In each Economic and fiscal outlook we publish a box that summarises the effects of the Government’s new policy measures on our economy forecast. These include the overall effect of the package of measures and any specific effects of individual measures that we deem to be sufficiently material to have wider indirect effects on the economy. In our March 2012 Economic and Fiscal Outlook, we made adjustments to our forecasts of real GDP, business investment and inflation.
This box considers the possible effects on the economy of policy measures announced in Budget 2012. More details of each measure are set out in the Treasury’s Budget document and our assessment of the fiscal implications can be found in Chapter 4.
The Government has announced policy measures that are expected to have a broadly neutral fiscal impact overall and, in aggregate, they have had limited effect on our economic forecast. The main effect is from the reduction in the main rate of corporation tax, which we estimate will reduce the cost of capital faced by firms and increase the level of business investment by 1 per cent over the forecast period. This judgement is the same as was reached by the interim OBR with regards to the cut to the corporation tax rate in the June 2010 Budget. Given that output is below potential across the forecast period, we assume no offset from monetary policy, leading to a very small increase in the level of GDP of 0.1 per cent by the end of the forecast period.
We have adjusted our inflation forecast for measures that directly influence the price level, including the increase in tobacco dutyand the widening of the VAT base. We have estimated that this will lead to a small upward effect of 0.1 percentage points on the annual rate of CPI and RPI inflation in 2012-13. This is a permanent effect on the price level but a temporary effect on inflation.
There are a number of measures that increase real household disposable income, for example the raising of the personal allowance, the tapering of child benefits and the reduction in the additional rate of income tax. However, a number of other measures are likely to reduce real disposable income, including the changes to age related allowances and the widening of the VAT base. The net effect on real household disposable income is likely to be small and the effect on consumption will depend on differences between the marginal propensities to consume of the winners and losers.
Some of the measures announced in Budget 2012 could also have an effect on labour supply. Higher personal allowances may make it more attractive for those out of work to enter the labour market. The impact on those in work is less clear. For example, higher real incomes may lead some individuals to reduce their hours worked. Similarly, the reduction in the additional rate of income could affect the net inflow of high income workers from overseas, although the size and timing of such effects are highly uncertain. Some workers may have seen the additional rate as temporary which could limit the migration impact of the reduction. Given these uncertainties, we judge there is insufficient evidence, at present, to adjust our labour supply assumptions.
In its Autumn Statement, the Government announced a credit easing initiative aimed at reducing the cost of borrowing for small and medium-sized firms (SMEs). The largest part of that initiative is the National Loan Guarantee Scheme (NLGS). Under this scheme, the Government will guarantee up to £20 billion of new debt issued by participating banks against default, lowering its price. In exchange, the banks will pay the Government a fee. Banks are required to pass on the whole benefit they receive from lower funding costs to SMEs. The economic impact of the scheme will depend on the reduction in funding costs achieved and the amount of net additional lending that it leads to.
Since November, the Government has announced some further details on the design of the scheme, including the participating banks and the size of the first tranche, and it has received State aid approval from the European Commission. Under current funding market conditions, the Government guarantee on the first tranche should lead to lower funding costs and some additional net lending. The scale of the initial tranche is not large enough to have a material impact on our aggregate business investment forecast, but within this it should provide a boost to SME lending.
The benefits associated with further tranches are less certain. The value of the Government guarantee would fall if conditions in funding markets improve, which is the case in our central forecast. In such circumstances the extent to which the further tranches would lead to lower funding costs and net additional lending is uncertain. However, the initiative would help to protect SMEs against higher borrowing spreads, should funding costs stay higher for longer than we expect.
This box was originally published in Economic and fiscal outlook – March 2012