The risk UK public finances face

The Office of Budjet Responsibility (OBR) publish his report on the risks the public finances of the United Kindom face. The OBR conduct fiscal stress test in order to calculated the risk of public finances and the impact that it may have on UK economy.

The Office of budget responsibility (OBR) in his fiscal risk report published in June 2017 considers that the UK public finances are in a weaker state than the period before the financial crisis of 2007-2008. The UK fiscal watchdog as the OBR is called warns that overall the public finances of the country are unable to face the twin threats of a recession or Brexit. According to OBR another recession is possible in the long term (a period of 50 years) as the history of financial crisis particularly shows (the estimated possibility is one to four for a financial bust) and the recent election results with the failure of the conservative party to win a majority had left the public finances to be more venerable than the 2007 period. The main message of the report as is expressed in the Press Notice by OBR is: ‘’ Governments should expect nasty fiscal surprises from time to time – because policy can only reduce risks, not eliminate them – and plan accordingly. And they have to do so in the context of ongoing pressures that are likely to weigh on receipts and drive up spending and a variety of risks that governments choose to expose themselves to for policy reasons’’

The statement from the OBR is true for any government in any country but the British government has to manage the uncertainty posed by Brexit. The Fiscal report doesn’t concern as a major issue the ‘’divorce’’ bill which up until now is estimated between 50 to 75 billion pounds and currently a matter of dispute between Brussels and London. The danger that a Brexit agreement may have is in Public finances and more importantly in the prospects of growth of British Economy. During the fiscal stress test the OBR conducted if GDP and receipts increase 0.1 percent slowly for the next 50 years and spending growth remain unchanged then the debt to GDP ratio will be increase by 50%. This could be caused by the uncertainty over the fiscal stability the Brexit agreement will have on subjects such as: how new trading agreements will affect economic growth, how the new migration policies will affect the working-age population growth, if will be any period of cyclical weakness during the exit date.

To become more specific according to the estimations the OBR has calculated the Brexit agreement will affect exports and imports, productivity, Business investments, migration and a number of sectors like the financial sector. The net trade could be affect by the openness of the trade regime the UK will follow with EU and non-EU countries. For example a more restrictive trading regime with the EU could lead to both lower exports and lower imports, but a more open regime including free trade agreements with countries outside the EU could boost them. Since the effect on trade flows could be positive or negative the effect on GDP will show through the expenditures sector. Productivity could be affected negative if the trade regime is more restrict than anticipated, although others assume it would rise because of the deregulation in some areas. The historical norms play a crucial role in the productivity subject. If the persistent weakness of productivity in recent years became the norm, then Brexit will add to the uncertainty over the GDP growth and the fiscal position of the country. The calculations shows that any 0.1 percent less productivity growth each year over a 50-year horizon would leave the economy 4.8 per cent smaller than would otherwise be the case, which is equivalent to £97 billion in today’s terms.

Business investments fall by 1.5% in 2016 as result of the uncertainty before the referendum, since firms delayed investments projects ahead of the vote and after the referendum trying to anticipate the implications for the UK market. Since any negotiations are unpredictable this could lead to increasing uncertainty and investments volatility. In near term conditions weakness in investments is the positive outcome for public finances but also is negative for the long term. The migration and the policies the UK government will follow on the matter also have an uncertain impact in public finances. How many will be allow to migrate in UK what benefits will be allow to have access how they will be taxed, what will be their insurance conditions, are matters that affect the public finances particularly tax receipts and public expenditures of the welfare system.

The uncertainty of the Brexit agreement is one factor that pose a threat for public finances, other factors are the political instability a government has when has lost its majority in parliament, the “austerity fatigue” of the population, alongside longer-term developments such as a rapidly ageing population putting upward pressure on the deficit. More specific the Office of Budget Responsibility (OBR) refer to the issue of revenue risks which subdivided in tax receipts and public spending. The categories that pose a risk for the tax revenues are: the tax base, tax raised from a given tax base, and tax policy .The revenues from some tax bases are not increase at the same pace as the economy, characteristic paradigms are the fuel duty (as engine efficiency continues to improve) and tobacco duty (thanks to the decline in smoking). The risk associated with declining North Sea oil and gas tax base has largely crystallized, but future repayments associated with decommissioning costs represent a risk for further revenues.

The second category refers to what HMRC name tax gap. This is the difference between what is and should be collected from individual taxes. The gap is ranging between 1 to 20 percent; a similar matter is the downward pressure on the tax-to-GDP ratio from rising self employment and incorporations, reflecting people’s choices of employment status and the different tax rates applied to the associated income types. Governments try to offset this effect by raising taxes elsewhere. Tax policy is also affecting the revenues when the government announces and then abandons a number of revenue-raising measures. Primary spending risk that could lead to upward pressure in the deficit are the Welfare spending and the Health and adult social care spending. Although there are other spending issues that the report of the OBR consider these two have according to their estimations the bigger influence on public finances. Welfare spending is an important long-term risk to fiscal sustainability, as the ageing population and triple lock on up rating are expected to rise state pension spending as a share of GDP. Health and adult social care spending are subject to significant medium and long term pressures. The governments in recent year were able to reduce spending as percentage of GDP but in order to achieve it finds other means to fund the sector, providing additional money from the Treasury’s reserve, from new issue-specific funds for the health sector. Adult social care funding has been boosted by council tax rises and additional grants from central government. These indirect funding could further pressure the fiscal conditions of the government upward. Since the demographics of the ageing populations slowly will built an increasing demand for financing by the government budget, the OBR report and stress test consider this financing the biggest risk to fiscal sustainability for the UK economy.

The stress test conducted from the Office of budget responsibility (OBR) is similar with those the Bank of England conducts for the Banks. The results regarding the Public debt shows that public sector debt could be rise to 114 percent of GDP, so the government must shore up the deficit in order to avoid the UK finances to become unsustainable. Currently the budget is still in deficit by 2 to 3% of GDP and public debt is at 80 percent of GDP amount to 1.6 trillion pounds which is twice the level before the financial crisis of 2007-2008 but below some other major economies as the USA, France and Japan.