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BRIEFING PAPER

Number 7290, 20 November 2015

Background to the 2015 Spending Review and Autumn Statement

By Matthew Keep Daniel Harari Richard Keen Steven Kennedy Feargal McGuinness Chris Rhodes Djuna Thurley Dominic Webb

Inside: 1. Spending Review 2. Economic situation 3. The public finances 4. Benefits and tax credits 5. Welfare cap 6. Pensions

Number 7290, 20 November 2015 2

Contents Summary 3

1. Spending Review 4 1.1 Public spending in context 4 1.2 The ‘spending envelope’ 5 1.3 Changes in spending, 2010/11 to 2019/20 6 1.4 Departmental budgets 7

Changes to departmental spending since 2010/11 8 Protected and unprotected departments 9 Devolved administrations 10

1.5 Single departmental plans 11

2. Economic situation 13 2.1 Growth and economic conditions 13

Forecasts 15 2.2 Productivity 17 2.3 Inflation and monetary policy 18 2.4 Labour market 20 2.5 Current account 21

3. The public finances 23 3.1 The deficit: public sector net borrowing 23 3.2 Structural borrowing 24 3.3 Public sector net debt 25

4. Benefits and tax credits 27 4.1 Background: £12 billion of savings 27 4.2 Tax credits: proposed changes 27 4.3 Tax credit changes: rejection by the Lords 28 4.4 Mitigation: possible options & comment 29

Personal Allowance & the National Living Wage 29 Universal Credit changes 30 Housing Benefit changes 30 Transitional tax credit arrangements 31

5. Welfare cap 32 5.1 How the cap works 32 5.2 What is included in the Welfare Cap? 32

6. Pensions 34

Appendix 1: Sources of further information 36

Appendix 2: Economic and public finance data 1979-2019 37

Contributing Authors: Daniel Harari, economic situation Richard Keen, tax credits Steven Kennedy, tax credits Feargal McGuinness, labour market Chris Rhodes, spending review and welfare cap Djuna Thurley, pension tax relief Dominic Webb, trade

3 Background to the 2015 Spending Review and Autumn Statement

Summary The Chancellor of the Exchequer will present the joint 2015 Spending Review and Autumn Statement to Parliament on 25 November 2015.

Spending Review and the public finances

The Spending Review will set budgets for government departments and the devolved administrations for each financial year from 2016/17 to 2019/20. Day-to-day spending is set to fall by £18 billion or 6% between 2015/16 and 2019/20 in real terms, meaning that many departments will see budget reductions.

Some departments are protected from spending reductions, including the NHS, some schools spending, defence spending and the international development budget. This means that other departments will see larger reductions, in many cases on top of reductions seen over the previous Parliament.

Reducing departmental spending forms part of the Government’s plan for shrinking the budget deficit – the difference between what the public sector spends and receives in taxes. Despite falling during the previous Parliament, the budget deficit remains high, and was £90 billion in 2014/15. The Government aims to eliminate the deficit by 2019/20. The Office for Budget Responsibility’s (OBR’s) latest forecast put the Government on course to meet its target.

Public sector net debt – the stock of borrowing arising from past deficits – remains high by international standards at around 80% of GDP.

Benefits and tax credits and other potential announcements

Having been defeated in the House of Lords, the Chancellor is committed to announce revised plans for changes to tax credits and benefits. Plans announced in the Summer Budget 2015 resulted in £12 billion of savings in 2019-20, around 45% of which were savings from tax credits – affecting around 3.3 million in-work families. The OBR will report on whether it expects relevant welfare spending to meet or exceed the welfare cap set by the Government for the forthcoming year. We may also expect an update on consultations carried out over the summer on pension flexibilities.

Economic situation

The Chancellor makes his statement at a time of healthy economic growth. Most economists expect growth in 2015 to be around 2.5%, with a similar figure forecast for 2016. Strong consumer spending is expected to support growth in the short term, as real (inflation-adjusted) household incomes rise: this is due to the combination of a recent acceleration in wage growth and near-zero inflation. Risks to the outlook come chiefly from a slowdown in emerging economies and if productivity growth fails to improve as is expected.

The labour market continues to improve: the unemployment rate is near its pre-recession level and a record-high proportion of the working-age population are in work. Average earnings growth has accelerated and earnings are now growing faster than during the previous five years. Nevertheless, average earnings growth is still slower than it was before the recession.

Number 7290, 20 November 2015 4

1. Spending Review

Summary

The 2015 Spending Review will be held on 25 November, and will set departmental spending limits for each financial year from 2016/17 to 2019/20.

Government figures published in the 2015 Summer Budget indicated that day-to-day spending will fall by £18 billion or 6% between 2015/16 and 2019/20 in real terms, meaning that many departments will see budget reductions.

Some departments are protected from spending reductions, including the NHS, some schools spending, defence spending and the international development budget. This means that other departments will see larger reductions, in many cases on top of reductions seen over the previous Parliament.

Spending limits will also be set for the devolved administrations. The Barnett formula will calculate annual changes in these limits based on annual changes in the spending limits of UK departments.

1.1 Public spending in context In 2015/16, Total Managed Expenditure (all public spending) will be £742 billion, 40% of GDP. This is marginally below the average over the last 60 years, from 1955/56 to 2014/15, of 41% of GDP. It is forecast to fall to 36% of GDP in 2019/20.

The years from 2009/10 onwards have been the most prolonged period of spending restraint since the Second World War. Public spending has fallen in real terms on only a handful of occasions, and after these occasions spending began rising again after one or two years.

The current period of austerity is also noteworthy because it contrasts strongly with the immediately preceding era. Between 2001/02 and 2009/10, total public spending grew by 4% a year on average. This is 1.5 percentage points higher than average annual growth in the period 1955/56 to 1999/00.

-4%

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0%

2%

4%

6%

8%

10%

12%

1955-56 1965-66 1975-76 1985-86 1995-96 2005-06 2015-16

Annual % change in public spending (real terms)

ForecastsBy 2019/20, spending will have been falling or growing by less than 0.5% in real terms each year for a decade.

5 Background to the 2015 Spending Review and Autumn Statement

Box 1: Types of public spending

The spending review only deals with 47% of all government spending. The rest is apportioned on a demand-led basis. There are two different kinds of public spending:

• Departmental Expenditure Limits (DEL) – the focus of the spending review. The predictable part of public spending, including public sector workers’ salaries. DEL accounts for £351 billion of public spending, 47% of the total.

• Annually Managed Expenditure (AME) – not included in the spending review. AME is demand-led spending which it is more difficult for forecast with accuracy. It includes welfare payments and government debt interest payments. AME accounts for £391 billion, 53% of the total.

DEL and AME spending can be divided by function:

• Resource spending (also known as current spending) is spending that is used up and recurs each year, such as salaries and welfare spending. Current spending accounts for 91% of all spending.

• Capital spending is spending on assets that last for a number of years, such as land, buildings and computers. Capital spending accounts for 9% of all spending.

The Spending Review will only deal with DEL spending. Although the allocation of capital spending will also be formally announced at the spending review, the Review’s main focus will be on resource spending. In 2015/16, resource DEL spending will be £315 billion.

1.2 The ‘spending envelope’ In the 2015 Summer Budget, the Government set out the implied ‘spending envelope’, that is, the total amount available for Government spending in each year between 2016/17 and 2020/21.1

Resource DEL spending (the kind of spending that will be dealt with in the Spending Review) is set out in the following table.

1 The DEL figures in the Budget and corresponding OBR documents are implied –

confirmed figures will be published in the Spending Review

Resource DEL spending in the 2015 Spending Review period

Nominal2015/16

pricesChange on year

£ billions% change

2015/16 315.1 315.1 - -

2016/17 318.8 313.5 -1.6 -1%

2017/18 316.7 305.9 -7.6 -2%

2018/19 316.2 299.7 -6.2 -2%

2019/20 320.3 297.4 -2.4 -1%

Change 2015/16 to 2019/20 5.2 -17.7 -6%

Source: Office for Budget Responsibility, Economic and Fiscal Outlook, July 2015, Table 4.17

HM Treasury, GDP Deflator, October 2015

£ billions Real terms DEL spending will be £297 billion in 2019/20, 6% lower than in 2015/16 (15/16 prices)

Number 7290, 20 November 2015 6

So, the 2015 Spending Review will apportion total real terms reductions in spending of £18 billion by 2019/20.

1.3 Changes in spending, 2010/11 to 2019/20 In 2015/16, DEL will be £315 billion. In 2019/20, DEL will be £297 billion (in 2015/16 prices), a fall of £18 billion or 6% over this period.

This is a smaller real terms fall than in the previous Parliament, when DEL spending fell by £37 billion or 11% in real terms.

Between 2010/11 and 2019/20, resource DEL spending is forecast to fall by £55 billion or 16% in 2015/16 prices.

Box 2: The Spending Review process

Having set out the spending envelope for the Spending Review period, the Government must decide how to apportion the reductions that the overall envelope implies. In order to do this, the Treasury asked Departments to “model” scenarios in which they reduce spending by 25% and 40% in real terms by 2019/20 compared to the 2015/16 level.

Star Chamber

The Public Expenditure Cabinet Committee (known as PEX, or the Star Chamber) will meet to discuss high level spending decisions. Once a Secretary of State’s department has agreed their spending settlement with the Treasury, that Minister will be invited to join the Star Chamber and help make decisions about the remaining departments. On November 9, it was announced that the Departments for Transport, Local Government, Environment, Food and Rural Affairs and the Treasury had all agreed spending settlements (their resource DEL budgets will fall by an average of 30% over the Spending Review period). On the 17 November, it was announced that a further seven departments have reached agreements on their Resource DEL budgets: the Department for Work and Pensions, HM Revenue and Customs, the Cabinet Office, and the offices for Scotland, Wales and Northern Ireland. Press reports stated that these departments had reached settlements that will result in their budgets falling by an average of 21% in real terms by 2019/20.

Final decision

Cabinet will formally sign-off all departmental settlements in November, and the Spending Review will be published on the 25th November. Although the Spending Review will focus mainly on Resource DEL spending, the Government has stated that it will also examine AME and capital spending so that all areas of spending are scrutinised. The Government will consult a variety of experts on public spending and public service delivery as part of the Spending Review process.

Resource DEL changes

2015/16 prices

£ billions % change

2010/11 to 2015/16 -37 -11%

2015/16 to 2019/20 -18 -6%

2010/11 to 2019/20 -55 -16%

Source: Office for Budget Responsibility, Economic and Fiscal Outlook, July 2015, Table 4.17

HM Treasury, Public Expenditure Statistical Analysis, 2015, Table 1.1

HM Treasury, GDP Deflator, October 2015

DEL spending fell by more in the previous Parliament than it will in the 2015 Spending Review period.

7 Background to the 2015 Spending Review and Autumn Statement

1.4 Departmental budgets Spending within the scope of the Spending Review in each department is set out below. These are the totals that will be affected by decisions taken in the Spending Review.2

There are a few key things to note about these data:

• Spending on the NHS dominates this kind of spending, accounting for just under a third of all DEL spending.

• The Government has stated that several areas of spending will be ‘protected’ from reductions, meaning that any savings will have to be found in other areas. The protected areas are the NHS, some school spending, overseas development aid and defence spending.3

• The chart above includes investment spending on assets such as new infrastructure and buildings. The Government has pledged to maintain infrastructure investment as a proportion of the economy, meaning that reductions in spending will likely fall on non-infrastructure spending.

2 These data are taken from the 2015 Summer Budget, Table 2.3. Note that they only

include spending which is within the scope of the Spending Review, around 47% of all spending. These data include current and capital spending.

3 HM Treasury, A country that lives within its means: the 2015 Spending Review, July 2015, pp13,14

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0 20 40 60 80 100 120

Law Officers' Departments

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Foreign and Commonwealth Office

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Chancellor's Departments

Energy and Climate Change

Work and Pensions

Justice

CLG Communities

Transport

International Development

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CLG Local Government

Northern Ireland

Wales

Business, Innovation and Skills

Scotland

Defence

Education

Health

Departmental Expenditure Limits, 2015/16, £ billions

Number 7290, 20 November 2015 8

Changes to departmental spending since 2010/11 The following charts show the changes to departmental spending in each department between 2010/11 to 2015/16 in real terms. The first chart shows the value of the changes in £ billions (2015/16 prices) and the second chart shows percentage changes.

These figures have been adjusted in a number of ways to take into account alterations in the way that expenditure on certain items is accounted for, so that the 2010/11 and 2015/16 figures are directly comparable. Alterations to the following departmental budgets have been made:

• The Department for Communities and Local Government’s budget has been adjusted to take into account additional personal social services responsibilities, the business rate retention scheme and council tax benefit localisation.

• The Department for Transport has been adjusted to allow for changes to the way the Network Rail grant is accounted.

• The budgets for Scotland and Wales have been adjusted to take into account council tax benefit localisation. Wales’s budget has also been adjusted to account for the devolution of business rates to the Welsh Assembly in 2015/16.

• The Ministry of Defence has been adjusted to account for the incorporation of the Special Reserve.

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CLG Local Government

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Environment, Food and Rural Affairs

Culture, Media and Sport

Foreign and Commonwealth Office

Law Officers' Departments

Small and Independent Bodies

Cabinet Office

Energy and Climate Change

International Development

NHS (Health)

Changes to Total DEL, 2010/11 to 2015/16£ billions, 2015/16 prices

9 Background to the 2015 Spending Review and Autumn Statement

Protected and unprotected departments Although the Government has stated that the Spending Review will set DELs for all departments, there are some areas of spending which will be protected from any reductions. These are listed below:

• The NHS: The Government has committed to increase spending on the NHS by £10 billion in real terms by 2020/21 compared to the 2014/15 level.4

• International development: The Government will continue to spend 0.7% of Gross National Income on Overseas Development Aid (ODA).5

• Defence: The Government has pledged to spend 2% of GDP on defence each year.6

• Schools: The Conservative Party Manifesto included a pledge to protect per-pupil spending in nominal terms.7

It should be noted that these pledges do not refer to entire departmental budgets, but rather to some aspects of their spending. For example, schools spending is one part of the larger Department for Education budget.

The defence and international development pledges may involve some overlap since both include some similar areas of spending which are controlled by a number of different departments across Government.8

4 HM Treasury, A country that lives within its means: the 2015 Spending Review, July

2015, p13 5 Ibid. 6 Ibid. 7 Conservative Party, Manifesto for the 2015 General Election, April 2015, p34 8 PQ 6583 [on Defence], 13 July 2015

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-60% -50% -40% -30% -20% -10% 0% 10% 20% 30%

CLG Local Government

Work and Pensions

Justice

Culture, Media and Sport

Chancellor's Departments

Environment, Food and Rural Affairs

CLG Communities

Law Officers' Departments

Home Office

Foreign and Commonwealth Office

Business, Innovation and Skills

Transport

Defence

Northern Ireland

Wales

Scotland

Education

Small and Independent Bodies

Cabinet Office

NHS (Health)

Energy and Climate Change

International Development

% changes to Total DEL, 2010/11 to 2015/16Real terms

Spending on protected areas totals £200 billion in 2015/16, almost two thirds of all rDEL spending.

Number 7290, 20 November 2015 10

The fact that some areas of spending will not be reduced over the Spending Review period means that other, unprotected areas will see greater reductions. The NHS, schools and ODA budgets were protected over the last Parliament, so other departments will see budget reductions in this Spending Review period on top of reductions seen over the last Parliament.

This practice of ‘ring-fencing’ certain budgets and focusing budget reductions on other areas of spending was examined by the Treasury Select Committee at the time of the 2013 Spending Review. The Committee stated that this practice “threatens to reduce scrutiny for ring-fenced spending and it can distort the balance of spending as a whole.”9

The report added that “ring-fencing particular areas of public expenditure was leading to a continued change in the shape of the state” and quoted Stephanie Flanders (then BBC Economic Editor) who stated that “…in future, the government will spend quite a lot on social security, health, defence and education – and not very much else.”10

George Osborne defended the ring-fence and argued that it was:

…an expression of the political desire by the Government to protect NHS spending, to protect schools spending and to hit our international development target. Much is made of the ring-fencing but, ultimately, it is just an expression of political will by Government and Parliament…These are areas of public spending that we want to relatively protect.11

The Institute of Fiscal Studies has published some analysis of the impact of protecting some areas of spending.12

Devolved administrations The Spending Review will also determine the spending limits (DELs) of the devolved administrations, which are funded by a block grant from the UK Government. The Barnett formula will determine how the block grants change in each year of the Spending Review period, based on changes in comparable budgets of UK government departments. In general, if a service is devolved it is considered to be comparable.

The Barnett formula will not calculate the total block grant; rather it will determine how much the block grant should change from one year to the next. The population-based Barnett formula aims to provide each devolved administration the same pounds-per-person change in funding for spending areas which are devolved.

The policy surrounding the Barnett formula, and wider funding of the devolved administrations, are set out in a Statement Funding of Policy which will be updated alongside the Spending Review.

9 Treasury Committee, Spending Round 2013, 11 September 2013, HC 575-I, para 7 10 Ibid. para 9 11 Ibid. para 13 12 IFS, Post Summer Budget Analysis, July 2015, Rowena Crawford slides

11 Background to the 2015 Spending Review and Autumn Statement

A grant floor for Wales

The UK Government has pledged that a block grant floor will be introduced to Wales’s block grant to protect its relative level of funding. The precise level of the floor, and the mechanism to deliver it, will be agreed alongside the Spending Review.13

The Holtham Commission, which considered funding for devolved government in Wales, recommended the introduction of a floor to prevent underfunding of public service in Wales. The Commission had identified a potential gap in the funding provided to the Welsh Government for services, relative to what it would receive if its services were funded on the same basis as in England. The Commission recommended a floor be introduced to prevent this gap widening.14,15

Further details are available in the Library briefing The Barnett formula.

Box 3: The Barnett formula

The Barnett formula uses three factors to determine the net change in each devolved administration’s block grant: 1. The change in planned spending (DELs) in the UK Government departments 2. The extent to which the services provided by the UK Government departments are

comparable with the services carried out by each devolved administration (comparability percentage)

3. Each country’s population as a proportion of England, England and Wales or Great Britain as appropriate (appropriate population proportion)

Using the three factors the net change for each devolved administration’s block grant is determined by adding the sum of the following formula for each of the UK government departments. Change to the UK Comparability Appropriate government department’s x percentage x population

budget (DEL) proportion

1.5 Single departmental plans Departments have been developing single departmental plans (SDPs) to replace business plans, and the first editions may be released alongside the Spending Review.

SDPs will, according to the Government, focus departments’ resources towards the Government’s priorities and allow progress against priorities and manifesto commitments to be monitored.16

13 HM Government, Powers for a purpose: Towards a lasting devolution settlement for

Wales, February 2015 14 Welsh Assembly Research Service, Barnett reform: Future funding for Wales 15 National Assembly for Wales, Explore the Assembly: St David’s Day announcement,

2015 16 HM Treasury, A country that lives within its means: Spending Review 2015, para

3.27

Number 7290, 20 November 2015 12

The Chief Executive of the Civil Service, John Manzoni, has said that SDPs will be aligned with the Spending Review and will enable departments to show what is achieved from the resources they use.17

An article in the FT said that SDPs will indicate ‘what will be delivered for each pound of public spending’ and are part of a wider drive to introduce business discipline into the way government is run.18

17 Civil service blog, Clarifying our priorities - Single Departmental Plans, 29 July 2015 18 “Government departments must have ‘business plans’ for spending”, FT, 29 July

2015

13 Background to the 2015 Spending Review and Autumn Statement

2. Economic situation

Summary

Despite slowing slightly in recent quarters, GDP growth remains healthy. Most economists expect growth in 2015 to be around 2.5%, with a similar figure forecast for 2016. Short-term prospects are supported by the likelihood of continued strong growth in consumer spending as real (inflation-adjusted) household incomes rise. This is due to the combination of a recent acceleration in wage growth and near-zero inflation. Risks to the outlook come chiefly from a slowdown in emerging economies and if productivity growth fails to improve as is expected.

Inflation has hovered around 0% for much of the year, mainly due to the fall in the oil price and lower food prices. It is expected to rise somewhat in 2016 due to increases in wages and past declines in energy prices dropping out of the annual inflation calculation. Despite earlier expectations that the Bank of England might raise interest rates from their historic low of 0.5% around the turn of the year, commentators are now not expecting a rate rise until the end of 2016 or 2017.

The labour market continues to improve with the unemployment rate falling to near its pre-recession level and a record-high proportion of the working-age population in work. Average earnings growth has accelerated and earnings are now growing faster than during the previous five years. Nevertheless, average earnings growth is still slower than it was before the recession.

2.1 Growth and economic conditions Economic growth has remained healthy in 2015. Weakness in manufacturing and construction has, however, led to a slight slowdown in the quarterly growth rate, with latest estimates for Q3 2015 showing growth of 0.5%, compared with 0.7% in Q2.

The services sector (which makes up nearly four-fifths of the economy) was the main driver of growth in Q3 2015, with its output rising by 0.7% compared with the previous quarter. There was strong quarterly growth in the transport, storage and communications sector (+1.3%) and the business services and finance sector (+1.0%).

-0.5%

0.0%

0.5%

1.0%

2010 2011 2012 2013 2014 2015

Real GDP growth has been healthy and steady in recent years% change in real GDP on previous quarter

Source: ONS, series IHYQ

Number 7290, 20 November 2015 14

In contrast, the construction sector (which makes up 6% of the economy) saw a sharp 2.2% quarterly decline in output. Activity in the manufacturing sector (accounting for 10% of the economy) declined for the third quarter in succession (-0.3% in Q3), while output in the other smaller industrial sectors (mostly oil and gas) rose.

This divergence between the services sector and the manufacturing and construction sectors is not new. The chart below shows how output in these three broad sectors of the economy have evolved since their pre-recession peak levels at the beginning of 2008.

The 2008/2009 recession had a much larger impact on the manufacturing and construction sectors than it did on the services sector. The recovery in services has also been much stronger and has been the most important factor in the economic recovery. Output in the services industries was 11.1% higher in Q3 2015 compared with its pre-recession peak of Q1 2008. Meanwhile, output in the manufacturing sector was still 6.3% lower than it was in Q1 2008, while construction sector output was 4.4% below its pre-recession level.

Box 4: GDP per head is now 1.0% above pre-recession level

Before the recession, GDP and GDP per head (both in real terms) peaked in Q1 2008. Overall GDP surpassed this level in Q2 2013 and was 6.4% above the pre-recession peak in Q3 2015. However, if you adjust for the growth in population, GDP per head in Q3 2015 was only 1.0% above its pre-recession peak over seven years earlier, having surpassed it at the beginning of 2015.

11.1%

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15%

2007 2008 2009 2010 2011 2012 2013 2014 2015

Services sector driving GDP growth% change in sector's output compared with pre-recession peak output in Q1 2008

GDP

Services

Manufact-uring

Construction

6.4%

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2007 2008 2009 2010 2011 2012 2013 2014 2015

GDP per capita has only recently risen above its pre-recession level% change in real terms from Q1 2008 (pre-recession peak)

GDP

GDP per capita

15 Background to the 2015 Spending Review and Autumn Statement

Since the recovery began, economic growth has been supported by domestically-generated expenditure, largely via consumer spending and investment. Net trade – the difference in the volume of exports from the UK abroad minus the volume of imports to the UK – has generally been a drag on growth in recent years.

Consumer spending has seen strong and consistent growth over the past two years, including a quarterly increase of 0.8% in Q2 2015 (the latest data available). Supporting this growth has been the continued rise in employment and accelerating average earnings growth in recent quarters (see section 2.4).

The combination of rising wages and close-to-zero inflation, has led to real (inflation-adjusted) household disposable income rising by an average of 3.6% in the first half of 2015 compared with the year before. Economists believe that this will underpin continued robust growth in consumer spending, and therefore GDP growth, in forthcoming quarters.

Along with consumer spending, investment has provided the other main contribution to growth in recent years. Investment in the first half of 2015 was up by 3.6% compared with the year before, with business investment rising by 5.0%.

Forecasts Most economists expect the economy to continue to grow at its recent pace of around 2.5% per year. At the time of the July Summer Budget, the Office for Budget Responsibility (OBR) forecast GDP growth of 2.4% in 2015 and 2.3% in 2016. Since then, the average of independent forecasters has been stable (see chart below). The latest survey of forecasters in November show a consensus forecast for GDP growth of 2.5% in 2015 and 2.4% in 2016.19 It seems likely the new OBR growth forecasts, released alongside the Autumn Statement/Spending Review, will be little changed from July. The main risks to the outlook come from the international economic outlook (see box 5) and if UK productivity growth fails to recover as expected (see section 2.2).

19 HM Treasury, Forecasts for the UK economy: a comparison of independent forecasts,

November 2015

2.5%2.4%

2.0%2.1%2.2%2.3%2.4%2.5%2.6%2.7%2.8%

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov

GDP growth forecasts have been stable recentlyGDP growth (%), consensus forecast for year shown

Month forecast made in 2015

Forecast growth for 2015

Forecast growth for 2016

Source: HM Treasury survey of independent forecasts

Number 7290, 20 November 2015 16

In its latest OECD forecasts, the OECD expects the UK to have the joint fastest growth rate, along with the US, in the G7 in 2015 at 2.4%. Eurozone growth is forecast to be 1.4%.20

Box 5: International economic outlook

Weakening growth in emerging economies – which make up over half of world GDP – has led to global growth forecasts being lowered since the Summer Budget of July 2015.

While advanced economies are not growing as fast as emerging economies, their growth in 2015 is forecast to be slightly higher than in 2014. Meanwhile, emerging economies are expected to see their slowest rate of growth since 2009, according to the latest IMF forecasts. This is partly a result of slowing Chinese growth but also due to recessions in Brazil and Russia.

The IMF cited three major forces currently affecting the world economy:

• China’s economy moving away from its investment and export-led growth model towards one where the services sector and consumer spending are more prominent. China’s growth is forecast to slow to 6.8% in 2015, its slowest rate since 1990.

20 OECD, Economic Outlook, November 2015

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UK US Eurozone

Germany Canada France Italy Japan

UK forecast to have equal highest growth rate in G7 in 2015OECD GDP growth forecast from November 2015

Source: OECD, Economic Outlook, Nov '15

0

1

2

3

4

5

6

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2010 '11 '12 '13 '14 '15 2010 '11 '12 '13 '14 '15 2010 '11 '12 '13 '14 '15

Global growth forecasts lowered as emerging markets see fifth year of slowing growthAnnual GDP growth (%) including IMF forecasts for 2015

World Advanced economies Emerging economies

Source: IMF World Economic Outlook October 2015 database

17 Background to the 2015 Spending Review and Autumn Statement

• Falls in commodity prices. This is related to the growth slowdown in China. China has been a dominant consumer in many commodity markets ranging from metals to natural resources such as coal and iron ore. Countries that are large commodity exporters, many of whom are emerging economies, are therefore experiencing negative shocks to their growth outlook.

• Expected increase in US interest rates. The US central bank, the Federal Reserve, have signalled that they intend to increase official interest rates from their current rate (close to 0%) in the near future (potentially in December). Possible negative effects from this include money being moved from emerging economies to the US (as relative financial returns improve), and rising debt service costs to many non-US companies that have borrowed in US dollars in recent years. One estimate puts outstanding US dollar debt held by non-US companies at over $9 trillion.

The Bank of England Governor, Mark Carney, recently remarked that the “crystallisation” of risks associated with a faster-than-expected slowdown in emerging economies “would slow UK growth” via reduced trade and depressed domestic sentiment.21 The degree to which this could reduce UK economic activity is uncertain, although given the relatively robust domestic picture at present these risks to the outlook shouldn’t be overblown.

2.2 Productivity Productivity – how much is produced for a given input (such as an hour’s work) – is directly linked to living standards, with a country’s ability to improve its standard of living over time almost entirely dependent on productivity growth.

Productivity is also crucial in determining long-term growth rates of an economy. In other words, stronger productivity growth leads to stronger GDP growth. This, in turn, increases tax revenues and lowers government budget deficits. Of course, lower productivity growth results in the opposite: lower GDP growth and higher budget deficits.

Productivity – as measured by output per worker – was growing at its historical average rate of around 2% per year in the decade prior to the 2008/2009 recession. During the recession productivity fell sharply, as we’d expect, but then failed to recover during the recovery (see chart below). 22

The level of labour productivity in Q2 2015 was just 0.4% above what it was seven years earlier in Q2 2008 (pre-recession peak level). The ONS has described the stagnation in productivity over this period as “unprecedented in the post-war period”.23

21 Bank of England, Inflation Report press conference: Opening remarks by the

Governor, 5 Nov 2015 22 Recent trends in UK productivity are also summarised in the Library Economic

Indicator page on Productivity and in the latest quarterly Office for National Statistics (ONS) release

23 ONS, Labour Productivity, Q4 2014, 1 April 2015

Number 7290, 20 November 2015 18

The first two quarters of 2015 have, however, seen a pick-up in productivity growth. In Q2 2015, productivity was 1.3% higher than a year previously, as GDP growth increased by more than the total number of hours worked in the economy. This acceleration in productivity growth is expected by many to continue, with the OBR in its July 2015 forecasts expecting a return to ‘normal’ levels – of about 2% annual productivity growth – by the end of 2016.24

This assumption of a recovery in productivity growth underlies forecasts of continued GDP growth of around 2.0-2.5% in the years ahead. With the proportion of people in work at historic highs, there is only limited room for growth in the economy to be driven by hiring more people (as has been the case in recent years). For growth to continue for much longer at its current pace the productivity of existing employees will need to improve. If this does not happen, then we can expect growth to slow and the public finances to deteriorate compared with current expectations.25

2.3 Inflation and monetary policy Headline inflation is currently very low. Prices fell over the year to October: inflation as measured by the Consumer prices index (CPI) was -0.1%. It has been very low for most of 2015, fluctuating between +0.1% and -0.1% since February. The current level of inflation is lower than in recent years. Inflation averaged 2.6% in 2013 and 1.5% in 2014. The fall in inflation is largely due to the fall in the oil price and lower food prices. Core inflation, which excludes energy, food, alcohol and tobacco, has also fallen over the last year, but by less than the headline figure. Core inflation was 1.1% in October 2015 compared with around 2% in mid-2014.

The UK is not alone in experiencing very low inflation, or deflation, at the moment. Eurozone inflation was 0.1% in October, up from -0.1% in September and inflation in the US was -0.7% over the year to August.

24 OBR, Economic and fiscal outlook – July 2015 25 Further information and analysis on productivity can be found in the Library Briefing,

Productivity in the UK

75

80

85

90

95

100

105

2000 2002 2004 2006 2008 2010 2012 2014

Productivity (GDP per hour) has stagnated since 2007Index where Q1 2007 level = 100

19 Background to the 2015 Spending Review and Autumn Statement

Inflation is forecast to remain low for the rest of this year. Independent forecasters expect inflation to be 0.2% in Q4 2015 and 1.6% in Q4 2016.26 In July, the OBR forecast that inflation would rise to 1.1% in 2016, 1.6% in 2017 and eventually reach the 2% inflation target in 2020. The OBR’s forecast is affected by a number of factors. It expected upward pressure on inflation to come from increases in wages and the fact that recent falls in energy prices were likely to drop out of the calculation of inflation. On the other hand, the OBR noted that the recent increase in sterling would bear down on prices of imports and there could be some lagged effects of recent falls in commodity prices.27

The Bank of England’s Monetary Policy Committee (MPC) has kept the base rate at the historically low level of 0.5% since March 2009. While the headline rate of inflation is currently very low, this is in part due to temporary factors. The MPC tends to place relatively little weight on these focusing more on the underlying drivers of inflation. With unemployment falling and wage increases strengthening, attention is turning to when interest rates might begin to rise. At its November meeting, the MPC voted 8-1 in favour of maintaining interest rates at 0.5%. Ian McCafferty has voted for an increase of 0.25% at each meeting since August. He is the only MPC member to have voted for a change in interest rates at any of this year’s meetings.

Following publication of the Bank’s November Inflation Report, many commentators now expect no change in interest rates until the end of 2016 or 2017. For example, Robert Peston, the BBC’s economics editor, said in a blog “today the Bank of England gave an equally unambiguous signal that the moment of truth for an interest rate rise has been delayed by ten or 12 months, to the latter months of 2016.” According to the Financial Times, “the market is not pricing in the first interest rate rise until early 2017.”28 In July, the Governor of the Bank of England had said that “the decision as to when to start such a process of adjustment will likely come into sharper relief around the turn of this

26 HM Treasury, Forecasts for the UK economy: a comparison of independent forecasts,

November 2015 27 Office for Budget Responsibility, Economic and Fiscal Outlook, July 2015, para 3.56

to 3.60 28 “BoE signals interest rates to remain low”, Financial Times, 6 November 2015

Headline

2% inflation targetCore

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15

InflationConsumer prices index, Annual % change

Source: ONS

Number 7290, 20 November 2015 20

year.”29 The weakening of the global economy, especially emerging markets, is one factor behind the change to the expected timing of the rise in interest rates. While it appears that interest rates are likely to remain on hold for longer than previously thought, the Governor has indicated that tighter lending rules may be considered to prevent excessive borrowing destabilising the economy.

2.4 Labour market After strong growth in employment during 2013 and 2014, the number of people in work has continued to rise during 2015 and the employment rate is at a record high of 73.7%. The unemployment rate is very close to its pre-recession level at 5.3%. Average earnings growth accelerated in the first half of 2015 and earnings are now growing at a faster rate than during the previous five years. However they are increasing more slowly than before the recession, suggesting there is still space for faster earnings growth.30

Employment and unemployment

UK employment increased by 419,000 in the year to July-September 2015 to 31.21 million people. This reflected a large increase in employee numbers of 435,000 compared to the year before. The number of people working full-time rose by 273,000 while part-time employment increased by 146,000.

The employment rate, the proportion of people aged 16-64 in work, reached 73.7%, the highest rate since comparable records began in 1971. Excluding people above State Pension age (SPA), the employment rate is the same as in late 2007 at 74.9%.31

1.75 million people were unemployed in July-September 2015, a fall of 210,000 compared with the year before. The unemployment rate was 5.3%, very close to its level in late 2007 and early 2008 (5.2%).

29 Mark Carney, From Lincoln to Lothbury: Magna Carta and the Bank of England,

Speech at Lincoln Cathedral, 16 July 2015 30 Labour market data are taken from ONS, Labour Market Statistics, November 2015 31 Some of the increase in the headline employment rate for people aged 16-64 can be

attributed to the rising State Pension Age for women.

66%

68%

70%

72%

74%

76%

2007 2009 2011 2013 2015

Employment rate, 2007-2015% of people aged 16-64

0%

2%

4%

6%

8%

10%

2007 2009 2011 2013 2015

Unemployment rate, 2007-2015

21 Background to the 2015 Spending Review and Autumn Statement

653,000 young people aged 16-24 were unemployed, 83,000 fewer than the year before. The youth unemployment rate was 14.2%.

Earnings

Average weekly pay in cash terms increased by 3.0% including bonuses in the year to July-September 2015 and by 2.5% excluding bonuses.

In the private sector, pay excluding bonuses was up 2.8% from the year before. This compared to a 1.2% increase in the public sector.

The recent acceleration in earnings growth comes on the back of a sustained period of falling real earnings. The large real terms increase in earnings in 2015 also partly reflects very low inflation, as prices were flat in the year to July-September 2015.32 In cash terms, pay growth is yet to return to pre-recession levels, when average pay excluding bonuses grew by around 4% between 2005 and 2007.

From April 2016 the Government is set to introduce a higher minimum wage for people aged 25 and over (the National Living Wage) of £7.20 per hour, which is expected to increase to over £9 per hour by 2020. As well as directly increasing the wages of some low-paid employees, the National Living Wage is likely to affect the economy in other ways as firms adjust to higher wage costs. Possible impacts are discussed in the Library’s note Economic impacts of the National Living Wage: in brief.

2.5 Current account The UK’s current account balance – the trade balance plus the balance in income and transfers moving into and out of the UK – has deteriorated in recent years. In 2014, the current account deficit was £93 billion, equivalent to 5.1% of GDP. This is the highest since records began in 1948.

The main reason for the rise in the deficit is not the trade balance (the difference between exports and imports). The trade deficit was a relatively modest 1.9% of GDP in 2014 and was 0.7% in Q2 2015. The reason for the widening current account deficit is that the return on 32 Prices measured by CPI inflation.

-4%

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

2001 2003 2005 2007 2009 2011 2013 2015

Annual % change in real average weekly earnings, 2001-15Excluding bonuses, three-month average, adjusted by CPI

Number 7290, 20 November 2015 22

foreign investments – in the form of profits, dividends and interest receipts/payments, known as the primary account – has fallen in recent years. The primary account ran a surplus every year between 2000 and 2012, peaking at 2.5% of GDP in 2005. It went into deficit in 2013 and the deficit was 1.8% of GDP in 2014. In Q2 2015, the primary account deficit was 1.5% of GDP.

It is unclear whether this is a temporary change or a more permanent structural effect. In July, the OBR forecast that the current account deficit would be 5.0% of GDP this year, falling to 3.1% in 2017 and 2.8% in 2020. This is based on the assumption that the deterioration in the primary account is temporary. The OBR note that there is significant uncertainty about this.

Current account balance

Trade balance

-7.0%

-6.0%

-5.0%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%2007 2008 2009 2010 2011 2012 2013 2014 2015

Current account and trade balance, % GDP

Source: ONS

23 Background to the 2015 Spending Review and Autumn Statement

3. The public finances

Summary

The budget deficit – the difference between what the public sector spends and receives in taxes and other revenues – is forecast to be £70 billion in 2015/16. During the previous Parliament the deficit fell from £153 billion in 2009/10 to £90 billion in 2014/15. The government plans to eliminate the deficit by 2019/20.

As a result of the financial crisis, public sector net debt – the stock of borrowing arising from past deficits – rose from around 37% of GDP in 2007/08 to 80% of GDP in 2014/15. The Office for Budget Responsibility (OBR) forecast that the debt to GDP ratio will fall in 2015/16, albeit slightly, and continue to do so over the following five years

The Autumn Statement will present updated plans for public spending and a new set of OBR forecasts for the public finances up to 2020/21.

3.1 The deficit: public sector net borrowing Public sector net borrowing, commonly known as the deficit, is the difference between the government’s spending and its revenues. Borrowing has fallen considerably since the very high levels it reached during the financial crisis. Borrowing was £153 billion in 2009/10. It fell to £90 billion last year.33

Since autumn 2015 the Government’s target for the public finances – its ‘fiscal mandate’ – has focused on this measure of the deficit. The Government has set a target for public sector net borrowing to be in surplus by the end of 2019/20.34 A surplus is reached when a government spends less than it receives from taxes and other receipts.

In July 2015 the OBR forecast that the Government was on course to meet the fiscal mandate. The OBR forecast a surplus of £10 billion, or 0.4% of GDP, in 2019/20.35

33 These figures are in nominal terms. Borrowing as a share of GDP is shown in the

chart. 34 The fiscal mandate is laid out in the Charter for Budget Responsibility. Further

information is available in the Library briefing, The Office for Budget Responsibility and Charter for Budget Responsibility.

35 OBR. Economic and Fiscal Outlook – July 2015, para 1.39

-2%

0%

2%

4%

6%

8%

10%

12%

07/08 10/11 13/14 16/17 19/20

Public sector net borrowing, % GDP

Source: ONS, OBR

In July 2015 the OBR forecast public sector net borrowing to fall in each year before reaching a surplus in 2019/20. This means that the Government is on course to meet its target for the public finances.

Number 7290, 20 November 2015 24

International comparisons Despite the fall in UK government borrowing over recent years, it remains high by international standards. The OECD forecast that borrowing in the UK will be 3.9% of GDP in 2015, similar to that of France and slightly lower than the US, but higher than in Italy, Canada or Germany. Amongst G7 countries only Japan is expected to have significantly higher borrowing than the UK.36

3.2 Structural borrowing A distinction is often drawn between the “cyclical” and “structural” elements of government borrowing:

• Cyclical elements of the deficit refer to the effect of the economic cycle on the level of government borrowing. In a recession, government borrowing tends to increase as tax receipts are reduced and spending on benefits increases. The reverse happens when the economy is growing strongly. These effects are sometimes known as the economy’s “automatic stabilisers”.

• Structural elements of the deficit are the underlying or persistent part of government borrowing which are unrelated to the economic cycle. The structural deficit is measured by cyclically-adjusted measures of borrowing.37

Adjusting borrowing for the position in the economic cycle gives an estimate of the underlying borrowing or structural borrowing. Put another way, structural borrowing is the level of borrowing we would expect to see if the economy was running at full potential. It requires an assessment of where the economy is in the economic cycle measured by the OBR through the output gap (see Box 4).

36 OECD. Economic Outlook Annex Tables, November 2015. The IMF also produce

forecasts – these are discussed in the Library briefing Government borrowing and debt: international comparisons.

37 There are various cyclically adjusted measures of borrowing. The figures in this section are for cyclically-adjusted net borrowing.

-3%

0%

3%

6%

9%

Germany Canada Italy France UK US Japan

Government borrowing, % GDP, 2015

25 Background to the 2015 Spending Review and Autumn Statement

The structural deficit is estimated to have been around 3-4% of GDP immediately before the financial crisis. It increased to just over 8% of GDP in 2009/10. The OBR forecast structural borrowing of 3.7% of GDP in 2015/16, and that structural borrowing will reach a surplus in 2019/20.

3.3 Public sector net debt Public sector net debt is the overall level of government indebtedness, built up over many years. Broadly speaking it is the stock of borrowing arising from past deficits.

Before the financial crisis, public sector net debt was around 36-37% of GDP. As a result of the crisis, debt increased sharply reaching 80% of GDP at the end of 2014/15. In July 2015 the OBR forecast that the debt to GDP ratio will begin to fall in 2015/16.

The Government’s target for the public finances is supplemented by a target for debt. Updated in autumn 2015, the target is for public sector

-2%

0%

2%

4%

6%

8%

10%

2007/08 2011/12 2014/15 2017/18 2020/21

Structural borrowing, % GDP

Source: OBR

0%

20%

40%

60%

80%

100%

2007/08 2010/11 2013/14 2016/17 2019/20

Public sector net debt, % GDP

Source: ONS, OBR

Box 6: The output gap

The difference between the actual level of economic output and what could be achieved if the economy was operating at full potential is known as the ‘output gap’. A negative output gap suggests that the economy is operating below its potential level and has idle resources. A positive output gap suggests that the economy is operating above potential or overheating. A big problem for policymakers is that the level of potential output cannot be directly measured and consequently neither can the output gap. Therefore economists must estimate what the output gap is. The OBR estimates that the output gap was close to 4% of GDP in 2009/10 and is currently around 1% of GDP.

In July 2015 the OBR forecast public sector net debt to fall as a % of GDP in each year of their forecasts. This means that the Government is on course to meet its supplementary target for the public finances.

Number 7290, 20 November 2015 26

net debt to be falling as a % of GDP in each year to 2019/20.38 In July 2015 the OBR forecast that the Government is on course to meet this target.39

International comparisons UK government debt is forecast to be similar to that of the US and France in 2015, well below Italy and Japan but well above Canada and Germany.40

38 Further information is available in the Library briefing, The Office for Budget

Responsibility and Charter for Budget Responsibility. 39 OBR. Economic and Fiscal Outlook – July 2015, para 1.40 40 OECD. Economic Outlook Annex Tables, June 2015

0%

50%

100%

150%

Canada Germany France UK US Japan Italy

Genral Government net debt, G7 countries,2015 forecast, % of GDP

27 Background to the 2015 Spending Review and Autumn Statement

4. Benefits and tax credits

4.1 Background: £12 billion of savings The Conservative Party 2015 election manifesto said that, by 2017-18, the Party would “find £12 billion from welfare savings, on top of the £21 billion of savings delivered in [the 2010] Parliament.”41

The Summer Budget 2015 announced measures expected to save £12 billion, but not until 2019-20.42 £5.45 billion of these savings in 2019-20 (45% of the total £12 billion) were expected to come from changes to tax credits and Universal Credit.

The chart below shows expected savings from welfare measures announced in the Summer Budget 2015 in each year to 2020-21. The three categories highlighted in shades of green show expected savings from proposed changes to tax credits and Universal Credit.

Exchequer savings from welfare measures announced in the Summer Budget 2015 £ billion, nominal terms

Source Table 2.1, “Policy Decisions”, Summer Budget 2015

4.2 Tax credits: proposed changes In addition to a four-year-freeze in most working age benefits, the Summer Budget 2015 proposed the following changes to tax credits and Universal Credit:

1- Reducing the income thresholds in tax credits over which a family’s maximum tax credit award starts to be tapered away, from

41 Conservative Party, 2015 Manifesto, April 2015, page 8 42 For further details, see Chapter 3 of the House of Commons Library briefing paper

Welfare Reform and Work Bill [Bill 51 of 2015-16]

£0

£2

£4

£6

£8

£10

£12

£14

2016-17 2017-18 2018-19 2019-20 2020-21

Other

Employment and SupportAllowance

Housing Benefit

4 year freeze in most working-agebenefits

Tax Credits & Universal Credit:other changes

Tax Credits & Universal Credit:reduce income thresholds in taxcredits and work allowances in UC

Tax Credits: increase taper to 48%

Number 7290, 20 November 2015 28

£6,420 to £3,850 for in-work families. Equivalent changes would also be made to Universal Credit work allowances

2- Increasing the tax credits withdrawal rate (taper) from 41% to 48% so that tax credits reduce more sharply as income increases

3- Limiting the child element of tax credits and Universal Credit to two children for new claims and births after April 2017

4- Removing the family element in tax credits and Universal Credit and the family premium in Housing Benefit for new claims from 2016 or 2017

Items 1 and 2, examined below, were to be implemented using a statutory instrument. Items 3 and 4 are to be implemented separately.

Almost all in-work families in receipt of tax credits would be affected by the Government’s proposed reduction in the tax credits income thresholds and increased taper rate (items 1 and 2 in the above list). As of April 2015 there were 3.28 million in-work families in receipt of tax credits in the UK, of which 83% had dependent children.43

In 2016-17 these changes (items 1 and 2) were expected to save £4.4 billion.44 Assuming savings accrue from in-work families only (i.e. ignoring the impact of the reduction in the threshold for CTC only families) gives a rough estimates of the average loss across all in-work families in the region of £1,300 in 2016-17. This is an average figure however – for some families the loss will be greater, for others less.

Further analysis of the Government’s proposed changes to tax credits, together with analysis of the impact of these changes in combination with other measures announced in the Summer Budget 2015, is available in:

• Tax Credit changes from April 2016 (House of Commons Library briefing paper)

• Tax Credit & Universal Credit changes: impact on example families (House of Commons Library blog)

• An assessment of the potential compensation provided by the new ‘National Living Wage’ for the personal tax and benefit measures announced for implementation in the current parliament (Institute for Fiscal Studies briefing note)

4.3 Tax credit changes: rejection by the Lords MPs agreed, by 325 votes to 290, to the draft regulations Tax Credits (Income Thresholds and Determination of Rates) (Amendment) Regulations 2015 when a debate was held on 15 September 2015.

On 26 October 2015, however, the House of Lords agreed two amendments to the proposed regulations.

43 HMRC Child and Working Tax Credits: provisional awards geographical analysis,

April 2015 44 Summer Budget 2015 Table 2.1, “Policy Decisions”

29 Background to the 2015 Spending Review and Autumn Statement

The first, tabled by Crossbencher Baroness Meacher, sought a delay until a report has been produce addressing the Institute for Fiscal Studies' analysis of the regulations and their impact, and considering possible mitigating action.

The second, tabled by Labour’s Baroness Hollis of Heigham, sought a delay and a report to Parliament on a scheme for full transitional protection for a minimum of three years for all existing tax credit claimants, as well as a report to Parliament on the Government’s response to the IFS report on the changes, including consideration of possible mitigating action.

4.4 Mitigation: possible options & comment At Treasury Questions on 27 October 2015, the Chancellor announced he would:

“continue to reform tax credits and save the money needed so that Britain lives within its means, while at the same time lessening the impact on families during the transition. I will set out these plans in the autumn statement. We remain as determined as ever to build the low tax, low welfare, high wage economy that Britain needs and the British people want to see.”

Possible mitigation measures examined by the Work and Pensions Select Committee, think tanks and the media include making further adjustments to Housing Benefit and/or Universal Credit, adjusting the period over which the Government’s proposed changes to tax credits are implemented and bringing forward increases to the “National Living Wage” and the Personal Allowance. These are outlined below.

On the 11 November 2015, following an emergency evidence session, the House of Commons Work and Pensions Select Committee published it’s A reconsideration of tax credit cuts report. Chapter 3 of the report offers detailed analysis of possible mitigation options. In summary, the Committee concluded there is:

“no magic bullet in the tax credit system. Something has to give: household incomes, work incentives or fiscal savings. We recommend that, if these major changes cannot be satisfactorily mitigated now, it would be better to pause any major reforms until 2017-18. This would enable a necessary and ambitious debate about the future of working age benefits, and their position in a sustainable welfare system.”

Personal Allowance & the National Living Wage On 15 November 2015 the Chancellor was reported to be considering bringing forward increases to the Personal Allowance; bringing forward increases to the new “National Living Wage” has also been mentioned.

On these issues, the Work and Pensions Select Committee identified that different groups would be affected by cuts to tax credits and increases to the Personal Allowance and the National Living Wage.45

45 Work and Pension Committee, A reconsideration of tax credit cuts, 9 November 2015,

HC 548

Number 7290, 20 November 2015 30

The Personal Allowance is not a well targeted tool for compensating those who lose from tax credit changes.46 In answer to the Committee, the Director of the Institute for Fiscal Studies Paul Johnson explained:

“To add £1,000 to the personal allowance costs a couple of billion pounds. It is very expensive to do and it is also not even nearly focused on the people who are losing from the tax credit changes. The vast majority of that money will go to people who are not on tax credits and those on tax credits will gain only a very small amount from it.”47

A higher National Living Wage in 2016-17 would do little to offset families whose tax credit award was reduced as a result of the Government’s proposed changes, the Resolution Foundation reported in its 5 November The tax credit crunch publication.48 In answer to the Work and Pensions Committee, the IFS estimated that “about a third of the losers from the tax credit changes would gain” from the NLW by 2020-21.49

The Work and Pensions Committee concluded:

“In the same way that the increase in the personal allowance and minimum wage announced in the Budget do not offer targeted respite from the tax credit cuts, further such changes are not the Chancellor’s answer in the Autumn Statement. The gains are to individuals rather than households and are too diffuse to efficiently compensate families facing tax credit cuts.”50

Universal Credit changes On 5 November 2015 the Chancellor was reported to be considering increasing the income taper in Universal Credit from 65% to 75%. Such a change could significantly reduce the incomes of those affected. Of the in-work families in receipt of Universal Credit examined in the Library blog Tax Credit & Universal Credit changes: impact of a 75% taper, all loose more than £1,200 in 2020-21 as a result of this taper rate change.

Note that such a change could be in addition to cuts to Universal Credit work allowances previously announced in the Summer Budget 2015.

Having long advocated Universal Credit, the Centre for Social Justice opposed looking to it as an alternative source of savings in its short note Reforming Tax Credits. To do so, the Centre concluded, would “weaken fundamentally Universal Credit’s ability to make work pay and so jeopardise the excellent investment that the Government has already made into its flagship welfare policy.”51

Housing Benefit changes Further media reports suggest the Chancellor may consider changes to Housing Benefit in order to mitigate cuts to tax credits while still

46 ibid, page 8 47 ibid, page 17 48 Resolution foundation, The Tax Credit Crunch, 5 November 2015, pages 15 and 16 49 op cit, page 9 50 ibid, page 20 51 The Centre for Social Justice, Reforming Tax Credits, November 2015

31 Background to the 2015 Spending Review and Autumn Statement

maintaining his commitment to save £12 billion from the welfare budget.

Suggested changes include: requiring all housing benefit claimants to pay the first 10% of their rent; increasing the rate at which Housing Benefit awards are tapered away; granting local authority tenants who have lived in their home for three years while in receipt of Housing Benefit 70% of the equity in their home, effectively moving them out of the rented sector.

Note that any such changes could be in addition to the four year freeze of Local Housing Allowance rates – the rate used to calculate the Housing Benefit of claimants in the private rented sector – in most areas and removal of the family premium of Housing Benefit for new claims from April 2017.52

The Institute for Public Policy Research, a think tank, estimated that requiring Housing Benefit claimants in the private rented sector to pay the first 10% of their rent would affect 4.8 million households and save around £2.4 billion a year.53 The think tank reported this measure would result in an average loss of £570 a year for households living in the private rented sector and an average loss of £460 for social housing tenants.

Transitional tax credit arrangements When giving evidence to the Work and Pensions Select Committee, Paul Johnson (IFS) observed that “if you want to mitigate these changes to the tax credit system you probably have to do it through the tax credit system”. Torsten Bell, Director of the Resolution Foundation, concurred that “the answer to tax credits is tax credits”.54

Pages 20 to 27 of the Committee’s A reconsideration of tax credit cuts report analyses the impact of various possible adjustments to the tax credits system.

52 HM Treasury, Summer Budget 2015, 8 July 2015, page 38 53 Patrick Wintour, The Guardian; “Cuts to housing benefit could make claimants £570

a year worse off”; 18 November 2015 54 Work and Pension Committee, A reconsideration of tax credit cuts, 9 November

2015, HC 548, page 20

Number 7290, 20 November 2015 32

5. Welfare cap The Summer Budget 2015 set a cap on the amount that can be spent on certain benefits in the five financial years beginning in 2016/17. The Office for Budget Responsibility (OBR) will report alongside the Spending Review/Autumn Statement 2015 on whether the cap has been met or exceeded.

5.1 How the cap works At the Summer Budget 2015 the Government set a limit on what can be spent on certain types of welfare in each of the next five financial years. The cap currently covers the years 2016/17 to 2020/21.

The OBR will report on whether it forecasts that relevant welfare spending will meet or exceed the cap level set by the Government for the forthcoming year. So, alongside Autumn Statement 2015, the OBR will report whether relevant welfare spending is set to meet or exceed £115.2 billion in 2016/17.

If the OBR forecasts that relevant welfare will exceed the cap level (plus 2% if the cap is exceeded because of forecast changes and not policy changes), then the Government must propose policy measures to reduce welfare spending, seek approval for the cap level to be increased or explain why a breach of the cap is justified. The Government must introduce a votable motion to the House of Commons within 28 sitting days seeking approval for these actions.

The Government has chosen to use the OBR’s forecast of welfare spending on relevant benefits as the cap level.

Box 7: Welfare cap vs. the household benefit cap

The welfare cap on specified elements of social security spending is not to be confused with the household benefit cap – introduced in 2013 – which limits total household benefits at £500 per week for a family and £350 per week for a single person with no children (subject to certain exemptions). See our note on The Household Benefit Cap for more on this.

5.2 What is included in the Welfare Cap? Around 56% of all welfare spending in 2015/16 is included in the Welfare Cap. The elements of welfare spending that are excluded are:

• Jobseeker’s Allowance (JSA) and housing benefit for people on JSA,

• Local Authority spending on Council tax benefit and Discretionary housing benefit

• State pension

Level of the welfare cap set out in Summer Budget 2015 , £ billions

2016/17 2017/18 2018/19 2019/20 2020/21

Welfare cap 115.2 114.6 114.0 113.5 114.9

Source: HM Treasury, Summer Budget 2015 , July 2015, Table 1.7, p25

Note: a 2% margin above the cap allows for forecast fluctuations each year

33 Background to the 2015 Spending Review and Autumn Statement

All other welfare spending is included within the cap, including incapacity benefit, child benefit and tax credits.55

Further information on the cap can be found in the House of Commons Library Briefing Paper, The welfare cap.

55 HM Treasury, Summer Budget 2015, Table B1, p103

Number 7290, 20 November 2015 34

6. Pensions Before 6 April 2015, pension tax legislation strongly encouraged people with defined contribution (DC) savings to buy an annuity, authorising lump sum or flexible withdrawals in limited circumstances.56 New rules introduced on that date gave people aged 55 and over more flexibility about when and how to draw their DC pension savings, subject to their marginal rate of income tax.57 People with ‘safeguarded benefits’ (for example, defined benefits58 or a guaranteed annuity rate) worth more than £30,000, who want to transfer these to ‘flexible benefits’, are required to take advice first. The reason was to ensure they were informed of potentially valuable benefits before giving them up.59

Following reports of individuals having difficulties in accessing their savings flexibly, the Government consulted over the summer on:

• Whether individuals were able to access the new pension flexibilities easily and at a reasonable cost; and

• Whether the requirement to take advice for people with ‘safeguarded benefits’ was working as intended. 60

In September 2015, the FCA reported that:

[…] the great majority of funds can be used to access the full range of options provided by the government’s reforms, and where new contracts are required most do not carry an exit charge. However, there are a minority for whom the full range of options is not available or who face possible exit charges.61

Most providers were requiring individuals to take advice in circumstances going beyond the statutory requirements, generally citing legislative and regulatory requirements as the reason.62 The Pensions Regulator suggested some schemes might be having difficulties interpreting benefit structures – the definition of safeguarded benefits and the overlap with flexible benefits.63

Earlier in the year, the Government consulted on proposals to allow people who had already purchased an annuity to sell that income to a third party in order to be able access their savings more flexibly.64 In July the Government said implementation would be delayed until 2017 “to ensure there is an in-depth package to support consumers in making their decision.”65

56 Finance Act 2004, Part 4; A defined contribution pension scheme is one where an

individual builds up a fund through contributions and tax relief, which can then be used to provide an income at retirement.

57 HC Deb 19 March 2014 c793; Taxation of Pensions Act 2014 58 Typically providing benefits based on salary and length of service 59 HM Treasury, Pension transfers and early exit charges: a consultation, July 2015,

para 4.3 60 HM Treasury, Pension transfers and early exit charges: consultation, July 2015 61 FCA Letter to Economic Secretary to the Treasury, 15 September 2015 62 FCA pension freedoms data collection exercise: analysis and findings, September

2015, para 1.4 63 TPR and OMB Research, Survey on Flexible Pension Access. Report of findings on the

2015 research survey, September 2015 64 HM Treasury, Creating a secondary annuity market, Cm9046, March 2015 65 HM Treasury, Summer Budget 2015, 8 July 2015, HC 264, para 1.230

35 Background to the 2015 Spending Review and Autumn Statement

An update on both these consultations may be expected in the Autumn Statement. For more detail, see HC Library Briefing SN06891 Pension flexibilities (November 2015).

Another issue on which the Government consulted over the summer was whether pension tax relief should be reformed to improve incentives to save.66 However, the Chancellor of the Exchequer has since said the Government will respond fully in the Budget:

It is a completely open consultation and a genuine Green Paper, and we are receiving a lot of interesting suggestions on potential reform. We will respond to that consultation fully in the Budget.67

The delay was welcomed by pensions industry representatives who argued it was important that the Government took time to consider all the arguments and evidence put to it.68

For more on the background to this, see HC Library Briefing SN05901 Restricting tax relief to higher earners (November 2015).

66 HM Treasury, Strengthening the incentive to save: a consultation on pensions tax

relief, Cm 9102, July 2015 67 HC Deb 27 October 2015 c195 68 ‘Pensions Isa’ decision deferred until next Budget’ Financial Times, 27 October 2015

Number 7290, 20 November 2015 36

Appendix 1: Sources of further information HM Treasury Summer Budget 2015

Budget 2015

Budget 2014

Autumn Statement 2014

Office for Budget Responsibility Economic and fiscal outlook, July 2015

Economic and fiscal outlook, March 2015

Economic and fiscal outlook, December 2014

Monthly commentary on the public finances

Public finance databank

Institute for Fiscal Studies Post-Summer Budget Briefing 2015

Post-Budget Briefing 2015

Post- Autumn Statement Briefing 2014

Green Budget 2015

The outlook for the 2015 spending review

Monthly commentary on the public finances

House of Commons Library Economic indicators (a special Budget edition will be published on 23 November)

External users can access this from (see under “Commons Briefing Papers”):

http://www.parliament.uk/topics/Economic-situation.htm

The outcome of the 2010 Spending Review, Commons Library briefing paper SN05718, 22 October 2010

House of Commons Treasury Select Committee Inquiry into the Summer Budget 2015

Inquiry into Budget 2015

Report on Autumn Statement 2014

Report on Spending Review 2010

37 Background to the 2015 Spending Review and Autumn Statement

Appendix 2: Economic and public finance data 1979-2019

Economic data, 1979-2019

Real GDP Inflation Inflation ILOgrowth RPI CPI Unemployment

% % % Q4, %

1979 3.7% 13.4% .. 5.4%

1980 -2.2% 18.0% .. 6.8%

1981 -0.8% 11.9% .. 9.6%

1982 2.1% 8.6% .. 10.7%

1983 4.2% 4.6% .. 11.5%

1984 2.3% 5.0% .. 11.8%

1985 4.1% 6.1% .. 11.4%

1986 3.2% 3.4% .. 11.3%

1987 5.6% 4.2% .. 10.4%

1988 5.9% 4.9% .. 8.6%

1989 2.5% 7.8% 5.2% 7.2%

1990 0.6% 9.5% 7.0% 7.1%

1991 -1.3% 5.9% 7.5% 8.9%

1992 0.4% 3.7% 4.3% 9.9%

1993 2.6% 1.6% 2.5% 10.4%

1994 4.0% 2.4% 2.0% 9.5%

1995 2.5% 3.5% 2.6% 8.6%

1996 2.7% 2.4% 2.5% 8.1%

1997 3.1% 3.1% 1.8% 6.9%

1998 3.4% 3.4% 1.6% 6.2%

1999 3.1% 1.5% 1.3% 6.0%

2000 3.8% 3.0% 0.8% 5.4%

2001 2.8% 1.8% 1.2% 5.1%

2002 2.5% 1.7% 1.3% 5.2%

2003 3.3% 2.9% 1.4% 5.0%

2004 2.5% 3.0% 1.3% 4.8%

2005 3.0% 2.8% 2.1% 4.8%

2006 2.7% 3.2% 2.3% 5.4%

2007 2.6% 4.3% 2.3% 5.3%

2008 -0.5% 4.0% 3.6% 5.7%

2009 -4.2% -0.5% 2.2% 7.6%

2010 1.5% 4.6% 3.3% 7.9%

2011 2.0% 5.2% 4.5% 8.1%

2012 1.2% 3.2% 2.8% 8.0%

2013 2.2% 3.0% 2.6% 7.6%

2014 2.9% 2.4% 1.5% 6.2%

2015 2.4% 0.9% 0.1% 5.4%

2016 2.3% 2.1% 1.1% 5.1%

2017 2.4% 2.8% 1.6% 5.2%

2018 2.4% 3.1% 1.8% 5.3%

2019 2.4% 3.1% 1.9% 5.4%

2020 2.4% 3.2% 2.0% 5.4%

Sources: ONS (series, IHYP, CZBH, D7G7, MGSX)

OBR, Economic and fiscal policy, July 2015, Table 3.6, and Economy Supplementary Table 1.6 and Table 1.7

Number 7290, 20 November 2015 38

Public finance data 1979-80 to 2019-20Structural

Public sector net borrowing deficit Public sector net debt

£ billion % GDP % GDP £ billion % GDP

1979/80 8.5 3.9% 4.2% 98.2 45.0%

1980/81 11.5 4.6% 3.2% 113.8 45.6%

1981/82 6.0 2.2% 0.0% 125.2 45.3%

1982/83 8.5 2.8% 0.8% 132.5 43.9%

1983/84 11.8 3.6% 2.3% 143.6 43.6%

1984/85 12.5 3.5% 3.1% 157.0 44.3%

1985/86 9.0 2.3% 2.3% 162.5 41.7%

1986/87 8.4 2.0% 2.2% 167.8 40.1%

1987/88 4.7 1.0% 2.2% 167.4 35.6%

1988/89 -6.0 -1.1% 0.9% 153.7 29.3%

1989/90 -0.6 -0.1% 1.3% 151.9 26.2%

1990/91 6.2 1.0% 0.8% 151.1 24.2%

1991/92 23.0 3.5% 2.1% 165.8 25.2%

1992/93 47.1 7.0% 5.3% 201.9 29.0%

1993/94 51.6 7.2% 5.9% 249.8 33.9%

1994/95 43.8 5.8% 5.0% 290.0 37.5%

1995/96 35.3 4.4% 3.2% 322.1 39.2%

1996/97 27.7 3.3% 2.8% 347.0 39.7%

1997/98 6.0 0.7% 1.6% 358.6 39.1%

1998/99 -4.4 -0.5% 0.9% 357.8 37.3%

1999/00 -14.6 -1.5% 0.0% 349.1 34.4%

2000/01 -17.0 -1.6% -0.4% 316.4 29.9%

2001/02 0.7 0.1% 0.8% 323.3 29.3%

2002/03 26.8 2.4% 2.4% 355.2 30.3%

2003/04 31.6 2.6% 3.1% 394.2 31.8%

2004/05 43.8 3.5% 4.2% 449.2 34.3%

2005/06 41.7 3.1% 3.7% 492.0 35.4%

2006/07 37.2 2.6% 3.2% 529.3 36.1%

2007/08 41.1 2.7% 3.9% 561.5 36.9%

2008/09 101.6 6.8% 6.7% 727.7 49.1%

2009/10 153.5 10.2% 8.1% 959.8 62.3%

2010/11 134.8 8.6% 6.5% 1,102.5 68.8%

2011/12 113.6 7.0% 5.1% 1,192.0 72.1%

2012/13 119.7 7.1% 5.1% 1,300.0 75.8%

2013/14 99.9 5.7% 4.1% 1,403.2 78.0%

2014/15 90.1 4.9% 4.1% 1,486.5 80.0%

2015/16 69.5 3.7% 3.2% 1,531.9 80.3%

2016/17 43.1 2.2% 2.0% 1,575.6 79.1%

2017/18 24.3 1.2% 1.1% 1,602.9 77.2%

2018/19 6.4 0.3% 0.3% 1,618.6 74.7%2019/20 -10.0 -0.4% -0.5% 1,618.3 71.5%2020/21 -11.6 -0.5% -0.5% 1,626.6 68.5%Source: OBR, ONS

Note: figures exclude public sector banks

BRIEFING PAPER Number 7290, 20 November 2015

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