Our inaugural Fiscal risks report

Robert ChoteChairman

13 July 2017

Background

• The IMF’s 2016 UK Fiscal Transparency Evaluation said that

– “In many cases, the government’s control of risks falls short of the Code’s standards of good or advanced practice”

– “The absence of summary reporting of specific risks is a weakness that should be addressed”

• The Government has legislated for us to produce an FRR every two years, to which it is obliged to respond

• Several countries already produce risk reports, but usually from their finance ministries or cabinet offices

Our approach

• The IMF defines fiscal risks as– “the possibility of deviations of fiscal outcomes from what

was expected at the time of the Budget or other forecast”

• In this report we focus on risks– To our latest (March 2017) forecast over the medium term– To fiscal sustainability over the longer term– With greater attention to downside risks in both cases

• We are interested in– Their probability and potential impact– Whether they are correlated with other risks– What the government is doing about them

Types of fiscal risk

• Increases in spending (one-off or persistent)

• Losses of revenue (one-off or persistent)

• ‘Stock-flow adjustments’

– Balance sheet transactions

– Balance sheet transfers (real-world or statistical)

– Balance sheet valuation changes

Structure of the report

• Introduction: analytical framework• Macroeconomic risks• Financial sector risks• Revenue risks• Primary spending risks• Balance sheet risks• Debt interest risks• A fiscal stress test• Conclusions

Structure of the report

• Introduction: analytical framework• Macroeconomic risks• Financial sector risks• Revenue risks• Primary spending risks• Balance sheet risks• Debt interest risks• A fiscal stress test• Conclusions

Including 57 issues that the Government might wish to consider in its response

-4

-2

0

2

4

6

8

10

12

1997-98 2003-04 2009-10 2015-16 2021-22

Public Sector Net Borrowing

Per

cen

t of

GD

P

March 2017 EFO

Public finances

0

20

40

60

80

100

1997-98 2003-04 2009-10 2015-16 2021-22

Public Sector Net Debt

Per

cen

t of

GD

P

March 2017 EFO

Public finances

Macroeconomic risks

• Risks to potential output growth– Including population and potential productivity growth

• Risks of a cyclical downturn

• Sectoral risks (especially housing)

• GDP composition risks

• Brexit-related economy risks

Population projections

50

55

60

65

70

75

80

85

90

1951 1971 1991 2011 2031 2051 2071

Mil

lion

s

Successive projections

2014

Actual

Total population

-150

-100

-50

0

50

100

150

200

250

300

350

400

1976 1988 2000 2012 2024 2036

Thou

san

ds

Successive projectionsActual2014

Net migration projections

-2

-1

0

1

2

3

4

5

6

7

8

1972 1980 1988 1996 2004 2012 2020 2028

Output per hour

Average

Per

cen

t

March2017 EFO

January2017 FSR

Productivity growth

The cycle and the public finances

-6

-4

-2

0

2

4

6

1975-76 1985-86 1995-96 2005-06 2015-16

Output gap

Per

cen

t

March2017 EFO

The cycle and the public finances

-4

-2

0

2

4

6

8

10

1975-76 1985-86 1995-96 2005-06 2015-16

Structural deficitCyclical deficitPublic sector net borrowing

Per

cen

t

March2017 EFO

Tax rates on components of GDP

Consumer spending

Business investment

Labour income

Corporate profits

-10

-5

0

5

10

15

20

25

30

0 20 40 60 80

Effe

ctiv

e t

ax

rate

GDP share

The housing sector

-40

-30

-20

-10

0

10

20

30

40

50

-8

-6

-4

-2

0

2

4

6

8

10

1969 1974 1979 1984 1989 1994 1999 2004 2009 2014

Real GDP growth (RHS)

Real house price inflation (LHS)

Perc

en

tag

e c

ha

ng

e o

n a

yea

r ea

rlie

r Perce

nta

ge ch

an

ge o

n a

yea

r ea

rlier

Bank balance sheets

0 250 500 750 2000 2250

LithuaniaSlovak Republic

PolandSloveniaHungary

EstoniaLatvia

NorwayItaly

AustriaBelgium

SpainFinlandSweden

GermanyPortugal

GreeceNetherlands

DenmarkFrance

IrelandUK

Luxembourg

Per cent of GDP in 2015

Costs of the financial crisis

• Direct – bailouts and nationalisations

– Upfront cost of £137 billion, but net cost estimated at £24 billion in March

• Indirect costs – via the hit to the economy

– Economy around 15 per cent smaller today than on pre-crisis trend. Around £300 billion of GDP lost in a single year

Revenue forecasts

31

32

33

34

35

36

37

38

39

2000-01 2004-05 2008-09 2012-13 2016-17 2020-21

Per

cen

t of

GD

P

Treasury forecastsOBR forecastsOutturn

Revenue risks

• Behavioural and technological change

• Oil and gas

• Avoidance, evasion and other non-compliance

• Changing work patterns

• Policy risks

• Concentration of tax receipts

Self-employment and incorporations

0

2

4

6

8

10

12

14

16

2000-01 2003-04 2006-07 2009-10 2012-13 2015-16

Self-employed (ONS definition)

Single director companies (HMRC definition)

Total company population (HMRC definition)

Per

cen

t

Tax paid on £50,000 income

0

2000

4000

6000

8000

10000

12000

14000

16000

18000

Employee Self-employed Single director

Dividend tax Corporation tax

Self-employed NICs Employer NICs

Employee NICs Income tax

Tota

l ta

x d

ue (

£)

The tax gap by type of tax

0

5

10

15

20

25

SA (IT,CGT)

Tobaccoduties

Alcoholduties

VAT CT(SMEs)

CT(Large)

PAYE(IT,

NICs)

AllHMRCtaxes

Per

cen

t

Actual and default fuel duty rates

45

50

55

60

65

70

75

80

2008-09 2012-13 2016-17 2020-21

Ma

in f

uel d

uty

ra

te (

pen

ce p

er

litr

e) June 2010 with outturn RPI

March 2017

Outturn rates

Shares of income and income tax

0

10

20

30

40

50

60

70

80

90

100

2007-08 2017-18

Per

cen

t

Share of total income

2007-08 2017-18

Top 1 percent

90th to99thpercentile

50th to90thpercentile

Bottomhalf

Share of total tax

Spending forecasts

32

34

36

38

40

42

44

46

48

50

2000-01 2004-05 2008-09 2012-13 2016-17 2020-21

Per

cen

t of

GD

P

Treasury forecasts

OBR forecasts

Outturn

Spending risks

• Welfare– Long-term: ageing and triple lock on pensions– Medium-term: reforms and legal challenges

• Health– Long-term: ageing and technology– Medium-term: pressures and ‘topping up’

Projected health and care costs

0

2

4

6

8

10

12

14

2016-17 2024-25 2032-33 2040-41 2048-49 2056-57 2064-65

Health Long-term carePer

cen

t

March2017 EFO

January 2017 FSR

Spending risks

• Welfare– Long-term: ageing and triple lock on pensions– Medium-term: reforms and legal challenges

• Health– Long-term: ageing and technology– Medium-term: pressures and ‘topping up’

Provisions and contingent liabilities

0

5

10

15

20

25

30

35

40

2009-10 2011-12 2013-14 2015-16

Remote contingent liabilities

Non-remote contingent liabilities

Provisions

Per

cen

t of

GD

P

Nuclear decommissioning costs

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2013-14 2033-34 2053-54 2073-74 2093-94 2113-14 2133-34

2012-13 projection

£ b

illion

Nuclear decommissioning costs

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2014-15 2034-35 2054-55 2074-75 2094-95 2114-15 2134-35

2013-14 projection

£ b

illion

Nuclear decommissioning costs

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2015-16 2035-36 2055-56 2075-76 2095-96 2115-16 2135-36

2014-15 projection

£ b

illion

Nuclear decommissioning costs

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2016-17 2036-37 2056-57 2076-77 2096-97 2116-17 2136-37

2015-16 projection

£ b

illion

Annual clinical negligence costs

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2005-06 2007-08 2009-10 2011-12 2013-14 2015-16

Existing Liabilities and Ex-Regional Health Authorities Scheme

Department of Health Clinical Liabilities Scheme

Clinical Negligence Scheme for Trusts

£b

illion

Spending control

• Departmental expenditure limits (DELs) a strength– But declining share of spending covered– And cash limits on welfare not very successful– DEL limits rarely overspent, but often adjusted

• Local government– Reserves being drawn down– Some risky commercial investment for revenue

Balance sheet risks

• Recent balance sheet shocks– Financial interventions and reclassifications

• Transaction risks– Student loans, financial asset sales, monetary policy and

housing schemes

• Transfer risks– Housing associations and ‘near government’ bodies

• Fiscal illusions– Asset sales, grant-to-loan, guarantees, off balance sheet

0

1

2

3

4

5

6

1973-74 1981-82 1989-90 1997-98 2005-06 2013-14 2021-22

Other public corporations

Local authorities

Central government net of the APF

Per

cen

t of

GD

P

March 2017EFO

Debt interest spending

Debt stock and debt interest

0.0

0.4

0.8

1.2

1.6

2.0

Stock

£ t

rillio

n

0

8

16

24

32

40

Debt interest

£ b

illion

Other debt

NS&Iproducts

Treasury bills

Index-linkedgilts

Conventionalgilts (APFholdings)Conventionalgilts (net ofAPF holdings)

Effective interest rate

(per cent)

1.61.5

0.53.4

0.4

2.6

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

Centralgovernment gilts

Plus Treasury billsand NS&I products

Plus central bankreserves tofinance APFpurchases

£ t

rill

ion

Over 10years

Up to 10years

Up to 5years

<1 year

Maturity of the debt stock

Stress test: real GDP

90919293949596979899

100101

0 1 2 3 4 5

Stress testLate 2000s2

00

8Q

1=

10

0, 2

01

7Q

1 =

10

0

Years from base

-3

-2

-1

0

1

2

3

4

5

6

0 1 2 3 4 5

Stress test

Late 2000s

Perc

en

tag

e c

ha

ng

e o

n a

yea

r ea

lier

Years from base

Stress test: average earnings

0

1

2

3

4

5

6

0 1 2 3 4 5

Stress test

Late 2000s

Per

cen

t

Years from base

Stress test: Bank Rate

Stress test: CPI inflation

0

1

2

3

4

5

6

0 1 2 3 4 5

Stress test

Late 2000s

Perc

en

tag

e c

ha

ng

e o

n a

yea

r ea

lier

Years from base

Stress test: net borrowing

0

2

4

6

8

10

12

2003-04 2009-10 2015-16 2021-22

Stress test

March 2017

Per

cen

t of

GD

P

0

20

40

60

80

100

120

2003-04 2009-10 2015-16 2021-22

Stress test

March 2017

Per

cen

t of

GD

PStress test: net debt

Stress test damage in 2021-22

£ billion Stress Test March 2017 EFO Difference

Public sector net borrowing: 175 17 158of which:

Spending 976 886 90Debt interest 110 44 66Welfare 255 240 15Other 611 602 9

Receipts 801 870 -69Capital and property taxes 53 77 -24Income tax and NICs 335 364 -28Other 412 429 -17

Stress test damage in 2021-22

£ billion Stress Test March 2017 EFO Difference

Public sector net borrowing: 175 17 158of which:

Spending 976 886 90Debt interest 110 44 66Welfare 255 240 15Other 611 602 9

Receipts 801 870 -69Capital and property taxes 53 77 -24Income tax and NICs 335 364 -28Other 412 429 -17

Conclusions: main risks

• Main medium-term risks– Economy: recession, weak productivity– Spending: debt interest, health, DELs– Policy: further fuel duty cancellation

• Main long-term risks– Economy: recessions and financial crisis– Spending: Ageing and health costs– Revenues: fuel, tobacco and work patterns

Giveaways today, takeaways tomorrow

-0.5

-0.4

-0.3

-0.2

-0.1

0.0

0.1

0.2

0.3

0.4

Year 1 Year 2 Year 3 Year 4 Year 5

Spending Review 2010 to Budget 2015

Summer Budget 2015 to Spring Budget 2017

All fiscal events since Spending Review 2010

Per

cen

t of

GD

P

Impact of policy measures in 2017-18

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

Dec12

Mar13

Dec13

Mar14

Dec14

Mar15

Jul15

Nov15

Mar16

Nov16

Mar17

Individual fiscal events

Cumulative effect

Per

cen

t of

GD

P

Net giveaways

Net takeaways

Conclusions: main risks

• Main medium-term risks– Economy: recession, weak productivity– Spending: debt interest, health, DELs– Policy: further fuel duty cancellation

• Main long-term risks– Economy: recessions and financial crisis– Spending: Ageing and health costs– Revenues: fuel, tobacco and work patterns

Conclusions: Brexit specific

• Economy related – Trade, productivity, investment, migration and

financial sector

• Spending related– Divorce bill, EU schemes, UK regulators,

negotiations/implementation, sector interventions

• Receipts related– Financial sector

Conclusions: lessons for policy

• Keep the risks that the Government has chosen to expose itself to under review

• Prepare for nasty surprises

• Take action on long-term pressures