BRIEFING PAPER Number 7290, 20 November 2015 By Matthew Keep Daniel Harari Background to the 2015 Richard Keen Steven Kennedy Spending Review and Feargal McGuinness Chris Rhodes Autumn Statement Djuna Thurley Dominic Webb Inside: 1. Spending Review 2. Economic situation 3. The public finances 4. Benefits and tax credits 5. Welfare cap 6. Pensions www.parliament.uk/commons-library | intranet.parliament.uk/commons-library | [email protected] | @commonslibrary Number 7290, 20 November 2015 2 Contents Summary 3 1. Spending Review 4 1.1 Public spending in context 4 1.2 The ‘spending envelope’ 5 1.3 Changes in spending, 2010/11 to 2019/20 6 1.4 Departmental budgets 7 Changes to departmental spending since 2010/11 8 Protected and unprotected departments 9 Devolved administrations 10 1.5 Single departmental plans 11 2. Economic situation 13 2.1 Growth and economic conditions 13 Forecasts 15 2.2 Productivity 17 2.3 Inflation and monetary policy 18 2.4 Labour market 20 2.5 Current account 21 3. The public finances 23 3.1 The deficit: public sector net borrowing 23 3.2 Structural borrowing 24 3.3 Public sector net debt 25 4. Benefits and tax credits 27 4.1 Background: £12 billion of savings 27 4.2 Tax credits: proposed changes 27 4.3 Tax credit changes: rejection by the Lords 28 4.4 Mitigation: possible options & comment 29 Personal Allowance & the National Living Wage 29 Universal Credit changes 30 Housing Benefit changes 30 Transitional tax credit arrangements 31 5. Welfare cap 32 5.1 How the cap works 32 5.2 What is included in the Welfare Cap? 32 6. Pensions 34 Appendix 1: Sources of further information 36 Appendix 2: Economic and public finance data 1979-2019 37 Contributing Authors: Daniel Harari, economic situation Richard Keen, tax credits Steven Kennedy, tax credits Feargal McGuinness, labour market Chris Rhodes, spending review and welfare cap Djuna Thurley, pension tax relief Dominic Webb, trade 3 Background to the 2015 Spending Review and Autumn Statement Summary The Chancellor of the Exchequer will present the joint 2015 Spending Review and Autumn Statement to Parliament on 25 November 2015. Spending Review and the public finances The Spending Review will set budgets for government departments and the devolved administrations for each financial year from 2016/17 to 2019/20. Day-to-day spending is set to fall by £18 billion or 6% between 2015/16 and 2019/20 in real terms, meaning that many departments will see budget reductions. Some departments are protected from spending reductions, including the NHS, some schools spending, defence spending and the international development budget. This means that other departments will see larger reductions, in many cases on top of reductions seen over the previous Parliament. Reducing departmental spending forms part of the Government’s plan for shrinking the budget deficit – the difference between what the public sector spends and receives in taxes. Despite falling during the previous Parliament, the budget deficit remains high, and was £90 billion in 2014/15. The Government aims to eliminate the deficit by 2019/20. The Office for Budget Responsibility’s (OBR’s) latest forecast put the Government on course to meet its target. Public sector net debt – the stock of borrowing arising from past deficits – remains high by international standards at around 80% of GDP. Benefits and tax credits and other potential announcements Having been defeated in the House of Lords, the Chancellor is committed to announce revised plans for changes to tax credits and benefits. Plans announced in the Summer Budget 2015 resulted in £12 billion of savings in 2019-20, around 45% of which were savings from tax credits – affecting around 3.3 million in-work families. The OBR will report on whether it expects relevant welfare spending to meet or exceed the welfare cap set by the Government for the forthcoming year. We may also expect an update on consultations carried out over the summer on pension flexibilities. Economic situation The Chancellor makes his statement at a time of healthy economic growth. Most economists expect growth in 2015 to be around 2.5%, with a similar figure forecast for 2016. Strong consumer spending is expected to support growth in the short term, as real (inflation-adjusted) household incomes rise: this is due to the combination of a recent acceleration in wage growth and near-zero inflation. Risks to the outlook come chiefly from a slowdown in emerging economies and if productivity growth fails to improve as is expected. The labour market continues to improve: the unemployment rate is near its pre-recession level and a record-high proportion of the working-age population are in work. Average earnings growth has accelerated and earnings are now growing faster than during the previous five years. Nevertheless, average earnings growth is still slower than it was before the recession. Number 7290, 20 November 2015 4 1. Spending Review Summary The 2015 Spending Review will be held on 25 November, and will set departmental spending limits for each financial year from 2016/17 to 2019/20. Government figures published in the 2015 Summer Budget indicated that day-to-day spending will fall by £18 billion or 6% between 2015/16 and 2019/20 in real terms, meaning that many departments will see budget reductions. Some departments are protected from spending reductions, including the NHS, some schools spending, defence spending and the international development budget. This means that other departments will see larger reductions, in many cases on top of reductions seen over the previous Parliament. Spending limits will also be set for the devolved administrations. The Barnett formula will calculate annual changes in these limits based on annual changes in the spending limits of UK departments. 1.1 Public spending in context In 2015/16, Total Managed Expenditure (all public spending) will be £742 billion, 40% of GDP. This is marginally below the average over the last 60 years, from 1955/56 to 2014/15, of 41% of GDP. It is forecast to fall to 36% of GDP in 2019/20. The years from 2009/10 onwards have been the most prolonged period of spending restraint since the Second World War. Public spending has fallen in real terms on only a handful of occasions, and after these occasions spending began rising again after one or two years. Annual % change in public spending (real terms) 12% By 2019/20, 10% Forecasts spending will have 8% been falling or growing by less than 6% 0.5% in real terms 4% each year for a decade. 2% 0% -2% -4% 1955-56 1965-66 1975-76 1985-86 1995-96 2005-06 2015-16 The current period of austerity is also noteworthy because it contrasts strongly with the immediately preceding era. Between 2001/02 and 2009/10, total public spending grew by 4% a year on average. This is 1.5 percentage points higher than average annual growth in the period 1955/56 to 1999/00. 5 Background to the 2015 Spending Review and Autumn Statement Box 1: Types of public spending The spending review only deals with 47% of all government spending. The rest is apportioned on a demand-led basis. There are two different kinds of public spending: • Departmental Expenditure Limits (DEL) – the focus of the spending review. The predictable part of public spending, including public sector workers’ salaries. DEL accounts for £351 billion of public spending, 47% of the total. • Annually Managed Expenditure (AME) – not included in the spending review. AME is demand-led spending which it is more difficult for forecast with accuracy. It includes welfare payments and government debt interest payments. AME accounts for £391 billion, 53% of the total. DEL and AME spending can be divided by function: • Resource spending (also known as current spending) is spending that is used up and recurs each year, such as salaries and welfare spending. Current spending accounts for 91% of all spending. • Capital spending is spending on assets that last for a number of years, such as land, buildings and computers. Capital spending accounts for 9% of all spending. The Spending Review will only deal with DEL spending. Although the allocation of capital spending will also be formally announced at the spending review, the Review’s main focus will be on resource spending. In 2015/16, resource DEL spending will be £315 billion. 1.2 The ‘spending envelope’ In the 2015 Summer Budget, the Government set out the implied ‘spending envelope’, that is, the total amount available for Government spending in each year between 2016/17 and 2020/21.1 Resource DEL spending (the kind of spending that will be dealt with in the Spending Review) is set out in the following table. Resource DEL spending in the 2015 Spending Review period £ billions Real terms DEL spending will be 2015/16 Change on year Nominal % change £297 billion in prices £ billions 2019/20, 6% lower 2015/16 315.1 315.1 - - than in 2015/16 2016/17 318.8 313.5 -1.6 -1% (15/16 prices) 2017/18 316.7 305.9 -7.6 -2% 2018/19 316.2 299.7 -6.2 -2% 2019/20 320.3 297.4 -2.4 -1% Change 2015/16 to 2019/20 5.2 -17.7 -6% Source: Office for Budget Responsibility, Economic and Fiscal Outlook, July 2015, Table 4.17 HM Treasury, GDP Deflator, October 2015 1 The DEL figures in the Budget and corresponding OBR documents are implied – confirmed figures will be published in the Spending Review Number 7290, 20 November 2015 6 So, the 2015 Spending Review will apportion total real terms reductions in spending of £18 billion by 2019/20.