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 the July 2015 Economic and fiscal outlook, we made a number of adjustments to real and nominal GDP, the labour market, inflation, business and residential investment, 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 Budget document. Our assessment of their fiscal implications can be found in Chapter 4 and Annex A.
The Government has announced significant changes to the pace and composition of the fiscal consolidation. Resource departmental expenditure limits (RDELs) have been cut slightly this year, but are then significantly higher over the remainder of the forecast than in March: by around £17 billion in 2016-17, £27 billion in 2017-18, £28 billion in 2018-19 and £12 billion in 2019-20. This additional spending is partly offset by cuts to welfare spending (AME) and net tax increases, but is also financed by higher government borrowing through to 2018-19.
In order to reflect these changes in our economic forecast, we have applied multipliers to them, as described in Box 3.2. This leads to a downward adjustment to real GDP growth of 0.1 percentage points in 2015-16 and an upward adjustment of 0.2 percentage points in 2016-17. Changes to the fiscal path in later years have negligible effects on real GDP growth, as the multipliers are assumed to diminish over time. The direct effect of changes in RDEL on the GDP deflator – via the government consumption deflator – means that the effects on nominal GDP growth are larger and more persistent. They imply an adjustment to nominal growth of -0.2 percentage points in 2015-16; 1.0 percentage points in 2016-17; 0.3 percentage points in 2017-18; -0.1 percentage points in 2018-19 and -0.6 percentage points in 2019-20.
The Government’s decision to introduce a Living Wage Premium on top of the National Minimum Wage has led us to make a number of small adjustments to our forecasts of employment, average hours, wages and inflation. Annex B sets out further details of these judgements. In aggregate we have made a small downward revision to the level of potential output – and therefore real GDP – of around 0.1 per cent by the end of the forecast period.
The Government has announced significant cuts to welfare spending. This includes a four-year freeze to working-age benefits, and other cuts to tax credits, universal credit and housing benefit, including a reduction in payments resulting from requiring social sector landlords to reduce rents. We estimate the direct effect of the welfare cuts on overall aggregate demand by applying the appropriate multiplier to the total change in AME spending. But these measures may also affect work incentives and therefore potential labour supply. Given that the package includes cuts to both in-work income and out-of-work income, we have not adjusted our labour supply forecasts for these measures. But there is clearly a risk that the net effect of these measures on labour supply is not neutral.
The Government’s decision to impose 1 per cent annual rent reductions in the social rented sector for four years from April 2016 will directly reduce social landlords’ rental income, and therefore their financing for, and returns to, investing in new housebuilding. To reflect this we have reduced our forecast for residential investment, proportionate to the expected reduction in rental income. This reduces private residential investment by around 0.7 per cent by the end of the forecast period. Around 37,000 ‘affordable homes’ were built by Housing Associations in England in 2013-14.a The adjustment would be broadly consistent with reducing housebuilding by housing associations by around 4,000 in 2019-20, when the full effect of the policy on their rental income has been reached. Over the forecast period, our assumptions suggest around 14,000 fewer ‘affordable homes’ will be built.
The Government has announced a number of measures that are expected to affect the cost of capital faced by firms, and therefore the level of business investment. These include: a reduction in the main rate of corporation tax from 20 per cent to 19 per cent in 2017-18 and a further reduction to 18 per cent in 2020-21; a permanent increase in the annual investment allowance (AIA) to £200,000 from January 2016, from its previous permanent level of £25,000; and the introduction of a supplementary tax on banking sector profits set at 8 per cent from January 2016. The net effect of these measures is to increase the level of business investment by around 0.6 per cent by the end of the forecast period. The bringing forward of quarterly corporation tax payments for large companies will have an effect on companies’ cash flow in 2017. As larger companies are more likely to have access to a range of funding sources, we do not expect this to have a significant effect on business investment.
This Budget includes a number of policies that we expect to have an impact on inflation. These are generally small and offsetting, with the level of prices at the end of the forecast little changed. The largest impacts that we incorporated into the forecast come from the forced cuts in social rents, which are expected to lower CPI inflation by up to 0.1 percentage points from 2016-17 to 2019-20, and the change in vehicle excise duty (VED) rates, which we expect to increase CPI inflation by around 0.1 percentage point in 2017-18 and have smaller effects thereafter. An increase in the rate of insurance premium tax (IPT) and the introduction of the Living Wage Premium are expected to lead to small increases in inflation. The changes in the VED and IPT rates we incorporated into the economy forecast are different to the final policy decisions. We also incorporated a tobacco measure that did not go ahead. The Government informed us of changes to these policies after the deadline for including them in our final economy forecast. Incorporating the final design of these policy changes would have had less than a 0.1 percentage point impact on our inflation forecast.
There are a number of measures that could affect the housing market. The introduction of a ‘main residence nil rate band’ in the inheritance tax regime is likely to increase the incentives for housing purchases and to discourage individuals from selling their homes. On the other hand, the restriction in mortgage interest rate relief to the basic rate is likely to reduce returns to buy-to-let property. Overall, we estimate that these measures will have small and offsetting effects, and so we have not adjusted our forecast for house prices. Changes to the inheritance tax regime could make it more likely that the co-existence of under-occupation among older owners and over-crowding among younger renters will become even more prevalent. It is not clear to what extent that might affect regional labour mobility or other issues relevant to our macroeconomic forecast, so we have not made any adjustments on account of this.
This box was originally published in Economic and fiscal outlook – July 2015