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 2016 Economic and Fiscal Outlook, we made a number of economy forecast adjustments to GDP, business investment, wage growth, inflation and the housing market.
This box considers the possible effects on the economy of the policy measures announced in this Budget. More details of each measure are set out in the Treasury’s documents. Our assessment of their fiscal implications can be found in Chapter 4 and Annex A.
The Government has loosened fiscal policy in the short term, reflecting net tax reductions and increases in Departmental Expenditure Limits (DELs), both current and capital. The Government has then increased the pace of fiscal tightening significantly in 2019-20, accounted for by net tax increases and lower spending on welfare, public services and capital investment. To reflect these changes in our economy forecast we have applied the same ‘multipliers’ we have used in previous forecasts. These are larger the shorter the period between a policy being announced and implemented. They imply a 0.1 percentage point boost to real GDP growth in 2017-18 and 0.1 percentage point reductions in both 2018-19 and 2019-20. These effects are sufficient to push the economy slightly above its potential level in 2017 and 2018 and slightly below in 2019, with the output gap closing by the end of 2020. The Government adjusted its plans for capital investment in 2020-21 after we closed our economic forecast. At this horizon we would assume that the multiplier has tapered to zero, so incorporating this adjustment would have no effect on our forecast for real GDP, although it would have had a small effect on the composition of expenditure.
The Budget includes two measures that are expected to affect the cost of capital faced by firms and therefore business investment – a reduction in the corporation tax rate to 17 per cent in 2020-21 and restrictions on corporate interest deductibility. We also adjusted our forecast to reflect one additional measure, but the Government informed us that it would not be going ahead after our final economy forecast had been closed. As a result, our business investment forecast is around 0.5 per cent higher in 2020-21 than would be consistent with the final policy package announced in the Budget. The net effect of the other two measures was small.
The Government has announced that termination payments over £30,000 will be subject to employer National Insurance Contributions. In the near term we expect the additional cost to employers to be reflected in lower wages and profit margins, with the majority of the cost passed through to wages by the end of the forecast period. This implies a reduction in total wages and salaries of 0.1 per cent by 2020-21.
The Budget includes a number of policies that are likely to affect housing associations’ finances. They include changes to ‘pay to stay’ (which is to be made voluntary rather than mandatory for housing associations, while rents above income thresholds are to be subject to a taper rather than a cliff edge); a one-year deferral of the capping of social sector rents in line with local housing allowance eligible rents; and a one-year deferral of the 1 per cent reduction in social rents for supported housing. We expect these measures to affect housing associations’ future housebuilding decisions, reducing total residential investment by 0.7 per cent by 2020-21.
The Government has announced the introduction of a ‘lifetime ISA’ for the under-40s. Contributions into the lifetime ISA will be made out of taxed income, then matched and not subject to tax when accessed, with an annual contribution limit of £4,000. Holders of lifetime ISAs will be allowed to make 100 per cent withdrawals for first-time house purchases up to £450,000. We think this is more likely than not to lead to higher demand for the relatively fixed supply of housing in the UK, and so to higher prices. We have therefore added 0.3 per cent to the level of house prices by the end of the forecast, although the effect of this policy is highly uncertain.
The Government has announced a number of policies that we expect to have an impact on inflation. The implementation of a soft drinks industry levy has the largest effect, and is expected to add around a quarter of a percentage point to CPI growth in 2018-19. We have also made small adjustments for several other policies announced in this Budget. The effects of these measures are small and broadly offsetting, and taken together imply almost no change to our CPI forecast. Measures which are expected to slightly increase CPI inflation across the forecast period include increases in tobacco duty and insurance premium tax, and measures to combat VAT fraud. Other policies are expected to reduce CPI inflation slightly, including the freezes to fuel and most alcohol duties. The replacement of the carbon reduction commitment with a higher climate change levy is also expected to lower inflation: while the net effect of these energy policies is to increase costs for medium sized companies, they reduce costs for large companies that make up a higher proportion of turnover. We expect this fall in costs to be passed through to consumers.
This box was originally published in Economic and fiscal outlook – March 2016