Martin Wheatcroft

The Chancellor was in a positive mood yesterday as he presented a budget to deliver the commitment to increase NHS spending without large tax increases.

The reason was an improvement in the OBR’s fiscal forecasts. As illustrated by our chart of the week on the 2018 budget, forecast receipts have been revised up by around 1%, and previously planned spending revised down by 0.6%, to give an additional £13bn a year in this and the next two years, rising to £16bn and £19bn in the two years after that. 

This is not due to significant changes in the economy. Lower unemployment and some additional revenues from higher oil prices have delivered an extra £1bn. A long period of very low interest rates and court wins on tax rules has also helped, but much of the improvement is from things not turning out as badly as forecast back in 2016. 

This has let him sprinkle a little extra cash to ease some of the pressure on public services, not to mention spending a penny or two on improving public conveniences. 

With the mantra of government changing from ‘austerity’ to ‘fiscal discipline’ it is clear that we are not out of the woods yet, especially with £1.8tn in net debt and £4.3tn in total liabilities weighing on the public finances for a long time to come.

With the budget less than a week away our two chapters in this year’s IFS Green Budget are proving highly relevant. 

While the Chancellor will benefit from prudence in previous forecasts, the underlying position remains extremely challenging. Total public liabilities are £4.3tn or 214% of GDP, while an increasingly long-lived population places ever greater demands on the state. 

One area where spending pressure may be unavoidable is Defence where a higher level of perceived threat, may result in higher spending. The Defence Select Committee has even suggested an extra £20bn a year may be needed. 

The burden would be less if all NATO members met the 2% defence and security spending commitment. This would lead to an extra £83bn of spending across NATO. The UK meets this threshold: spending £43bn, or 2.1% of GDP. Persuading our allies to meet this target would boost our collective defence with no extra funding by the UK taxpayer. 

Less likely to gain traction is President Trump’s suggestion that NATO members spend 4% of GDP. This implies a £38bn increase in defence spending by the UK and proportionately much greater increases by most NATO members. 

Watch this space and stay in touch with the Budget with ICAEW at https://www.icaew.com/technical/economy/uk-budget-2018.

Our #ICAEW #chartoftheweek is about defence this week – the subject of our second chapter in this year’s #IFSGreenBudget. This examines how the evolving defence and security position might affect defence resources and spending, and the pressure this could put on the public finances.

Our chart reflects the ‘peace dividend’ following the end of the Cold War, with the UK’s regular forces falling by more than half from 320,700 in 1980 to 146,560 in 2018.

The savings were used to fund a growing welfare state – with defence falling from 15% to 5% of total public spending over the last fifty years just as health and welfare spending has increased from around 25% to over half. Defence and security spending now stands at 2.1% of GDP.

This long-term decline will have to end if the UK is to meet its commitment as a member of NATO to spend at least 2% of GDP on defence and security. Indeed, changing perceptions of potential threats may lead to defence spending starting to increase. To read all about defence – and public sector assets (our first chapter), go to www.icaew.com/technical/economy/ifs-green-budget-2018. See the launch presentation online, read the full report or find out more at our follow up webinar on 25 October at 1pm – to register go to events.icaew.com/pd/11508.

Next Tuesday, ICAEW will host the launch of the Institute for Fiscal Studies’ 2018 Green Budget. This is the authoritative pre-Budget report on the outlook for the UK economy supported by in-depth analysis on the options available to the Chancellor.

The ICAEW has again contributed two chapters, the first of which is on the subject of public assets, complementing the chapter we did last year on liabilities. In the past the government focused on a narrow range of fiscal measures, however with the advent of the Whole of Government Accounts it has started to think about the wider public balance sheet.

This year’s Budget is scheduled to include a progress report on the Balance Sheet Review being undertaken by HM Treasury to look at ways public assets can be used more effectively, be freed up for other uses, or generate better returns. As our chart of the week illustrates, the UK’s £1.9 trillion (94% of GDP) of public assets are dwarfed by £4.3 trillion (214% of GDP) in public liabilities. With many public assets not readily saleable, effective asset management is more important than ever.

You can find out more about the 2018 IFS Green Budget event next Tuesday and register for your free place to attend at: https://lnkd.in/gu-PKEU.

Today’s chart of the week is on the recent increase in the oil price to above $80 a barrel. Given the potential impact on the global economy, this rise is the cause of some concern. A sudden spike in oil prices has been linked to a number of past recessions.

The last time that the one-month forward price for Brent Crude was above $80 was in October 2014, when it cost $85.93 to buy a barrel of mixed hydrocarbons (with free sulphur included).

Just 15 months later in January 2016 the price was down to less than $35, but since then the price has bounced back and was up to $82.69 at 30 September 2018, reaching $84.79 at the close yesterday – just 1.3% below the 31 October 2014 price.

From a US perspective, this is a return to the position of four years ago, but for the UK it is different. With Sterling weaker against USD, the price yesterday was £65.34, over 20% higher than the £53.71 a barrel it would have cost in October 2014.

This effect is even more pronounced for emerging economies with weakening domestic currencies. The price of oil in Brazilian Reals is now over 50% higher that it was four years ago.

For growing economies, higher oil prices are unhelpful. For economies that are struggling, markedly higher oil prices might prove devastating.

With suggestions that the retail prices index (RPI) may be on its way out, our chart this week is on the subject of inflation.

RPI is consistently higher than the consumer price index (CPI), with RPI on average 0.8% higher than CPI since 2010. Similarly, RPI was on average 1.0% higher than CPIH (CPI including housing), the even more preferred inflation measure of the statistical world (not shown in the chart).

The Office for National Statistics would dearly like to get rid of RPI given the known methodological flaws in its calculation. They might describe RPI as ‘Not a National Statistic’, but legally they have to publish it every month.

The problem is that RPI is used in many financial contracts, including £410bn of index-linked gilts issued by the government. Using CPI or CPIH instead would result in lower returns for investors and (no doubt) consequent litigation.

Statisticians and economics tend to joke about RPI as “inflation +1”, as it is close to 1% higher than CPIH. That joke could provide a solution – while a straight replacement of RPI with CPI or CPIH might not be feasible, perhaps redefining RPI as CPIH + 1% could be a starting point for a discussion with debt investors.

A potential route to sparing the statisticians’ blushes at last.

Our chart this week is on the subject of what the 66.6 million people that live in the United Kingdom do.

31.6m (47%) of UK citizens, are in full or part time work, not including 0.9m students in part-time jobs. About 4.8m of those working are self-employed, while the remaining 26.8m are employees. Although 47% may sound a relatively low share of the total, children and students make up a quarter of the population and a further 11.7m (18% of the population) are retired.

Just under 10% of the working age population are not in work. With 2.0m (3%) not working because of illness or disability and 3.2m (5%) who are homemakers or who have chosen not to work for other reasons that leaves just 1.2m who are registered as unemployed and looking for work.

Many are likely to find jobs within a relatively short period – 0.7m have been unemployed for less than six months – meaning that around half a million people have been unemployed for longer. Less than 1% of the population.

This is almost full employment. What is surprising is we have yet to see any significant upward pressure on wages. Whether you blame structural changes in the labour market, Brexit or wider economic uncertainties, something is up with the usual demand and supply dynamic.

Our choice of chart this week is based on the news that the government is considering increasing fuel duties.

This tax is a good example of the dilemma faced by government. It is a valuable source of revenue – £28bn this year – but government environmental policy is to ban petrol and diesel cars in around 20 years’ time.

The point there will be no fuel to tax might be reached even sooner as the financial incentive for drivers to switch to electric cars is considerable.

As our chart highlights, we estimate that fuel for a small petrol car to drive 460 miles might cost £52 at current pump prices, around twice the cost of charging an equivalent electric car.

The difference is almost entirely down to tax, with around 60% of the pump price going to the exchequer in fuel duty and full-rate VAT, as opposed to the 22% of domestic electricity charges going in levies for environmental and social obligations and lower-rate VAT.

So the Chancellor’s decision will not just be about the politics of lifting an eight-year freeze in an unpopular tax. Increasing fuel duty might actually accelerate the switch to electric cars and hence the volume of fuel sold.

Suggestions for replacement taxes on a postcard (or electronic equivalent) please.