2014 Autumn Statement

Thursday, December 4, 2014

Question 1: Do you agree that the scale of this planned reduction in total managed expenditure is credible?

Question 2: Do you agree that the underperformance of tax receipts in recent years, provides a strong case for higher taxes?

Summary

In the wake of the Chancellor’s Autumn Statement on Wednesday, the Centre for Macroeconomics (CFM) has conducted its monthly survey of leading UK-based macroeconomists.

The responses indicate overwhelming disagreement with the view that the scale of the planned reduction in total managed government expenditure is realistic. They also indicate disagreement with the view that observed shortfalls in tax receipts make a strong case for higher tax rates.

The experts have never been as united in their views since the beginning of the CFM survey in April of this year. In contrast to previous surveys, this survey was not announced in advance and panel members were given only half a day to answer the question after the survey was opened. Nevertheless, 28 of the 42 panel members participated in this survey.

PLANNED REDUCTION IN GOVERNMENT EXPENDITURES

Total managed government expenditure as a share of GDP is forecast to fall substantially from its peak of 45.3% in 2009-10 in the aftermath of the financial crisis. The ratio fell to 41.4% in 2013-14 and is forecast to reach 35.2% in 2019-20. Many commentators – for example, Martin Wolf in his Financial Times column ‘A political Chancellor’s delusional plan’ – have expressed considerable disbelief that such a consolidation is possible.

The survey’s first question asks the panel members whether the planned further reduction is credible.

Question 1: Do you agree that the scale of this planned reduction in total managed expenditure is credible?

SUMMARY OF RESPONSES

An overwhelming majority disagree with the question. To be precise, nobody strongly agrees, 10.7% agree, 7.1% neither agree nor disagree, 42.9% disagree and 39.3% strongly disagree. Answers weighted by confidence level give an even stronger level of disagreement with 86% indicating that they either disagree or strongly disagree.

Several panel members point out that the planned reductions are extreme and will be hard to implement. Martin Ellison (University of Oxford) points out that the UK has not seen levels of government expenditures relative to GDP that are that low since World War II whereas several reasons for increases in government expenditures have emerged during this period such as increases in life expectancy and (worldwide) trends in increased demands for health services and pensions as economies have developed.’ Tony Yates (University of Bristol) points out that ‘the first lot of cuts made were no doubt the easiest, low-hanging fruits. The second lot will be harder’.

Another point made by several panel members is that this is likely to hurt the UK economy, which in turn will make it more difficult to reach these targets. Sir Christopher Pissarides (London School of Economics) writes that ‘if such a cut were made the NHS would be so damaged, the labour market would so stagnate that the politics will win and the project abandoned’.

The panel members that agree with the statement point out that growth in the UK may be higher than expected. Nicholas Oulton (London School of Economics) writes that ‘the reduction can be achieved by growing the numerator, GDP, as well as by reducing the numerator, spending. I am more confident than the OBR [Office for Budget Responsibility] that productivity growth will revive.’

Former Monetary Policy Committee member Kate Barker argues that ‘cuts on this scale will be very hard to find. More cuts will be needed – but these will be very contentious especially if public sector wage pressure is up, meaning bigger service cuts’.

TAX HIKES TO MAKE UP FOR LOW TAX REVENUES

In part because real incomes have not shown any sustained growth in this recovery, tax receipts have been persistently revised down in recent years. For example, the OBR has revised down its forecasts for tax receipts in 2017-18 by £20Bn.

The survey’s second question asks whether it is desirable to respond to these shortfalls by increasing future tax rates.

Question 2: Do you agree that the underperformance of tax receipts in recent years provides a strong case for higher taxes?

SUMMARY OF RESPONSES

Again, many more panel members disagree than agree with the statement: 25.9% of the respondents either agree or strongly agree, 62.9% disagree or strongly disagree and 11.1% neither agree nor disagree. Weighing the answers with confidence level increases the fraction of respondents on both side of the argument and reduces the fraction of respondents who neither agree nor disagree.

Numerous experts point out that low tax receipts are due to a (still) weak economy and that increases in tax rates in such a situation are likely to hurt the economy. Sir Christopher Pissarides writes ‘the underperformance is due to recession and it would be folly to increase taxes (especially when combined with cuts in spending) before the recovery is well and truly established.’

David Cobham (Heriot-Watt University) argues that downward revisions of tax receipts ‘provide a strong case for a sea-change in fiscal and other policies which can bring about a genuine recovery with significant wage growth.’ Moreover, as argued by David Smith (Sunday Times), ‘The lesson of recent years is that it is hard to raise tax receipts relative to GDP, even with higher tax rates.’

Another theme present in the experts’ answers is the lack of knowledge behind the low levels of tax receipts. Silvana Tenreyro (London School of Economics) writes that ‘By definition, nothing is normal in a crisis; the government should be more patient and let the economy recover before reassessing its tax policy.’

Tax revenues depend on tax rates and income levels. Christopher Martin (University of Bath) argues that shortfalls in tax revenues ‘provide a strong case for higher wages not for higher taxes’ and ‘a policy of increasing wages in line with inflation would have supported tax receipts.’

Experts that do see a case for tax increases take a more long-run perspective. For example, Jonathan Portes (National Institute of Economic and Social Research) writes ‘There will be increasing pressures on pensions and health from demographic trends. These will (and should) be accommodated – a richer, older society ought to spend more on health and pensions.’

Andrew Mountford (Royal Holloway) also argues for tax increases, ‘both to reduce the deficit and to fund much needed public investment’; and Mike Wickens (York) goes further, stating that ‘prior to 2010 expenditures on the NHS, welfare and education doubled while taxes increased by just over half this. This is how public finances got into its present state.’