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Our inaugural Fiscal risks report Robert Chote Chairman 13 July 2017
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
