We look at how Japan’s population is ageing and falling fast, presenting some major challenges for the public finances of the third largest national economy in the world.
Our chart this week is on the demographics of Japan, looking at how its population grew rapidly from 96m in 1963 to 119m in 1983 and then 127m in 2003, before falling to 124m this year, to a projected 110m in 20 years’ time, and to 93m in 40 years’ time.
Our analysis starts with the 96m people who lived in Japan in 1963 and shows how increased longevity saw the population increase to 119m in 1983 (an increase of 24m from 36m births and 2m migrants less 14m deaths), before increasing to 127m in 2003 (a further 8m increase from 25m births less 17m deaths).
The population has been relatively stable since then, peaking at 128m in 2010 (not shown in the chart), before dropping to 124m this year as the number of births (20m over the last 20 years) fell below the number of deaths (25m). This was offset by a small amount of net inward migration, with the non-Japanese component of the population amounting to 3m in 2023.
Fewer younger people means that the number of births is expected to be even smaller over the next 20 years to 2043 at around 15m, at the same time as deaths are expected to increase in line with an older population. According to the latest medium-variant projections of Japan’s National Institute of Population and Social Security Research, the population is projected to drop by 14m to 110m in 2043 (15m births + 3m migrants – 32m deaths) before falling by a further 17m to 93m in 2063 (12m births + 3m migrants – 32m deaths).
The primary purpose of the chart is to illustrate how the age profile has shifted and continues to change as Japan gets older. Grouped into five age segments: 0-19, 20-39, 40-59, 60-79 and 80+, the population was, is, and is projected to be as follows:
1963 – 36m, 32m, 19m, 8m and 1m – 96m total 1983 – 35m, 36m, 31m, 15m and 2m – 119m total 2003 – 25m, 35m, 35m, 27m and 5m – 127m total 2023 – 20m, 26m, 35m, 31m and 12m – 124m total 2043 – 15m, 22m, 26m, 31m and 16m – 110m total 2063 – 12m, 17m, 22m, 24m and 18m – 93m total
The contrast in the age profile in the 20th century compared with 21st century Japan is dramatic, with the proportion of population aged 60 or over increasing from 9% in 1963 to 35% today and to a projected 45% in 2063, at the same time as the share aged under 40 has fallen from 72% in 1963 to 37% in 2023 and to a projected 31% in 2063.
Also not shown in the chart is Japan’s median age, which was 26 in 1963, 33 in 1983, 42 in 2003 and 49 this year, before being projected to reach 53 in 2043 and 56 in 2063 – more than double that of a century earlier.
These demographic shifts have and will continue to present a major fiscal challenge for the Japanese government. The continued growth in size of older generations (who typically consume the most in public services and welfare), accompanied by a shrinking working-age population (the group that typically pays most of the taxes that fund public services and welfare), will not be an easy dynamic to manage. At the same time, Japan already has one of the largest national debts of any country at in excess of 250% of its GDP.
One action Japan could take is to increase the pace of net inward migration even more than it already has, given it is currently at a much lower level than in many other developed countries such as the UK. This would have the benefit of bringing in more tax-paying individuals of working age and potentially assist in driving up the birth rate, slowing the rate of fall in the size of the population. However, there would be significant political challenges to overcome for such a route to be successful.
The good news for Japan is that it can still borrow at very low interest rates, with the effective interest rate payable on 10-year government bonds currently at 0.4%, much lower than in many comparable countries with much lower levels of external debt. This is both a threat, in that interest rates could go up significantly in the future, but also an opportunity in that the Japanese government is able to invest in adapting itself for a very different future.
The mystery of just why so many businesses sit just below the VAT registration threshold will be a big topic of debate at ICAEW’s VAT at 50 conference on Monday 22 May.
Our chart this week celebrates the 50th anniversary of the introduction in the UK of Value Added Tax (VAT), the indirect tax on commercial transactions that now generates around 20% of tax receipts.
One of the big mysteries in the tax system is why so many small businesses and sole traders cluster just below the VAT threshold of £85,000.
As illustrated by our chart, the number of businesses below the threshold gradually falls from almost 31,000 in the turnover band between £50,000 and £50,999 to just under 17,000 in the turnover band between £77,000 and £77,999, before diverging above the trendline to increase up to just over 20,000 in the £84,000 to £84,999 turnover band – immediately below the threshold for registering for VAT. This is almost twice as many as the just over 10,000 traders in the £85,000 to £85,999 turnover band, the first band legally required to register for VAT.
One explanation may be that there is some gaming (or possibly even misreporting) going on, with business owners approaching the threshold for VAT deciding to spread their business activities across multiple legal entities or keeping ‘cash-in-hand’ transactions off the books to avoid, or evade, adding VAT of 20% in most cases onto their prices.
However, perhaps a more worrying concern is if these businesses are not getting around the rules, but instead deliberately choosing to keep their businesses small given the competitive disadvantage that goes with adding VAT to prices charged to consumers, and the hassles and hazards involved with becoming a tax collector on behalf of the government.
This is a big issue for a UK economy experiencing weak economic growth. Not only is government income at stake, but also the wider benefits of more prosperous small businesses to the overall economy and what that means for the national economy.
Of course, many businesses do register despite being below the threshold, with around 1.1m traders in 2018/19 with turnover less than £85,000 signed up to VAT.
Other countries take a different approach, with much lower registration thresholds across most of Europe. Domestic thresholds range from nil in Spain, Italy and Greece, NOK40,000 (approximately £3,000) in Norway, €22,000 (£19,000) in Germany and €37,500 (£33,000) in Ireland, up to €50,000 (£43,000) in Slovenia. Switzerland is an exception with a higher registration threshold than the UK at CHF100,000 (£89,000).
In general, this means that a much greater proportion of actively trading businesses across Europe are registered for VAT compared with the UK, where there are estimated to be more than 3m or so traders with annual revenue of between £10,000 and £84,999 who have not registered for VAT – more than £100bn in total revenue.
Some believe that raising the threshold would provide a boost to the economy, given that many businesses would be more willing to grow (or declare) more of their revenue, while others believe the better option would be to reduce the threshold to capture many more businesses. The former would likely result in lower tax receipts overall, by allowing businesses just above the existing threshold to stop collecting VAT. The latter should in theory generate much more in tax receipts, perhaps as much as £20bn a year, in addition to removing one of the distortions that the tax system creates in this part of the economy.
The irony is that a relatively high VAT threshold in the UK designed to encourage and support small businesses may be one of the factors holding back economic growth. And with an unchanged threshold combined with inflation of more than 10% over the past year, this may be an even bigger drag on the economy/incentive to cheat than it has been in the past.
Click here to find out more about VAT at 50, ICAEW’s celebration (if that is the right word) of the 50th anniversary of VAT, and what the future holds for our most beloved of indirect taxes.
His Majesty’s Coronation prompts us to peek into how the monarchy is funded and where the money goes.
Our chart this week is on the finances of the Royal Household, based on its most recent financial statements for the financial year ended 31 March 2022 (2021/22), a period in which Her Majesty Queen Elizabeth II was in charge.
Income during the year was £96.2m, comprising a core Sovereign Grant of £51.8m and an additional Sovereign Grant of £34.5m (a total of £86.3m), together with commercial income of £9.9m. Expenditure amounted to £112.3m, comprising core operating costs of £41.6m, core property maintenance of £16.1m, and Buckingham Palace refurbishment costs of £54.6m.
The net loss was £16.1m, consisting of £20.1m transferred from reserves to cover amounts spent in the year refurbishing Buckingham Palace in excess of the additional Sovereign Grant for that year, less £4m transferred to reserves from the surplus by which the core Sovereign Grant and commercial income exceeded core operating costs and property maintenance.
The Sovereign Grant is funded out of the profits of the Crown Estate, a portfolio of property and other investments that were originally handed over to the state in 1760 by King George III in exchange for ending his responsibility to contribute towards the costs of running the civil government. This arrangement included a contribution from the Civil List to the Royal Household towards the costs of his official duties as head of state, separate from personal expenditure funded from his private resources as Duke of Lancaster (and as Duke of Cornwall, given there was no Prince of Wales at that point).
The Civil List continued through the reigns of George IV and William IV and was made permanent in 1837 when Queen Victoria took the throne, at least until 2012 when it was replaced by the Sovereign Grant. This consolidated into one budget the previously separate departmental grant-in-aid payments for royal travel, communications, and maintenance of official royal palaces in addition to the Civil List payments to cover official duties, although it excludes the costs of police and military security, armed forces ceremonial duties, and royal events such as the Coronation.
The Crown Estate’s contribution was initially set at 15% of its net income, with a cap on the level of reserves that the Royal Household can build up, as well as a floor that prevents the grant from falling if profits go down. This is being supplemented on a temporary basis by an additional 10% from 2017-18 onwards to fund a 10-year £369m refurbishment of Buckingham Palace.
The Royal Household generates commercial income from property rentals and from The Royal Collection Trust (a charity, which in turn generates income from visitors to Buckingham Palace and Windsor Castle), as well as from recharges to the King and other members of the Royal Family for their personal usage of the royal palaces, including their accommodation. Contributions from The Royal Collection Trust were waived during the pandemic, including most of 2021/22.
Expenditure during 2021/22 of £112.3m comprised £54.6m on the refurbishment of Buckingham Palace, £41.6m in core operating costs and £16.1m on property maintenance.
Core operating costs of £41.6m consisted of £23.4m in staff costs, £4.5m in official travel, £3.2m for utilities, £2.9m for digital services, £1.3m for housekeeping and hospitality, £2m in depreciation, and £4.3m in other spending.
Property maintenance expenditure relates to Buckingham Palace, St James’s Palace, Clarence House, Marlborough House Mews, Hampton Court Mews, Windsor Castle, Windsor Home Park, and parts of Kensington Palace, but does not include the Palace of Holyroodhouse (which is maintained by Historic Environment Scotland).
Not shown in the chart is the balance sheet, with net assets of £63.6m comprising property improvements, plant and machinery and other fixed assets of £29.1m, cash of £45.1m and other current assets of £4.1m, less £16m in payables, plus £1.3m in net defined benefit pension scheme asset. Reserves comprise £15.7m in relation to the core Sovereign Grant, £15.1m to the Buckingham Palace refurbishment, £2.4m in retained surpluses, and £30.4m in other reserves. The balance sheet does not include the royal palaces and other royal properties themselves, which are held in trust for the nation by the King.
Lower net income from the Crown Estate over the course of the pandemic mean that the core and additional Sovereign Grants have been frozen at the same level in both 2022/23 and 2023/24, although they are expected to increase in 2024/25.
As the accounts illustrate, most of the cost of the monarchy goes towards the cost of maintaining and refurbishing the royal palaces, which are held in trust for the nation. It may be surprising to discover that the King pays to use the royal apartments, and so if the UK ever were to become a republic, it is likely that the net cost of a future ‘Presidential Household’ would likely be higher without those contributions. Unless we decided to give some of the palaces – and their associated maintenance costs – back to the Royal Family.
Either way, the amounts involved represent a tiny proportion of UK public spending, which exceeded £1trn in 2021/22 or £15,400 per person (£1,280 per month).
On a per capita basis, the Royal Household received £1.27 per person in core and additional Sovereign Grant in 2021/22 and generated 15p in commercial income, a total of £1.42 in the year (or 12p a month). It spent £1.65 per person (14p per month), comprising core operating costs of 61p, property maintenance of 24p, and Buckingham Palace refurbishment expenditures of 80p.
The public finances continue to be battered by economic shocks as this week’s chart on the past five years of red ink illustrates.
The monthly public sector finances for March 2023 released on Tuesday 25 April contained the first cut of the government’s financial result for 2022/23, with our chart this week illustrating trends over the past five years in receipts, expenditure and the deficit.
As our chart highlights, tax and other receipts increased from £813bn in 2018/19 to £827bn in 2019/20, before falling to £793bn during the first year of the pandemic. They recovered to £920bn in 2021/22 before rising with inflation to a provisional estimate of £1,016bn for the year ended 31 March 2023.
Total managed expenditure (TME) increased from £857bn in 2018/19 to £888bn in 2019/20, before exceeding £1trn for the first time in 2020/21 as the pandemic caused expenditure to rise significantly. TME fell in 2021/22 to £1,041bn as pandemic-released spending was scaled back, before rising this year to £1,155bn as inflation, higher interest rates and energy support packages more than offset the pandemic related spending that was not repeated in 2022/23.
The deficit of £44bn in 2018/19 was the lowest it had been since the financial crisis, following an extended period of spending restraint over a decade. The purse strings were loosened a little in 2019/20 as previous government plans to eliminate the deficit were abandoned, with the deficit rising to £61bn. The huge cost of the pandemic saw the deficit rise to £313bn in 2020/21 as the borrowing rose to meet the huge costs of dealing with the pandemic, before falling back to £121bn in 2021/22.
There were hopes that the situation would improve further, with the government in October 2021 budgeting for a deficit of £83bn. Unfortunately, rampant inflation and the energy crisis following Russia’s invasion of Ukraine mean that the government does not currently expect to reduce the deficit to below £50bn until 2027/28 at the earliest. And that is with what some commentators believe are unrealistic assumptions about the government’s ability to reduce spending on public services beyond the cuts already delivered.
Provisional receipts in 2022/23 were 25% higher than the outturn for 2018/19, which in the absence of economic growth has principally been driven by inflation of around 15% over that period combined with an increase in the level of taxation and other receipts from around 37% to approaching 41% of the economy. Total managed expenditure is provisionally 35% higher than in 2018/19, although this includes substantial amounts of one-off expenditures on the energy support packages and index-linked debt interest that should moderate, at least assuming inflation reduces in the coming financial year.
Not shown in the chart is what these numbers mean for public sector net debt, which has increased by £753bn over the past five years from £1,757bn at 1 April 2018 to a provisional £2,530bn at 31 March 2023. This comprises £678bn in borrowing to fund the deficits shown in the chart, and £75bn to fund lending by government and working capital requirements.
Our chart this week may be well presented, but it is not a pretty picture.
My chart this week examines the late lamented Silicon Valley Bank and how its outsized investment in securities made it particularly vulnerable to a bank run.
Silicon Valley Bank collapsed on 10 March 2023 after a bank run saw depositors rapidly withdraw funds as they lost confidence in the bank’s ability to survive. The bank’s collapse followed concerns that had been growing since 24 February 2023, when Silicon Valley Bank’s parent company, SVB Financial Group, published its annual consolidated financial statements for the year ended 31 December 2022.
As illustrated by this week’s chart, SVB’s consolidated balance sheet at 31 December 2022 comprised assets of $212bn, liabilities of $196bn and equity of $16bn.
Assets consisted of investment securities recorded at amortised cost of $91bn, investment securities recorded at fair value of $26bn, loans of $74bn, cash of $13m, and other assets of $8bn. Liabilities comprised customer deposits of $173bn, short-term debt of $14bn, and other liabilities of $9bn (including long-term debt of $5bn).
Not shown in the chart is the breakdown of equity of $16bn, which at 31 December 2022 primarily comprised preference stock of $4bn, additional paid-in capital of $5bn and $9bn of retained earnings, less $2bn in negative accumulated other comprehensive income.
As disclosed on the face of the balance sheet, the fair value of SVB’s $91bn portfolio of held-to-maturity investment securities was $15bn below its carrying value at amortised cost, reflecting how the main fixed-asset securities in this category – predominantly federally guaranteed mortgage-backed securities and collateralised-mortgage obligations – had fallen in value as interest rates climbed over the course of 2022. These unrealised losses of $15bn were not that far off the $16bn of equity reported by SVB, suggesting the bank would struggle if it ever had to sell these investments before they matured.
SVB’s intention had been to hold onto these investments, but circumstances changed on 9 March when depositors – concerned about further falls in the value of SVB’s assets as interest rates continued to rise during 2023, and an adverse reaction to a belated capital raising exercise launched by SVB on 8 March – withdrew $42bn in one day. This forced SVB to rapidly liquidate assets and borrow to find the cash required to repay depositors, but by then the first major digital bank run had gained too much momentum, with depositors attempting to withdraw a further $100bn on Friday 10 March. With insufficient cash to repay the amounts requested by SVB’s customers, the bank was closed by regulators that lunchtime.
A similar situation played out in the UK, where £3bn out of £10bn of deposits in SVB’s local subsidiary were withdrawn on Friday 10 March, causing the Bank of England to step in over the weekend to enforce a sale to HSBC for £1, a significant discount to previously reported equity of £1.4bn.
While banking regulators in the US, the UK and elsewhere will pour over the entrails of Silicon Valley Bank (and other recent bank failures such as Signature Bank of New York and Switzerland’s Credit Suisse) for some time to come, most commentators consider SVB to be unusual in how it had (or rather hadn’t) managed its exposure to changes in interest rates. At a minimum, closer regulatory supervision appears a likely consequence.
However, perhaps the biggest legacy of the failure of SVB is the decision of US regulators to protect the full amount of customer deposits and not just those covered by the $250,000 federal deposit insurance cap. For depositors in this mid-size banking institution that is of course good news, but the concern is that this might set a precedent for how to deal with potential bank failures in the future, where the price tag could be very much larger.
My chart takes a look at how employment in the public sector has grown from 5.3m to 5.8m over the past five years.
The size of the public sector workforce has grown significantly over the last five years between December 2017 and December 2022, with the number of full-time-equivalent employees (FTEs) increasing by 11% from 4,430,000 to 4,911,000 and headcount rising by 9% from 5,344,000 to 5,801,000.
This compares with a population increase of 2% over that time, but a 7% increase in those aged 65 or more (from 12.1m to 12.9m), which adds significantly to the demands placed on the National Health Service.
Our chart highlights how the number of FTEs working in health and social care increased by 16% from 1,602,000 to 1,864,000 between 2017 and 2022, while headcount went up by 14% from 1,870,000 to 2,134,000. This principally relates to the National Health Service, which saw FTEs go up 19% from 1,430,000 to 1,700,000 and headcount go up 17% from 1,640,000 to 1,916,000. Other health and social work staff fell slightly with FTEs down from 172,000 to 164,000 and headcount from 230,000 to 216,000. The latter excludes most social care staff, which are principally employed in the private sector.
The next biggest category is education, which saw FTEs increase by 2% from 1,099,000 to 1,119,000 at the same time as headcount was broadly flat, going from 1,494,000 to 1,498,000, implying more hours being worked by school staff and other state employees in the education sector. This represents an increase in efficiency given that pupil numbers have increased by around 4% over the same period.
Public administration FTEs increased by 16% from 859,000 to 996,000 and headcount by 13% from 1,018,000 to 1,154,000. This category includes the civil service (FTEs up 22% from 396,000 to 483,000 and headcount up 21% from 427,000 to 515,000) in addition to local authority and other office staff across the wider public sector. Much of this increase in public administration has been driven by Brexit, which has required more staff to perform duties previously outsourced to the EU as well as to administer more bureaucracy in the nation’s trading arrangements, although other factors such as pandemic have also had an impact.
Police and armed forces FTEs increased by 8% from 391,000 to 421,000 and headcount by 7% from 404,000 to 431,000. This can be analysed between the armed forces where FTEs were broadly the same at around 155,000 for both FTEs and headcount in both 2017 and 2022, and the police, including civilians, where both FTEs and headcount increased by around 12% (FTEs from 236,000 to 265,000 and headcount from 246,000 to 276,000). The latter principally reflects the government’s decision to reverse cuts in police numbers implemented in the early 2010s.
Other staff in the public sector have also increased over the last five years, with FTEs up 7% from 479,000 to 511,000 and headcount up 5% from 5,344,000 to 5,801,000.
Overall, the public sector in the UK has seen both employment headcount and hours worked per employee grow over the last five years as demands on public services have increased significantly. This is partly down to an ageing society, which puts pressure on the NHS, combined with the consequences of the pandemic, which exacerbated backlogs throughout the system. It is also a consequence of Brexit, which has added significantly to administrative and policy burdens placed on the civil service in particular.
These significant increases in FTEs and headcount perhaps explain the government’s moves to cut public sector pay in real-terms over the last few years. It remains to be seen if that Canute-like policy will be sufficient to hold back the tide of higher payroll costs that have been and are continuing to roll in to the shores of the public finances.
February fiscal deficit hits £17bn, while the cumulative deficit for 11 months of £132bn doesn’t include backdated public sector pay awards.
The monthly public sector finances for February 2023 released on Tuesday 21 March 2023 reported a provisional deficit for the month of £17bn, which is a return to red after a surplus of £8bn last month in January 2023.
The deficit was £10bn more than the £7bn deficit reported for the same month last year (February 2022), as higher interest costs, higher inflation on index-linked debt, and the cost of the energy price guarantee for households and businesses incurred during the month drove up the need to borrow.
The cumulative deficit for the first 11 months of the financial year was £132bn, which is £15bn more than in the same period last year but £155bn lower than in 2020/21 during the first stages of the pandemic. It was £78bn more than the deficit of £54bn reported for the first 11 months of 2019/20, the most recent pre-pandemic pre-cost-of-living-crisis comparative period.
The reported deficit does not reflect backdated public sector pay settlements that have been or are expected to be agreed in March 2023, although the numbers are broadly in line with the £152bn estimated deficit for the full year in the Office for Budget Responsibility (OBR)’s revised forecasts made at the time of the Spring Budget. This was lower than their previous forecast of £177bn in November, primarily because the energy price guarantee is costing less than anticipated.
Public sector net debt was £2,507bn or 99.2% of GDP at the end of February 2023. This is £692bn higher than net debt of £1,815bn on 31 March 2020, reflecting the huge sums borrowed since the start of the pandemic. The OBR’s latest forecast is for net debt to reach £2,546bn by March 2023 and to exceed £2.9trn by March 2028.
Tax and other receipts in the 11 months to 28 February 2023 amounted to £924bn, £91bn or 11% higher than a year previously. Higher income tax and national insurance receipts were driven by rising wages and the higher rate of national insurance for part of the year, while VAT receipts benefited from inflation in retail prices.
Expenditure excluding interest and investment for the 11 months of £888bn was £52bn or 6% higher than the same period in 2021/22, with Spending Review planned increases in spending, the effect of inflation, and the cost of energy support schemes partially offset by the furlough programmes and other pandemic spending in the comparative period not being repeated this year.
Interest charges of £120bn for the 11 months were £51bn or 73% higher than the £69bn reported for the equivalent period in 2021/22, through a combination of higher interest rates and higher inflation driving up the cost of RPI-linked debt.
Cumulative net public sector investment to February was £48bn, £4bn more than this time last year. This is much less than might be expected given the Spending Review 2021 pencilled in significant increases in capital expenditure budgets in the current year.
The increase in net debt of £125bn since the start of the financial year comprised borrowing to fund the deficit for the 11 months of £132bn, less £7bn in net cash inflows from repayments of deferred taxes, and loans made to businesses during the pandemic, less funding for student, business and other loans together with working capital requirements.
Alison Ring OBE FCA, Public Sector and Taxation Director for ICAEW, said: “The public finances are back in the red this month as a deficit of £17bn brings the total for the 11 months to February to £132bn, with public sector net debt in excess of £2.5trn. Although broadly in line with the OBR’s improved estimate accompanying the Spring Budget, the numbers don’t reflect the cost of backdated public sector pay settlements to be recorded in the final month of the 2022/23 financial year.
“The chancellor still needs to top up departmental budgets for pay awards in the next financial year, reducing his capacity to address inflationary cost pressures in other areas. HS2 may not be the only capital programme at risk of being scaled back or delayed as he seeks to make savings.”
Caution is needed with respect to the numbers published by the ONS, which are expected to be repeatedly revised as estimates are refined and gaps in the underlying data are filled.
The ONS made several revisions to prior period fiscal numbers to reflect revisions to estimates. These had the effect of reducing the reported fiscal deficit for the 10 months ended 31 January 2023 by £1bn to £116bn.
Jeremy Hunt limits his tax and spending ambitions in the Spring Budget to stay within a very tight fiscal rule.
The Spring Budget 2023 for the government’s financial year of 1 April 2023 to 31 March 2024 was presented by the Chancellor of the Exchequer to Parliament on Wednesday 15 March 2023, accompanied by medium-term economic and fiscal forecasts from the Office for Budget Responsibility (OBR) covering the period up to 2027/28.
The fiscal numbers in the Budget are based on the National Accounts prepared in accordance with statistical standards. They differ in material respects from the financial performance and position that will eventually be reported in the Whole of Government Accounts prepared in accordance with International Financial Reporting Standards (IFRS).
A (slightly) lower fiscal deficit in 2023/24
Table 1 shows the Spring Budget estimate for the deficit in 2023/24 is £132bn, £8bn lower than the £140bn forecast in November 2022. Positive revisions to the forecast added £27bn to the bottom line, before £19bn from tax and spending decisions made by the Chancellor.
Forecast revisions in 2023/24 comprised £13bn in lower debt interest, £7bn less in energy support and £8bn in higher tax receipts, less £1bn other changes. The cost of tax and spending decisions in 2023/24 was estimated to be £8bn in lower corporation tax receipts from the full expensing of capital expenditure, £5bn from freezing fuel duties, £5bn from extending the energy price guarantee and other energy support measures, £2bn more for defence and security and £2bn from other decisions, less £3bn in indirect effects of those policy decisions on tax receipts and welfare spending.
Total receipts in 2023/24 are now expected to be £1,057bn (£2bn higher than previously forecast) and total managed expenditure is now anticipated to be £1,189bn (£10bn lower).
The forecast for the deficit in 2024/25 was up £1bn at £85bn and was unchanged in 2025/26 at £77bn, with upward revisions of £18bn and £19bn respectively offset by an estimated £19bn net cost of tax and spending decisions. The latter includes £3bn in 2024/25 and £4bn in 2025/26 for expanded childcare eligibility.
The final two years of the forecast were better by £17bn in 2026/27 (down to a fiscal deficit of £63bn) and by £20bn in 2027/28 (down to £49bn), although several commentators have pointed out this is on the basis of unrealistic spending assumptions that do not take account of significant pressures on public services.
In addition to forecasts for the next five years, the OBR also revised its estimate for the deficit in the current financial year ending 31 March 2023 to £152bn, £25bn lower than November’s estimate of £177bn. This is £53bn more than the OBR’s March 2022 estimate of £99bn and £69bn more than the November 2021 Budget estimate of £83m.
Table 2 provides a breakdown of the forecast changes by year, showing how lower debt interest and higher tax receipts flowing through the forecast period have provided the Chancellor with capacity to extend energy support, incentivise business investment, freeze fuel duty for yet another year (and extend the temporary 5p cut) and increase spending in specific areas.
Receipts and expenditure development
As illustrated by Table 3, receipts are expected to rise from £1,020bn in the current financial year to £1,231bn in 2027/28, while expenditure excluding energy support and interest is expected to rise from £968bn in 2022/23 to £1,121bn in 2027/28..
Interest costs are expected to fall from £115bn this year to £77bn in 2025/26 as interest rates and inflation moderate, before rising to £97bn in 2027/28 based on a growing level of debt.
Net investment is expected to increase in 2023/24 as an £8bn one-off credit from changes in student loan terms in 2022/23 reverses, before declining gradually as capital expenditure budgets flatline and depreciation grows. Public sector gross investment is planned to be £134bn, £134bn, £133bn, £132bn and £132bn over the five years to 2027/28, in effect a cut in real terms over the forecast period.
The government’s secondary fiscal target is to keep the fiscal deficit below 3% of GDP by the end of the forecast period. Based on the March 2023 forecasts, it has headroom of 1.3% of GDP, or £39bn, against this target.
Table 4 provides a summary of the year-on-year changes in receipts and spending, together with the forecast for the increase in the size of the economy, including inflation. This highlights how tax and other receipts are expected to increase faster than the overall rate of growth in the overall size of the economy, while the government plans to constrain the average rise in expenditure excluding energy support and interest to 3.0% including inflation.
The former is principally a result of ‘fiscal drag’ as tax allowances are frozen, bringing in proportionately more in tax as incomes rise with inflation. The latter reflects what is generally considered to be unrealistic plans to constrain public spending in the context of an expected 9% rise in the number of pensioners over the five-year period (that will add to pensions, welfare, health and social care spending), pressure on public sector pay and the deteriorating quality of public services.
Average nominal GDP growth over the five years of 3.3% combines average real-terms economic growth of 1.7% a year and inflation of 1.6%, the latter using the GDP deflator, a ‘whole economy’ measure of inflation. This is different to consumer price inflation, which is forecast to fall to 4.1% in 2023/24 and average 1.4% over the five years to 2027/28.
Public sector net debt
Lower deficits over the forecast period translate into lower borrowing requirements, reducing forecasts for public sector net debt from just under £3.0trn to £2.9trn. This is partly increased or offset by changes in the forecasts for financial and other transactions and working capital movements.
Table 5 shows how forecast public sector net debt is now expected to reach £2,909bn by March 2028, £54bn less than was forecast in November. Although an improvement, debt at the end of the forecast period is expected to be £1,089bn higher than £1,820bn reported for March 2020 before the pandemic, reflecting the large amounts borrowed during the pandemic, in addition to borrowing planned over the next five years.
The government’s primary fiscal target is based on ‘underlying debt’, a non-generally accepted statistical practice measure that excludes the Bank of England and hence quantitative easing balances. Underlying debt needs to be falling as a proportion of GDP between the fourth and fifth year of the forecast period.
The forecast gives the Chancellor just £6.5bn in headroom against this target, with underlying debt / GDP expected to fall from 94.8% to 94.6% between March 2027 and March 2028.
Fiscal rules limit ambitions for tax and spending
Following the disastrous ‘mini-Budget’ of his predecessor Kwasi Kwarteng, the Chancellor’s principal goal has been to stabilise the public finances to provide confidence to debt markets. To do this he has prioritised meeting his fiscal rules over incentivising business investment, cutting taxes and increasing defence spending. He has also adopted what are generally considered to be unrealistic assumptions about public spending in the later years of the forecast to keep within his self-imposed fiscal rules.
This has led to the Chancellor announcing ‘ambitions’ to extend the full expensing of capital expenditure beyond three years and to increase defence and security spending to 2.5% of GDP, as well as continuing to plan for increases in fuel duties each year despite the repeated practice of cancelling these rises.
Because these are ambitions and not plans, they are not incorporated into the forecasts enabling fiscal targets to be met. The OBR reports that continuing to cancel fuel duty rises each year would reduce the headroom to just £2.8bn, while converting the Chancellor’s ambitions to extend full expensing beyond three years and to increase defence spending to 2.5% of GDP into formal plans would cause him to breach his primary fiscal rule.
Conclusion
The overall fiscal position remains weak, with public finances vulnerable to potential economic shocks.
The Chancellor has followed the practice of many of his predecessors in increasing planned borrowing when fiscal forecasts worsen, as occurred in November 2022, only to then use upsides from improvements in subsequent forecasts to fund new tax and spending commitments. This ratchets up borrowing and debt as forecasts fluctuate and creates instability in both tax policy and public spending plans.
The consequence is a relatively unchanged fiscal position for the financial year commencing 1 April 2023 and the two subsequent financial years, as tax and spending decisions offset forecast upsides. And although there is an anticipated improvement in the projected fiscal position in the final two years of the OBR’s five-year forecast (after the next general election), the likelihood is that it will be offset in due course by the reality of pressures on public service and welfare budgets.
There is a reason why the first Budget following a general election typically sees taxes rise and the Spring Budget 2023 suggests that this pattern is likely to be repeated, irrespective of whichever party wins power.
My chart this week is on the Chancellor’s tax and spending plans for the coming financial year commencing on 1 April 2023.
Chancellor Jeremy Hunt presented his first Budget to Parliament on Wednesday 15 March 2023, setting out his formal Budget estimate for the financial year ended 31 March 2024 (2023/24) accompanied by fiscal forecasts from the Office for Budget Responsibility (OBR) for the period up to 2027/28 and the OBR’s final estimate for the current financial year ending on 31 March 2023.
Our chart this week starts by summarising the final estimate for 2022/23, highlighting an expected shortfall of £152bn between anticipated receipts of £1,020bn and spending of £1,172bn. This is followed by a similar analysis for the budget year of 2023/24, with a deficit of £132bn resulting from a shortfall between estimated taxes and other receipts of £1,057bn and spending of £1,189bn.
Receipts in 2022/23 and 2023/34 respectively comprise £922bn and £950bn in tax and £98bn and £107bn in other receipts. The increase in tax of 3.0% is perhaps lower than might be expected given the level of inflation and the new higher rate of corporation tax from 1 April 2023, with an anticipated 10% growth in corporation tax receipts (net of full expensing of business investment) offset by flat or relatively small growth in other taxes. Other receipts are expected to increase by 9%, primarily the effect of higher interest rates on investments.
Total managed expenditure in 2022/23 and 2023/24 respectively comprise £968bn and £1,015bn in current expenditure excluding energy support costs and debt interest, £30bn and £5bn in energy support packages, £115bn and £95bn in debt interest, and £59bn and £74bn in net investment.
Current expenditure excluding energy support costs and debt interest is expected to increase by 4.9% in 2023/24 compared with 2022/23, more than the 2.5% ‘whole economy’ measure of inflation used by the government and the 4.1% forecast for consumer price inflation. This partly relates to inflation in the current financial year feeding through into next year’s budgets, as well as spending measures announced by the Chancellor.
The three-month extension of the energy price guarantee is anticipated to cost £3bn in 2023/24, with other energy support measures adding a further £2bn to the forecast.
Debt interest is expected to fall by 17% to £95bn, principally because of the effect of a much lower rate of inflation on index-linked debt more than offsetting higher interest rates overall.
Public sector net investment comprises gross investment of £116bn and £134bn in the two years respectively, net of depreciation of £57bn and £60bn respectively. The increase in gross investment is flattered by a £8bn one-off credit in the current financial year arising from changes to student loans, which if excluded implies an 8% increase in capital expenditure and other public investment overall. This reflects delays in capital programmes that are expected to come in significantly under budget in the current financial year but cost more in the next, relatively high construction price inflation, and an extra £2bn of capital investment allocated to defence.
The final estimate for the deficit in the current financial year of £152bn is £25bn lower than was expected in the OBR’s November 2022 forecast of £177bn, while the Budget estimate for 2023/24 of £132bn is £8bn lower than the £140bn forecast last time. The reduction in 2022/23 reflects the benefit of a slightly improved economic outlook, with policy decisions for the last couple of weeks of the financial year by the Chancellor netting off to close to nil. This contrasts with 2023/24, where forecast upsides amounting to around £27bn have been mostly offset by a net cost of £19bn from tax and spending decisions.
Overall, the chart highlights just how much money the UK raises in tax and incurs in public spending. Tax and other receipts are expected to approach £1.1trn in the coming financial year, while public spending is anticipated to be just under £1.2trn.
On a per capita basis in 2023/24 this is equivalent to receipts and spending of approximately £1,290 per month and £1,450 per month for each person in the UK respectively, a shortfall of £160 per person per month that needs to be funded by borrowing.
The challenge for the Chancellor is that with the number of pensioners projected to increase by 9% over the next five years (with consequent implications for spending on pensions, welfare, health and social care), there is not much room to invest in public services or in infrastructure at the same time as also reducing taxes as he would very much like to do.
The Chancellor wasn’t able to square this circle in the Spring Budget 2023, so watch this space to see whether he can be any more successful in future fiscal events.
Ahead of the Spring Budget on 15 March, I take a look at how the official forecast for the 2022/23 fiscal deficit has fluctuated through successive forecasts.
My chart this week is on the topic of fiscal forecasting, and how the forecast deficit for the UK government’s financial year ending 31 March 2023 (2022/23) has changed over the course of five or so years of official forecasts.
Our story starts with the Autumn Budget in November 2017, when the Office for Budget Responsibility (OBR) first published a medium-term fiscal forecast that extended to 2022/23. After plugging economic assumptions into its model and combining it with the government’s plans for public spending, it came up with a forecast of £26bn for the 2022/23 fiscal deficit, the shortfall between receipts and public spending calculated in accordance with statistical rules.
Then Chancellor Philip Hammond was at that time pretty positive about the economic prospects for the UK, despite weak productivity causing him to abandon the government’s medium-term plan to completely eliminate the budget deficit. Instead, he settled for a more modest objective of a balanced current budget and a falling debt-to-GDP ratio, extending austerity policies to cut public spending.
The next few fiscal events saw the OBR revise down its forecast for the 2022/23 deficit in the light of moderately better economic data each time. This saw the forecast for the 2022/23 deficit reduce to £21bn in the March 2018 forecast, stay at £21bn in October 2018 and fall to £14bn in the March 2019 forecast.
The forecasts up to this point were before methodology changes announced in 2019 relating to the treatment of student loans and other items. According to the OBR these had the effect of increasing the forecast for the fiscal deficit in 2022/23 by an estimated £21bn.
The calling of a general election in December 2019 prevented Chancellor Sajid Javid from presenting a Budget in November 2019, so the OBR had to wait until March 2020 to publish its next forecast. At this point, 2022/23 was in the middle of the forecast period and Rishi Sunak’s first fiscal event as Chancellor saw a £26bn increase in the 2022/23 deficit to £61bn in an ‘end-to-austerity’ Budget that saw £46bn in extra planned spending compared with previous forecasts.
Frustratingly for the OBR, its forecasts that day were immediately out of date, as initial emergency pandemic measures were decided too late to be incorporated into its calculations. While these and subsequent temporary measures to support households and businesses through the pandemic primarily affected the 2020/21 and 2021/22 financial years, the economic hit caused by COVID-19 was the primary reason for the OBR increasing its forecast for the 2022/23 fiscal deficit to £105bn in November 2020.
March 2021 saw a small tweak to the forecast to £107bn, but the Autumn Budget and Spending Review in November 2021 saw an improvement to £83bn as the economy emerged from the lockdown phases of the pandemic in a slightly better place than was previously anticipated, with higher spending funded by planned tax rises.
This positive move went into reverse in March 2022 as the OBR revised its Budget estimate upwards to £99bn, reflecting rising interest rates on government debt and the government’s initial response to an emerging cost-of-living crisis.
The OBR was not asked to produce an official forecast to accompany short-lived Chancellor Kwasi Kwarteng’s tax-cutting ‘mini-Budget’ in September. At £177bn the OBR forecast for the 2022/23 fiscal deficit in November 2022 was eye-watering enough, and that was after current Chancellor Jeremy Hunt’s Budget had reversed most of his predecessor’s tax cuts.
Lower than anticipated wholesale energy prices have led several commentators to suggest that the OBR’s final estimate for the fiscal deficit could be revised down by £30bn or more when it presents its medium-term forecasts up to 2027/28 to accompany the Spring Budget on 15 March 2023. As the chart suggests, this is not a ‘windfall’ as some commentators have claimed. Even if the gap between receipts and spending narrows, the deficit will still be significantly higher than the £83bn official estimate included in the Budget for 2022/23 presented to Parliament.
Fiscal forecasting is of course a very difficult task even in normal times. The deficit is the difference between two very large numbers – receipts of just over a trillion pounds and public spending of nearly £1.2trn – that can each move up or down significantly as economic conditions change, and policy choices are made. Add to that a global pandemic, a cost-of-living crisis and an uncertain policy outlook, and it is perhaps unsurprising that the forecasts have changed so much over the past five years.
In an uncertain world, fiscal forecasts fluctuate.
