2014 Autumn Statement

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.’ 

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How the experts responded

Planned reduction in government expenditure

Participant Answer Confidence level Comment
Kate Barker's picture Kate Barker British Coal Staff Superannuation Scheme and University Superannuation Scheme Strongly Disagree Very confident
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.
Jagjit Chadha's picture Jagjit Chadha National Institute of Economic and Social Research Disagree Confident
Although there was a similar fall in the ratio of total managed government expenditure in the second half of the 1980s it was driven by a fairly sustained economic boom. Highly accommodative interest rates may stoke extra demand but we need significantly higher growth in productivity if we are to get anything like this scale of adjustment in managed government expenditure.
David Smith's picture David Smith Sunday Times Agree Very confident
It is credible, but probably only in the context of stronger growth than the OBR is predicting, and no longer ring-fencing some protected areas of spending.
Sir Christopher Pissarides's picture Sir Christopher... London School of Economics Strongly Disagree Very confident
of course, anything is possible if the Chancellor simply refused to give money for spending. But we have to be realistic and see it in the context of British political thinking and voter preferences. 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.
Jonathan Portes's picture Jonathan Portes KIng's College, London Strongly Disagree Extremely confident
Even the Office of Budget Responsibility - whose mandate effectively precludes it from questioning the projections - has made it clear that it expect a future government, of any party or combination to revise these plans. The detailed analysis published by the IFS explains why. This is particularly unfortunate in the run-up to the election In retrospect, it would have been far better if each of the main parties had been asked to provide their own fiscal plans and the OBR had published 3 (or more) separate projections; that would at least have provided the basis for informed public debate on the fiscal choices we face.
Martin Ellison's picture Martin Ellison University of Oxford Strongly Disagree Very confident
The planned reductions would bring total managed expenditure down to levels not seen in the UK since before World War II. Since then, governments in the UK and worldwide have responded to societal pressures to increase spending on transfer payments, health services and pensions as economies have developed. Reversing this trend as planned would require unprecedented cuts in government provision, which are likely to be politically difficult and may in some cases be technically infeasible. For example, increases in life expectancy are themselves likely to lead to increased health and pensions expenditure in the future, so the real size of the planned cuts in government provision is likely to be perceived as especially large. Some cuts may even be infeasible, for instance reducing pensions would involve reneging on the "triple lock" guaranteeing state pensions.
David Cobham's picture David Cobham Heriot Watt University Strongly Disagree Very confident
Even if one thought a major reduction in the role of the state was desirable (I do not), such a reduction in the timeframe envisaged is not possible.
Ethan Ilzetzki's picture Ethan Ilzetzki London School of Economics Strongly Disagree Confident
Government spending in the decades preceding the crisis hovered around 40% of GDP. Current levels of spending are entirely within historical averages. It is hard to see how public spending could be cut by an additional 35% without a wholesale change in the role of the state. It is hard to envision such a change.
Christopher Martin's picture Christopher Martin University of Bath Strongly Disagree Extremely confident
The planned reduction of 40% in non-protected areas would imply cuts of close to 60% in these areas since 2010. Cuts on this scale would imply sharp reductions in - (admittedly generous) welfare payments to the retired - benefits to low-paid in-work families, most likely through lower housing benefit. - a reduction in real NHS spending per head, after adjustment for the effects of the projected rise in the number of over-85s These types of cuts do not seem feasible. There is no appetite for such a sharp reduction in the size of the state among the electorate. They will not be included in the party manifestos at the coming election and so the next Government will not be able to claim a mandate for this.
Gianluca Benigno's picture Gianluca Benigno London School of Economics Disagree Confident
John VanReenen's picture John VanReenen London School of Economics Strongly Disagree Extremely confident
Balancing the budget through this scale of public service cuts will not be done. See my blog post http://blogs.lse.ac.uk/politicsandpolicy/the-chancellors-2014-autumn-statement-missed-targets-and-missed-opportunities/?utm_content=bufferb51b0&utm_medium=social&utm_source=twitter.com&utm_campaign=buffer. There will (and should) be (i) a slower pace of reduction; (ii) an increase of taxes as well as spending; (iii) some action on pensioner benefits and welfare; (iv) end to ring-fencing of NHS, schools & foreign aid
Paolo Surico's picture Paolo Surico London Business School Neither agree nor disagree Confident
Historically we have seen such a sizable change happening (perhaps not in such a short time window). The devil is in the details of the composition as well as the possible impact on future tax revenues.
Angus Armstrong's picture Angus Armstrong Rebuilding Macroeconomics, IGP, UCL Disagree Confident
I doubt the GDP growth forecasts will be met with this extent of cuts. Therefore the projected decline in the ratio is unlikely to be achieved.
Alan Sutherland's picture Alan Sutherland University of St. Andrews Disagree Confident
Michael McMahon's picture Michael McMahon University of Oxford Disagree Confident
I don't believe that the scale of the spending reductions is possible. I think it the actual executed plan is much more likely to require (a) an even slower transition to surplus, and/or (b) tax changes either from a recovery of income tax rates (see next question) or higher taxes from other tax instruments.
Simon Wren-Lewis's picture Simon Wren-Lewis University of Oxford Disagree Very confident
But the danger is that Osborne may nevertheless try to achieve it. As a political strategy, sharp cuts in the first 2 or 3 years of an administration, followed by easing off before the election, will have appeared to work if he is still in charge.
Richard Portes's picture Richard Portes London Business School and CEPR Strongly Disagree Very confident
Francesco Caselli's picture Francesco Caselli London School of Economics Strongly Disagree Very confident
Costas Milas's picture Costas Milas University of Liverpool Disagree Confident
The IMF predicts the ratio to fall to 37.8% in 2019; this is notably higher than what the budget predicts. A big reduction in expenditure is arguably questionable especially in 2016-2017, when (a) borrowing costs might come under pressure and (b) GDP growth might be pushed back if a Brexit referendum drives us out of Europe.
Morten Ravn's picture Morten Ravn University College London Disagree Very confident
It is only credible to the extent that welfare expenses and other sources of income transfers fall more than expected which would require either a much larger growth in the economy than expected or political willingness to cut transfers to low-income households. The latter is politically difficult not the least because pensioners would be hard to protect from such cuts. Thus, in the absence thereof, either spending in other government departments would have to fall, the stabilization of public debt would take much longer or tax revenues would have to increase. A large cut in government departments is difficult given that the NHS is being ring fenced thereby forcing other departments - such as education - to be cut much deeper. At the end of the day, it is most like that the outcome will be a balanced mix of all these options unless the economy recovers even more than expected (therefore producing a larger than expected rise in tax revenues and a larger than expected fall in income transfers).
Silvana Tenreyro's picture Silvana Tenreyro London School of Economics Disagree Confident
The forecast cut seems extreme. It's hard to imagine a sensible government would be willing to inflict so much pain on an economy that is only feebly recovering from a large crisis.
Nicholas Oulton's picture Nicholas Oulton London School of Economics Agree Not confident
I think that the planned reduction can be achieved but I am not confident that it will be. This is mainly because of political risks. Who knows who will be Chancellor in 2019-20? Also our recovery could be derailed by another disaster in the eurozone which would dictate a relaxation in fiscal policy. On the positive side, the reduction can be achieved by growing the denominator, GDP, as well as by reducing the numerator, spending. I am more confident than the OBR that productivity growth will revive. In my view the OBR gives too much weight to the disappointing experience since 2007 and not enough to the good performance before then. The OBR has output per hour growing at only 2% even in 2019-20 which means that the level of output per hour will still be about 14% below its pre-crisis trend. Though the crisis will have caused permanent losses I think their figures are too pessimistic. So I expect faster productivity growth to reduce the spending/GDP ratio. .
Andrew Mountford's picture Andrew Mountford Royal Holloway Disagree Confident
Credibility is as much about politics as economics. The proposed cuts imply huge hardship for vulnerable members of society e.g. the appalling state of social care for the elderly is well documented. I think a representative member of the UK would not carry out the proposed cuts and would look for another way to manage the deficit (e.g. raise taxes ). But whether a future government would see these proposals through does not only depend on this but also on the strength of their political opinions and how insulated they are from their effects(politically and economically)
Michael Wickens's picture Michael Wickens Cardiff Business School & University of York Disagree Very confident
The Chancellor aims to achieve the further reduction is mainly through more cuts to welfare benefits. There is no economic reason why it can't be achieved but the politics of doing so strongly reduce its likelihood.
George Buckley's picture George Buckley Deutsche Bank Agree Confident
The government has already halved both the headline and structural deficits over the course of the parliament. That is, however, slower than they had intended at the time of the Emergency Budget in 2010, thanks to weaker economic growth in the early part of this parliament and receipts failing to respond as expected to the recovery in growth when it eventually came. Over the next five years the government intends to cut current departmental spending by around 12% in cash terms - this is sizable especially when some of the larger departments (such as the NHS) is being ringfenced. Much wil depend on the result of next May's election as to whether the government intends to continue to cut the deficit through sizable spending cuts as opposed to a mix of spending cuts and tax rises.
John Driffill's picture John Driffill Birkbeck College, University of London Neither agree nor disagree Confident
This is not likely to happen, in my view. To achieve it there will have to be a conservative governent in power throughout the period and it will have to stick to a probably unpopular and difficult policy in the face of widespread opposition. It will be less difficult to achieve if there is strong economic growth in the coming years. To achieve it may also require cutting spending in the so far protected areas of health, education and overseas aid. It may also require devising some highly innovative ways of providing public services more cheaply.
Tony Yates's picture Tony Yates University of Birmingham Strongly Disagree Very confident
Not credible for a couple of reasons. First, they failed to meet the targets they set last time, so why believe a second time. Second, the first lot of cuts made were no doubt the easiest, low-hanging fruits. The seocnd lot will be harder. Each expenditure review seeks to prioritise and cut low priorities. So inevitably further rounds of cuts fall on higher priority items. This gets me to the second reason. These cuts aren't wanted, probably not even by most of the Tory party either.
Wouter Den Haan's picture Wouter Den Haan London School of Economics Disagree Confident
Given the headwinds that the UK economy is still facing, this would be a tough challenge. More importantly, such extremely drastic austerity measures are likely to weaken the UK economy.

Low tax receipts

Participant Answer Confidence level Comment
Kate Barker's picture Kate Barker British Coal Staff Superannuation Scheme and University Superannuation Scheme Neither agree nor disagree Not confident
There is a case for higher taxes, but not for that reason! It is to provide the right level of public services for a civilised society.
Jagjit Chadha's picture Jagjit Chadha National Institute of Economic and Social Research Agree Confident
Continued underperformance in tax receipts will mean that either public debt levels will not adjust down especially quickly to pre-crisis norms of 40% to GDP or less and/or tax rates will have to rise. Each of VAT, Income Tax, Corporate Taxes and Council Taxes may need reform and rehabilitation to meet these challenge.
David Smith's picture David Smith Sunday Times Strongly Disagree Extremely confident
The lesson of recent years is that it hard to raise tax receipts relative to GDP, even with higher tax rates, though the government has also deprived itself of some revenues by raising the tax-free personal allowance.
Sir Christopher Pissarides's picture Sir Christopher... London School of Economics Strongly Disagree Extremely confident
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. the budget should be balanced on average across the business cycle and not be subject to knee-jerk reactions to macroeconomic shocks
Martin Ellison's picture Martin Ellison University of Oxford Disagree Confident
Tax receipts are underperforming because the economy is weak. What we already know about fiscal multipliers suggests that raising taxes when the economy is weak is not a very good idea - the claim that fiscal contractions can be expansionary has largely been discredited amongst economists. However, the ageing of the UK population and a taste for socially redistibutive policy (as witnessed by the Piketty-inspired debate over inequality) suggests that both government spending and taxes will drift up in the future. I therefore foresee a time when taxes will have to rise, but that time is probably some way off when we know for certain that the UK economy is performing better and well on the left hand side of the Laffer curve.
Jonathan Portes's picture Jonathan Portes KIng's College, London Strongly Agree Very confident
The projections in the Autumn Statement for the tax/GDP level show it remaining stable at levels that are low by historical standards. There will be ncreasing 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. So either taxes need to go up, or more financing for health and pensions needs to come from private provision; or, more likely, and probably most sensible, both.
David Cobham's picture David Cobham Heriot Watt University Strongly Disagree Very confident
No, it provides a strong case for a sea-change in fiscal and other policies which can bring about a genuine recovery with significant wage growth (and, even if it comes later, productivity growth).
Ethan Ilzetzki's picture Ethan Ilzetzki London School of Economics Neither agree nor disagree Not confident
The drop in tax revenues has been largely cyclical. Revenues are recovering to their pre-crisis levels (as a percent of GDP). Nevertheless, the lost revenues have left a debt burden that needs to be addressed in the long term. Deficit reduction should and will most likely involve some combination of (moderate) public spending cuts and moderate tax increases. But there I do no see a strong case for precipitous action on tax revenues.
Christopher Martin's picture Christopher Martin University of Bath Disagree Confident
This provides a strong case for higher wages not for higher taxes. The government has tried to reduce the deficit by reducing real wages in the public sector. This policy has failed : the NHS, for example, is using much of the reduced wage bill to pay for temporary agency staff to cover staffing gaps. A policy of increasing wages in line with inflation would have supported tax receipts.
Gianluca Benigno's picture Gianluca Benigno London School of Economics Disagree Confident
low growth in real income is a symptom of a fragile recovery and an increase in taxes could undermine the recovery
Angus Armstrong's picture Angus Armstrong Rebuilding Macroeconomics, IGP, UCL Neither agree nor disagree Confident
I don't think there is enough evidence yet to fully understand what is behind the underperformance of receipts yet (maybe this will change with the self-assessment results). Until we understand more fully the reasoning, I don't think it follows that this would justify higher taxes. Whether taxes should be higher or not, regardless of the reasons of the under-performance, is another question.
Paolo Surico's picture Paolo Surico London Business School Strongly Disagree Very confident
Evidence suggests tax hikes are very contractionary whereas the evidence on the effects of changes in government spending is less conclusive.
Alan Sutherland's picture Alan Sutherland University of St. Andrews Agree Confident
Michael McMahon's picture Michael McMahon University of Oxford Disagree Confident
I believe it is likely that tax revenues will have to be increased. This does not mean that rates on tax instruments which have underperformed, e.g. income taxes, need to be raised. There are two issues: 1. do we think that the underperformance will be persistent, or whether there could be a faster than expected pick up in tax receipts as / if the recovery gathers pace; 2. it may be an opportune moment to rethink the use of all tax instruments and to reoptimise toward taxes other than income taxes.
Simon Wren-Lewis's picture Simon Wren-Lewis University of Oxford Disagree Confident
The economy is still in an unusual situation, with real wages very depressed. I still hope that is temporary.
Richard Portes's picture Richard Portes London Business School and CEPR Agree Very confident
Francesco Caselli's picture Francesco Caselli London School of Economics Disagree Confident
Costas Milas's picture Costas Milas University of Liverpool Disagree Confident
Morten Ravn's picture Morten Ravn University College London Disagree Very confident
The underperformance of tax revenues is probably quite closely related to the changes in the income distribution combined with tax exemptions at the lower end and increasing marginal rates at the higher end. On the other hand, these aspects are also important for understanding why employment is recovering and why the UK economy is doing well in terms of income growth. Increasing taxes would be very likely to produce higher tax revenues (I do not think that we are on the wrong side of the Laffer curve) but would also endanger the recovery.
Nicholas Oulton's picture Nicholas Oulton London School of Economics Disagree Confident
Since I believe (subject to the caveats in my answer to the first question) that the UK will grow more rapidly than the OBR currently forecasts I expect tax receipts to revive. So I see no case for higher taxes now. Of course those (unlike me) who want a bigger state should definitely be in favour of higher taxes.
Silvana Tenreyro's picture Silvana Tenreyro London School of Economics Disagree Confident
By definition, nothing is normal in a crisis; the government should be more patient and let the economy recover before re-assessing its tax policy.
Andrew Mountford's picture Andrew Mountford Royal Holloway Strongly Agree Extremely confident
Yes both to reduce the deficit and to fund much needed public investment. A successful economy is based on having highly productive inhabitants and this requires investment in providing them with globally competitive skills. It also requires investment to make sure the UK is an efficient productive place to do business such as investment in R&D, government administration and transport infrastructure and also in things like housing so that workers feel wealthy with their income and don't need to spend a disproportionately large share of their income on essentials such as housing costs etc..etc..
Michael Wickens's picture Michael Wickens Cardiff Business School & University of York Agree Very confident
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. Not much seems to have changed in this respect. Sound long-term economic management requires that current expenditures like these should be paid for out of current taxation. The government (and opposition) plan future increases in NHS expenditures. The recession has kept tax receipts from wages from increasing and the pick-up in growth is yet to feed through to higher wages and tax revenues. As this is likely to persist for a few years, in order to reduce debt, it is necessary to raise tax rates in the interim. Only if the government could achieve its spending targets could this be avoided - which takes us back to the politics.
John Driffill's picture John Driffill Birkbeck College, University of London Disagree Confident
No! The unexpectedly low tax revenues have resulted from lower than expected growth of wage rates. This may well be a temporary phenomenon. As slack in the labour market disappears in the coming years, wages are likely to start increasing modestly and tax revenue to rise. There is good reason to keep tax rates as they are at present and allow for higher than expected public borrowing. The automatic stabilisers should be allowed to work. There seems little danger of the UK's public debt getting out of control. At some future date, when the economy is booming and tax revenues are buoyant, tax rates should not be cut; rather borrowing should be lower than planned and the public debt reduced.
George Buckley's picture George Buckley Deutsche Bank Disagree Confident
Weaker tax receipst have in part been due to the composition of employment growth (i.e. lower skilled and paid) but also due to the postponement of pay following the cut in the top rate of income tax. This may well be recorded later this fiscal year, thus explaining why the OBR thinks income tax receipts will be back-loaded. As such, it may simply be a case of lags before we see an improvement in tax receipts. If growth remains strong going forward then this should aid receipts, reduce spending naturally (via AME) and help reduce the deficit.
Tony Yates's picture Tony Yates University of Birmingham Agree Confident
Yes it does, with a couple of qualifications. First, not yet. With monetary policy at the zero bound, and QE of uncertain furher impact, and inflation sliding somewhat, a fiscal tightening right now is not advisable. Second, it's plausible that productivity will bounce back, and that such tax increases cd be reversed later.
Wouter Den Haan's picture Wouter Den Haan London School of Economics Strongly Disagree Extremely confident
I can imagine that a case can be made for austerity even when the economy is doing poorly. For example, because this will comfort investors about long-run tax rates. But a policy in which any unexpected downfall in revenues lead to additional austerity really runs the risk of getting the UK into a downward spiral of more austerity, lower growth, lower tax receipts, more austerity, etc.