Budget) –no fiscal tightening in 2010–11 (although economy would have to deal with the removal of the fiscal stimulus that was in place in 2009–10) –six year fiscal consolidation starting in April 2011 –composition of cure in 2014–15: 70% spending cuts, 30% tax rises –no detail of additional measures for 2015–16 and 2016–17 New Government –fiscal tightening to start this year –aim to fill the hole in 2014–15, further tightening in 2015–16 to build some caution into the plans –overall package in 2014–15: 73% spending cuts and 27% tax rises © Institute for Fiscal Studies

7. Fiscal tightening: Labour’s plans Sources: HM Treasury; IFS calculations. 70% 30%

8. © Institute for Fiscal Studies Fiscal tightening: additional measures Sources: HM Treasury; IFS calculations. 22% 78%

9. © Institute for Fiscal Studies Fiscal tightening: coalition plan Sources: HM Treasury; IFS calculations. 27% 73%

10. Differences in cure (2014–15) Overall tightening: new Government to tighten by more Composition of tightening –mix between tax and spending very similar to March 2010 Budget plan –sharper fall in borrowing leads to greater reduction in debt interest spending –similar £bn cut to investment spending (both very deep) –significant welfare cuts announced since election (not known whether Labour would have done this) –bigger £bn tax rises, and deeper £bn cut to non-investment spending, than implied by the March 2010 Budget plan © Institute for Fiscal Studies

11. Composition of the tightening in 2014–15 © Institute for Fiscal Studies £ billion (nominal)March 2010 Budget October 2010 Spending Review Tax 21.529.8 Spending 50.980.5 Investment spending 17.217.0 Current spending 33.763.5 Of which: Debt interest 710 Benefits –0.317.7 Public services 27.035.7 Total tightening (£bn) 72.4110.3 % Spending 7073 % Tax 3027

12. Latest forecasts Measures forecast to offset increase in underlying borrowing seen Budget 2008 –deficit to return to pre-crisis levels in 2015–16 Measures also to return debt to a sustainable path –but constant borrowing beyond 2015–16 would see not debt return to pre- crisis levels until late 2020s –if no further tax rises / spending cuts to offset costs of ageing population then debt still sustainable, but may not return to below 40% of national income Significant uncertainty remains –if latest forecasts are as accurate as previous ones then 60% chance of meeting the Government’s fiscal mandate on current policies –40% chance that further tax rises or deeper spending cuts required © Institute for Fiscal Studies

13. Cure: borrowing back to pre-crisis levels © Institute for Fiscal Studies Sources: Author’s calculations using all Budgets and Pre-Budget Reports since March 2008 (all available at http://www.hm-treasury.gov.uk/).

14. Cure: debt sustainable but not back to pre-crisis levels for a generation © Institute for Fiscal Studies Source: Author’s calculations based on the March 2008 and June 2010 Budget.

15. Meeting the fiscal mandate? © Institute for Fiscal Studies Source: Office for Budget Responsibility (http://budgetresponsibility.independent.gov.uk/d/fan_charts_intervals.xls).http://budgetresponsibility.independent.gov.uk/d/fan_charts_intervals.xls 60% chance of surplus in 2015–16

16. Tax & spend Crisis depressed tax revenues and increased public spending as a share of national income –tax revenues: lower financial sector profits, lower house and equity prices –public spending: public service spending set in cash terms for three years in 2007 and economy turned out much smaller than expected As a share of national income increase in spending greater than the fall in revenues –provides possible rationale for more of the policy response being on spending than on tax –aim to return spending to slightly below, and revenues to slightly above, pre- crisis levels © Institute for Fiscal Studies

17. Cure: impact on tax and spending © Institute for Fiscal Studies

18. Impact of tax rises and welfare cuts Measures reduce net incomes across the income distribution Impact regressive across most of the income distribution –with notable exception of the richest the losses are larger among low income groups than among higher income groups Throughout the income distribution pensioners lose, on average, less than families with children © Institute for Fiscal Studies

19. Cure: all in this together? © Institute for Fiscal Studies Impact of tax & benefit reforms to be in place by 2014–15, by income

20. Cure: all in this together? © Institute for Fiscal Studies Impact of tax & benefit reforms to be in place by 2014–15, by family type

21. Impact of cuts to spending on public services Total spending on public services to be cut in real terms for six years –since WW2 cuts have only been achieved for two consecutive years –deepest sustained cuts since April 1975 to March 1980 Central government spending on public services (DELs) –to be cut as a share of national income back to the late 1990s levels –in real terms spending in 2014–15 to be 11.2% lower than in 2010–11 or 13% below the level Labour planned for 2010–11 © Institute for Fiscal Studies

22. Cure: public service spending set for a squeeze © Institute for Fiscal Studies Note: Figure shows total public spending less spending on welfare benefits and debt interest.

23. DELs: The grand old Duke of York? © Institute for Fiscal Studies Note: Figure shows Departmental Expenditure Limits (DELs) as a share of national income under current policies.

24. DELs: deep cuts coming © Institute for Fiscal Studies –11% –10% – 13%

25. Sharing the pain Two winners? –spending on international aid and energy & climate change Relative protection for NHS and schools? –tightest settlement for NHS spending since early 1950s –schools spending per pupil to fall in all but most deprived schools Several losers? –Home office, Justice, Local Government and Department for Business, Innovation and Skills all face cuts of around one-quarter –latter primarily comes from deep cuts to taxpayer support for higher education teaching One big loser? –DCLG communities budget to be cut by two-thirds, with capital budgets cut by three-quarters: public investment in new social housing the big loser © Institute for Fiscal Studies

26. ‘Winners’ © Institute for Fiscal Studies Note: Figures show real change in total (resource + capital) DEL

27. ‘Losers’ © Institute for Fiscal Studies Note: Figures show real change in total (resource + capital) DEL

28. © Institute for Fiscal Studies English schools spending DfE to receive total real-terms cut in DEL of 10.8% Schools spending including pupil premium to grow by 0.1% per year in real-terms (or 0.4% in total) –but total pupil numbers to increase by average of 0.7% per year –total schools spending per pupil to be cut in real-terms by 0.6% per year (total of 2¼%) Assuming flat-rate pupil premium of £2,400 (stated total cost £2.5 billion) and underlying funding per pupil frozen in cash-terms –60% of primary school pupils in schools where real funding falls –87% of secondary school pupils in schools where real funding falls –43% of pupils in (less deprived) schools would see cuts of 5% or more –1 in 8 pupils in (very deprived) schools would see increase of 5% or more Note: Assumes all schools experience the same growth in pupil numbers.

29. Record breakers? Real increase over next 4 years –total spending: tightest since World War II –spending on public services: tightest since April 1975 to March 1980 –NHS: tightest since April 1951 to March 1956 –(ODA: greatest since Jan 2002 to Dec 2006) © Institute for Fiscal Studies

30. Conclusions Permanent hit to public finances from financial crisis estimated at £86 billion a year (in today’s terms) Response is a £98 billion fiscal tightening by 2015–16, comprising a £24 billion tax rise and a £74 billion spending cut (in today’s terms) –OBR estimates 60% chance of hitting fiscal mandate on current policies Overall post crisis tax and benefit reforms regressive across most of the income distribution, although very focussed on richest 2% –cuts to welfare payments for working-age individuals Four years from next April will be the tightest sustained squeeze to public service spending since April 1976 to March 1980 –total DELs cut by 11% in real terms –overseas aid budget increased sharply –in England: NHS and schools relatively protected; largest cuts to: Communities and Local Government, DEFRA and BIS Would be sensible to review plans in 2012 © Institute for Fiscal Studies

31. Disease and cure in the UK: The fiscal impact of the crisis and the policy response Slides prepared by Carl Emmerson for SOLACE November 2010 http://www.ifs.org.uk/projects/346