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Economics focus: A make or break month

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This is a make or break time for the public finances and George Osborne’s deficit reduction strategy. The government and the Office for Budget Responsibility expect a strong self-assessment season, partly the backwash from the abolition of the 50% additional tax rate. It needs to be, if there is to be a meaningful deficit reduction this year

We will not know for a while whether the taxpayers who missed the 31 January self-assessment deadline were numerous enough, or owed enough tax, to affect the overall numbers. What we do know is that typically hundreds of thousands of people leave it until the last minute. According to HMRC, nearly 570,000 filed on 31 January last year; and even more leave it too late – around 700,000 last year.

It matters particularly this year, of course, because January has become the pivotal month for the public finances. If, when the Office for National Statistics gets around to publishing the numbers for the public finances in a couple of weeks, January has been good, then the government’s deficit reduction strategy will still be on course.

If not, then David Cameron and George Osborne’s boasts about their long-term economic plan will start to look very thin. We would have an election campaign in which even the Tories might not want to talk too much about the budget deficit.

To explain why, it is necessary to provide a little context. As I write, we have official figures for the public finances for the first nine months of the 2014/15 fiscal year. They show that there has been a reduction in the budget deficit, but that you would need a pretty powerful magnifying glass to see it. In the first nine months, the cumulative deficit for 2014/15 was £86.3bn, just £0.1bn down on the corresponding period a year earlier. The margins do not come much thinner than this.

Drilling into the detail, regular Tax Journal readers will not be surprised to hear where the problem lies. Some taxes are showing the kind of increases you would expect in a growing economy. VAT revenues are up by a cumulative 3.6%, for example, within a rise of 4% in so-called taxes on production. Income tax and NICs, however, are not going according to plan. Receipts are up by just 2.2%, well below official forecasts, leaving the public finances off track.

To remind you, the Office for Budget Responsibility’s December forecast was for public sector borrowing to fall by £6.3bn to £91.3bn this year, itself a revision from the OBR’s March forecast, which was for a 2014/15 deficit reduction of around £12bn.

For a fall of £0.1bn over nine months to turn into a drop of £6.3bn on over the full year requires some significant catching up in the remaining three months. This is where January comes in. One reason why income tax receipts have been depressed this year relative to 2013/14 is our old friend the 50% additional tax rate – the old top rate. Its reduction from 50% to 45% in April 2013 produced a wave of income shifting, and boosted 2013/14 tax receipts. In comparison, the monthly run of numbers for 2014/15 has looked somewhat subdued.

Now, however, this year is about to get its 50% effect, in the form of self-assessment payments for the 2013/14 tax year. They should show a significant boost compared with a year ago and do most of the heavy lifting when it comes to deficit reduction. The OBR expects income tax and capital gains tax receipts  in the January–March period to be £4.3bn higher than a year ago. Most of this will be the income shifting effect on income tax, though the OBR is also expecting CGT to be boosted by the rise in house prices and the stock market during 2013/14.

The rest of the deficit reduction should come from lower debt interest and a refund on Britain’s EU budget contribution. Though lower interest rates on UK government debt – gilts – does not feed through immediately to an across-the-board reduction in the debt interest bill, there is a significant effect. At present, gilt yields are at record lows and the OBR expects the government to be paying £1bn less in debt interest over the next three months than a year ago. The other effect is that, while Britain’s EU contribution has gone up by £2.9bn, thanks to the economy’s relatively successful performance in recent years, £1.2bn of that should come back before the fiscal year is out.

Will it happen?

Analysts have learned to be sceptical of official projections for the public finances, not least because recent years have been a story of frequently missed targets. Most, however, think the factors identified by the OBR will kick in, and that there will be a deficit reduction this year. Even so, this could be less than the reduction that OBR expects and leave Osborne borrowing about £60bn more at this stage than he intended back in 2010.

Some think the OBR might have been a little too cautious about the extent to which the deficit can come down. Goldman Sachs, for example, has a forecast that will gladden the chancellor’s heart, should it come to fruition. It predicts a deficit outturn of £86bn for this year, £5bn below the OBR’s forecasts. It thinks, in other words, that the self-assessment season will be a bumper one.

We will know a lot more, as I say, soon. The January figures for the public finances will be published on 20 February, so keep an eye out for them, though there could be some spillover into February. Those numbers will not be known until around the time of the 18 March Budget, of which more next time. Nobody much enjoys doing their self-assessment returns. But a lot hangs on them.