A unique collaboration between the TaxPayers' Alliance (TPA) and leading economic forecaster the Centre for Economics and Business Research (CEBR) reveals the worrying vulnerability of the public finances, and the dangerous reliance of the Treasury on optimistic predictions of the future economy. Given the Treasury's track record of making highly optimistic assumptions to balance their Budgets, the report uses detailed economic modelling of the UK economy using the experiences of comparable economies in past recessions to stress test the 2009 Budget. Testing the Budget's calculations for the public finances first in a moderate scenario of a slower, shallower recovery than the Treasury are predicting and then in a more pessimistic "double dip" recession revealed the potential for national debt to spiral over £2.3 trillion and for unemployment to reach 3.8 million - both far higher than the Treasury is willing to accept. The CEBR also tested the impact on public finances, economic growth and unemployment of the proposed 50p tax rate and an even more wide-ranging programme of tax rises.
The full report can be downloaded here (PDF).
1) Stress-testing the 2009 Budget:
Debt and Unemployment:
The Treasury’s optimistic forecasts of economic growth could radically underestimate national debt and unemployment figures:
National Debt: The Government predicts national debt of £1.54 trillion by 2017/18, but the CEBR’s double dip scenario projects debt to top £2.34 trillion by that year. Even in the CEBR's moderate scenario, national debt would reach £2.1 trillion.
Unemployment: The Treasury’s projections for the economy imply unemployment of 2.8 million people in 2011, whilst the CEBR’s pessimistic scenario modeling estimates that number could instead reach 3.8 million. The CEBR's moderate scenario would see unemployment reach 3.2 million.
The Treasury must come clean about the risks they are running with the future of the economy and the public finances – the potential £800 billion of extra debt and 1 million extra unemployed cannot be ignored.
Public Spending and Debt Repayment:
The Treasury’s self-imposed temporary fiscal rule that government debt should begin to decline as a share of GDP by 2017/18 which they believe will be met, will be breached not just in a pessimistic economic scenario but also under CEBR's moderate central growth forecasts. In even a moderate scenario, central government spending would need to be reduced by £45 billion in order to meet the rule. This would equate to reducing government spending by 1 per cent in nominal terms or 3 per cent each year from 2010/11 to 2017/18. The Government must accept that they will need to reduce spending to have a decent prospect of meeting their own targets of reducing the debt burden.
2) Alternative Tax Policies:
Having stress-tested the Budget as laid out by the Government, CEBR also tested the dynamic impact on the economy and on the public finances of attempts to raise taxes in order to reduce the public deficit.
The two policies tested were:
(i) implementing the increase in higher rate income tax from 40 per cent to 50 per cent, which is set to come in in 2010/11.
(ii) a broader programme of tax rises - increasing the basic rate of income tax to 25 per cent, the higher rate of income tax from 40 to 50 per cent and the rate of corporation tax to 31 per cent
The research finds that as a result of the dynamic supply side impacts of these taxes:
(i) the 50p tax rate alone will reduce economic growth by 0.4 per cent of GDP, increase public borrowing by £1.8 billion a year and increase the base unemployment rate by 0.8 per cent by 2020/21.
(ii) a broad programme of tax rises would initially raise an extra £15 billion a year for the Exchequer in the first three years, but that short term gain would swiftly decline to a situation of costing the Treasury £33 billion a year by 2020/21.
The full report can be downloaded here (PDF).
Matthew Sinclair, Research Director of the TaxPayers' Alliance, said:
"The Treasury has a track record of overly optimistic economic projections in order to make their sums add up. If they are wrong about the length and depth of the recession, then taxpayers will be landed with an even bigger national debt bill and even higher unemployment. The Government must come clean about the economic prospects and cut back spending or our economic recovery will be hobbled by the burden. It was wrong for them to overstate the health of the public finances when times were good, but now we are in a crisis we need honesty and realism to avoid a disaster. The current strategy of keeping their fingers crossed and trying to ignore massive risks is highly irresponsible."
Matthew Elliott, Chief Executive of the TaxPayers' Alliance, said:
"This collaboration between the TPA and the CEBR is a great step forward in focussing a spotlight on the Treasury's financial plans and for informing the public policy debate on how to escape recession and create jobs. For far too long the Government have claimed to have the best forecasts in the business, but their predictions almost always prove overly optimistic. The Treasury have assumed an unlikely Darling Bounce will take place, but in reality the recovery may be far slower or we could even face a double dip recession. It is important to make sure that the public finances are planned on the basis of realistic forecasts. Without that, taxpayers are constantly left filling unplanned for black holes in the Treasury's sums. This piece of research is part of an ongoing collaboration as we expand our work in the field of hard economic research."
Douglas McWilliams, Chief Executive of the CEBR, said:
“Our report highlights the state of public finances by considering different scenarios for the strength of the economic recovery. We find that the 2009 Budget took no serious action to control public borrowing – which is only a sustainable path under the most optimistic assumptions for growth. The most likely outcome is for the government to be forced into implementing major public spending cuts during the next parliament."