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The puzzling strength of the public finances

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Each month this year, official figures for the public finances have confounded expectations by coming in below both City forecasts and last year’s outturns. The expected Brexit-related deterioration in the public finances has yet to show itself and the Office for Budget Responsibility, after some bad forecast misses, is in danger of developing a reputation for being too gloomy.

There is no denying that it is a surprise. When, a few months ago, the monthly figures for the public finances started to come in much better than expected, the assumption, including from me, was that this was a flash in the pan. Before too long, the realities of slower growth – an ever-present for the economy this year – would hit home.

We still await that moment. September’s figures for the public finances completed what has been by recent standards a very successful half-year. For September itself, public sector net borrowing, of £5.9bn, was not only £0.7bn lower than a year earlier but it represented the lowest September figure since 2007, before the financial crisis began to wreak havoc on the public finances.

For the half-year April to September, borrowing was £32.5bn, which was £2.5bn lower than the corresponding period of 2016/17 and, again, the lowest figure since 2007. The hit from the Brexit vote that was supposed to happen has yet to materialise for the public finances.

The improvement results from some straightforward fiscal arithmetic. Receipts in the first half of the tax year were up by 3.8% on a year earlier. VAT receipts, up 3.7%, and national insurance contributions, up 4.3%, have been leading the pack. Current government expenditure also rose, but by only 3%.

Not everything in the tax garden is rosy. Corporation tax receipts are up by a weak 0.8% this year, while income tax and capital gains tax are up by 2.3%. But the overall picture is a lot healthier than expected.

The Office for Budget Responsibility (OBR) has cautioned against assuming that this year’s borrowing will undershoot 2016/17. As it put it after the releases of the latest figures: ‘Halfway through 2017/18, borrowing is £2.5bn down on the same period in 2016/17. While this suggests we will need to revise down full-year borrowing in our November forecast, it remains likely that the deficit will rise relative to 2016/17. Self-assessment income tax receipts in January and February are expected to fall year-on-year.’ One of its central forecasts in the wake of the EU referendum was that after the special factors that had depressed borrowing in 2016/17, the deficit in the following year would be higher.

But the official statisticians have been making life difficult for the OBR, both by revising down last year’s borrowing figures and by recording an improvement in this year’s monthly figures, even from that lower base. To put this in context, the OBR’s forecast a year ago for public borrowing in 2016/17 was £68.2bn. That forecast was revised down dramatically in March, to £51.7bn, but that was not enough. The latest outturn figure is just £45.7bn. The forecast the OBR made a year ago ranks as one of its worst misses. Its prediction was nearly 50% too high. As for this year, its March prediction of a £58.3bn deficit again looks much too high. Even with the OBR’s health warnings, the expectation is that it will come in below £50bn.

The OBR will, of course, be centre stage in the 22 November Budget. There are many moving fiscal parts in any set of Budget projections. Weaker productivity growth, which the OBR has told us to expect as one of its central assumptions underlying its projections, worsen the public finances by reducing the economy’s sustainable rate of growth. Other factors, including higher employment than was expected, will tend to help it.

In the longer term, the OBR may revise its net migration assumptions in line with new population projections from the Office for National Statistics. It has reduced its long term net migration assumption from 185,000 to 165,000 a year, and reduced its prediction of the UK’s population in 2041 by two million (from 74.9m to 72.9m). Lower net migration is bad for the public finances.

Overall, as Philip Hammond has already intimated, the new official projections will be gloomier than those in March. The OBR’s pronouncements on the medium and long term outlook for the public finances will, however, suffer from something of a credibility problem because it has been getting the short term so badly wrong recently. We will not know until next year, for example, whether its worries about next year’s self-assessment receipts are justified.

In the meantime, it will be a question of following the numbers closely, and watching for the deterioration that we were led to expect. My sense of what is happening is that once deficit reduction achieves reasonable momentum, as it did towards the end of George Osborne’s chancellorship, and tighter control of public spending becomes the norm, this kind of downward momentum in borrowing is not unusual. It happened in the 1990s, admittedly against a far sunnier economic backdrop, when a large budget deficit in the early part of the decade evolved into a surplus within five to six years – much sooner than anybody expected.

This time, of course, the government has officially given up on the prospect of achieving a budget surplus until the mid 2020s, which in political terms is another era. That probably makes sense. The way things are going, however, it may have thrown in the towel too soon. Certainly, if Britain had voted to stay in the EU and George Osborne were still chancellor, he would be celebrating the numbers as evidence that he was on track to delivering a surplus much earlier.

Even downward momentum in the deficit can be halted and reversed, however, if the economy falters. Growth has been slower this year, though the third quarter rise in gross domestic product of 0.4% slightly exceeded expectations. If growth were to hit the buffers, which could happen with a bad Brexit outcome, we may yet look back on this period of undershooting deficits as the calm before the storm. 

Issue: 1375
Categories: Analysis