Select Committee on Treasury Minutes of Evidence


Memorandum submitted by Mr David Walton, Specialist Advisor

SUMMARY

  Following the UK government's Spending Review, total UK public spending in the three years from 2002-03 remains as set out in the Budget.

  Spending on front-line services is set to rise by a hefty 5.6 per cent a year in real terms during this Parliament, helped by low levels of spending on both unemployment benefits and debt interest. Discretionary spending will rise almost three times a year faster than achieved during Labour's first term and four times a year faster than when the Conservatives were in office.

  Despite these rapid increases in spending, the government's fiscal rules should continue to be met comfortably. The government's projections are based on reasonably central (though not cautious) economic assumptions.

  At a time when there is continued uncertainty about world economic prospects, fiscal policy will continue to support UK GDP growth this year and next.

THE UK CHANCELLOR'S SPENDING SPREE

  The UK Chancellor, Gordon Brown, has set out the government's detailed spending plans for the three year period from 2003-04 to 2005-06. As expected, there were no revisions to the overall spending totals set out in the Budget on 17 April 2002. These imply that in the three years covered by the Spending Review:

    —  Total government spending (known as total managed expenditure or TME) will rise 4.3 per cent a year.

    —  Current spending will rise 3.8 per cent a year.

    —  Public investment will rise 15.7 per cent a year to 2 per cent of GDP in 2005-06, up from 0.9 per cent of GDP in 2001-02 (the outturn for 2001-02 has been revised down by 0.3 per cent of GDP from the estimate in the Budget).

  Apart from the current/capital split, public spending is divided into two main components for planning purposes—departmental expenditure limits (DELs) and annually managed expenditure (AME). In the Spending Review, departments were allocated fixed three-year DELs. The remainder of spending which cannot be controlled within fixed departmental budgets—usually because it is demand-led (eg social security payments and debt interest payments)—is controlled within AME and reviewed annually. In the three years covered by the Spending Review:

    —  AME spending is projected to grow by 3 per cent a year in real terms.

    —  DELs are planned to grow by 5.2 per cent a year in real terms. Within DELs, spending on the National Health Service will rise by 7.3 per cent a yer in real terms (as previously announced in the Budget). The other big winners were education and transport with annual real rises of 5.7 per cent and 8.4 per cent respecively.

HOW DOES SPENDING COMPARE WITH PREVIOUS GOVERNMENTS?

  Table 1 compares public spending under Labour with the Conservatives. During Labour's first term, TME grew by just 1.1 per cent a year in real terms—in line with public spending growth during the Thatcher years and well below that achieved during the Major government (2.6 per cent a year). Labour's plans for its second term are much more ambitious. TME is planned to rise by 4.3 per cent a year over the five years of this Parliament. For the whole of Labour's period of office since May 1997, TME is planned to grow by 2.9 per cent a year compared with 1.6 per cent a year under the previous 18 years of Conservative rule (see Graph 1).

Table 1

PUBLIC SPENDING COMPARISONS
Average annual % change
2001-02 prices
Total Managed ExpenditureDiscretionary Total Managed Expenditure*
Conservatives
1979-80 to 1996-971.6 1.4
Thatcher (1979-80 to 1990-91)1.1 1.0
Major (1991-92 to 1996-97)2.6 2.2
Labour
1997-98 to 2005-062.9 4.0
Blair-1 (1997-98 to 2000-01)1.1 1.9
Blair-2 (2001-02 to 2005-06)4.3 5.6

*Excluding cyclical social security spending and debt interest payments. Partially estimated by Goldman Sachs.

  The growth in discretionary public spending is even more striking, stripping out cyclical social security spending (primarily unemployment benefits) and debt interest payments (see Graph 2). A combination of lower unemployment, lower interest rates and a sharp fall in the share of public debt in GDP means that much more of Labour's spending is on front line services compared with previous governments. Discretionary TME is set to rise by 4 per cent a year in real terms between 1996-97 and 2005-06—almost three times as fast as the 1.4 per cent a year achieved by the Conservatives. During the current Parliament, spending is planned to increase at an annual rate of 5.6 per cent a year. This is almost three times a year faster than achieved during Labour's first term and four times a year faster than that achieved when the Conservatives were in office.

ARE THE SPENDING PLANS AFFORDABLE?

  Despite these rapid increases in spending, the government's fiscal rules should continue to be met comfortably. On Goldman Sachs' economic forecasts, which are very similar to the Treasury's, the current budget is in surplus by around Ø per cent of GDP in 2006-07 while the ratio of net public sector debt to DPG is around 30 per cent (see Graph 3).

  Of course, the public finances could be blown off course if the economy performs less well than the Treasury expects or if underlying tax revenues fail to grow at least as fast as nominal GDP growth (note that the outturn for tax receipts in 2001-02 was £0.3 billion higher than estimated in the Budget). But it is reasonable to assume that the UK economy will grow by around a trend rate of 2Ö per cent in 2002-03 (GDP growth appears to have bounced back very strongly in 2002Q2 after two quarters of near stagnation) and in subsequent years. This assumption would only be too optimistic if the UK were already operating above potential which does not seem likely given the very low level of inflation (RPIX of 1.5 per cent in June 2002).

  At a time when there is continued uncertainty about world economic prospects, fiscal policy will continue to support UK GDP growth this year and next. After easing by 1.3 per cent of GDP in 2001-02, we estimate that the fiscal stance will ease by a further 0.9 per cent of GDP in 2002-03 and 0.4 per cent of GDP in 2003-04 (see Graph 4).





 
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