UK Quarterly Outlook

Economics – Budget – Wealth

April 2014

James Sproule, Chief Economist

Institute of Directors James.sproule@iod.com

@jamesrsproule

Macro Economics

UK economic forecasts remain too calm

Source: HM Treasury

UK GDP (HM Treasury consensus survey forecast)

Economic forecasts have a strong tendency to underestimate volatility

• Consensus estimate real trend rate of UK growth to be ~2.0%

• Disaggregating consensus does not significantly raise forecast volatility

Conclusions

• Look to economists for a trend

• Any trend forecast has to stack up with expected changes that can be observed (demographics etc.)

Forecast -8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

2000

2002

2004

2006

2008

2010

2012

2014

2016

GDP

Consensus Aug 2006

Consensus Aug 2009

Consensus Aug 13

Fcst Feb 14

-5%

-4%

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

2000 2004 2008 2012 2016

Euro area GDP

US GDP

European economic forecasts have proved too optimistic

Source: IMF, IoD Policy Unit

GDP (2007 & 2012 forecast)

Economic forecasts have a strong tendency to underestimate volatility

• IMF expects economies in Europe and the US to recover slowly to trend rates of growth over the next two years

• Looking to 2007 IMF forecasts, a slowdown was predicted, but nothing of the length or scale that subsequently developed

• Quantitative easing programmes in US (significant), UK (very significant) and Euro zone (moderate), yet to provide solution to underlying financial problems

• Forecasts specifically exclude a renewed euro zone crisis

Forecast

0

500

1,000

1,500

2,000

2,500

3,000

Jun-82 Jun-86 Jun-90 Jun-94 Jun-98 Jun-02 Jun-06 Jun-10

M4 (SA)

M3 (SA)

0

50

100

150

200

250

300

350

400

450

1987 1990 1993 1996 1999 2002 2005 2008 2011

Credit – still stalled

Source: Fed Reserve, ECB, BoE, IoD Policy Unit

• 1918 - 2008: US money supply grew at 6%, since then it has grown at 28% p.a.

• US QE has involved wider range of instrument purchases than in UK and Japan, including Mortgage securities.

• Banks have used easy money to rebuild balance sheets. US bank credit has grown by -0.4% p.a. since 2008

• From 2000-08 Euro zone M3 grew by 8.8% p.a., since 2008, growth has slowed to 2.7% p.a.

• Disaggregated data shows that southern EU has seen substantial drop in bank credit.

• Flow of savings to “safe” northern Euro-zone banks has been slowly reversing.

• Overall Target 2 system remains in deficit• German deposits are down 23%• Spanish claims fell by 34%, French 42% & Italian 23%

• UK Broad money has not grown since Jan 2010 • QE remains focused on Gilts, banks on meeting capital

requirements • Bank of England has indicated that it is to ease focus on

capital solvency ratios in order that banks can lend more

US Bank Credit (1987=100)

UK Money Supply -2

0

2

4

6

8

10

12

14

0

100

200

300

400

500

600

700

800

900

1,000

Jan-

81

Jan-

84

Jan-

87

Jan-

90

Jan-

93

Jan-

96

Jan-

99

Jan-

02

Jan-

05

Jan-

08

Jan-

11

EU Bank Credit

UK Money Supply

UK CPI

Source: ONS, IoD Policy Unit

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

1999 2001 2003 2005 2007 2009 2011 2013

Misc Resturants

Education Recreation

Coms Transport

Health Furniture

Housing & H Coss Clothing

Alcohol Food & Drink

Budget 2014

Income and profits, 36.3

Social security, 18.9

Property, 11.6

Goods and services, 32.7

UK Taxation

• UK Tax total revenues as a per cent of GDP - constant over last decade (35% with a standard deviation of 0.7%).

• Peak 36.3% in 2006, trough 34.3% 2003

• Highest OECD taxes globally are in Denmark (48.5%) and Sweden (47.4)

• Lowest OECD taxes are in: Mexico (17.9%); Chile (20.5%), US (26.4%), lowest European is Switzerland (28.5%).

20

25

30

35

40

45

50

55

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Denmark United KingdomUnited States OECD

Tax Revenues as per cent of GDP

UK Tax Revenues – source by tax

Source: OECD

• UK total General Government Outlays as a per cent of GDP has averaged 45% since 2001.

• The difference is the deficit and the accumulated deficit (debt), the latter rising from X% in 2001 to y% in 2012

Key Tax Policy Questions – An Overview & Summary of IoD proposals

We consider that the four overarching concepts which ought to drive fiscal policy to be fairness, incentives, simplicity and sustainability.

Fairness

Our proposals highlight areas where the tax burden could become or has already become unfair:-•Reversal of significant erosion of basic rate tax band•Aligning tax thresholds to create a more transparent personal taxation system•Elimination of economically and fiscally undesirable addition rate of income tax•Legislating to cap direct taxation so that individuals will always retain the greater part of their income and capital

Business Incentives

Our proposals recognise the need to provide broad based incentives across the business spectrum by:-•Further business rates reliefs•An option for all entrepreneurial businesses to opt to become tax transparent•Removing tax distortions impacting business (or personal) decisions

Tax Simplification

It is important to enhance the stated intention to simplify taxation for both businesses and individuals by:-•Removing complex requirement for entrepreneurial businesses to estimate taxable profits•Alternative to the complex, unpopular and expensive saving for pensions

Focus on Sustainability & Fiscal Receipts

It is essential that the capacity for taxation in the economy is continually re-assessed and challenged by:-•Government capital receipts need to be matched by debt reduction, not spending increases•Taxes raising less than £5 billion ought to be challenged for fundamental reform if they create economic distortions or are expensive to collect

Wealth

Global Gini co-efficients

Source: UN University, IoD Policy Unit

20

25

30

35

40

45

50

55

60

65

70

1950 1960 1970 1980 1990 2000

Brazil

Russia

US

UK

Germany

France

• Gini coefficients are measures of a Lorenz curve: 1=all wealth is concentrated in a single person, 0=all wealth is equally distributed regardless of merit.

• Gini above ~0.5 clearly leaves a populace disenfranchised, does a Gini below ~0.25 simply fund a bureaucratic state and hence hinder growth?

• UK Gini hit an all time low of 24 in 1978, and has now risen in 2012 to 4, the global average

• UK has moved large manufacturing and Trades Union domination to smaller company services economy

• Elimination of punitive high tax rates now make aspiration realistic option

• Limited movement since 2009 indicates a new equilibrium has been reached

UK Income Dispersion

0.0

0.5

1.0

1.5

2.0

2.5

3.0

520 10,920 21,320 31,720 42,120 52,520

Mil

lio

ns

of

Ho

use

ho

lds

Annual Income (£2012)

1979

1990/91

2009

2012

Source: ONS, IoD Policy Unit