Evanomics

Return to normality

• Evan Davis | Notes on Real Life |
• 5 Oct 07, 08:51 AM

Among the many highlights of the Pre-Budget Report will be an update of the government’s borrowing forecasts for the next few years.

Alas, the revisions to be made may not be in the most attractive direction. So far this financial year, government borrowing has deteriorated not improved. Tax revenues are coming in below expectations.

The missing money might come in later as the figures are always volatile and were very volatile last year. But it seems that corporation tax in particular is not as lucrative as the Treasury thought it would be.

As a result the government is set to borrow about £5 billion this year, on its “Golden Rule” measure of borrowing ie the amount it borrows in excess of the amount it invests in long term capital projects.

The economy has hitherto been strong not weak, so there is no obvious explanation for the shortage of cash.

Now there’s no need to pour blame on to the Treasury for getting it wrong this year. They are only one or 2% adrift on their revenue forecasts, and it’s hard to predict tax revenues more precisely than that at the best of times. And they may still turn out to be right – we’re not even halfway through the year.

But it does have to be said that in recent history the government’s forecasts have usually turned out to be too optimistic. And there’s quite a bit of history to this which is worth re-visiting now, as we see the borrowing problem remain as stubborn as it is.

Before the 2005 election, the government was warned that it was being too optimistic in its revenue forecasts; not just by oddballs and opponents but by the consensus of credible expert opinion.

Indeed, in January 2005, the Institute for Fiscal Studies (the most respected independent analysts of the public finances) published projections showing that unless the government changed policy by raising taxes or cutting spending, it would be borrowing £10 billion this year (on the Golden Rule measure).

Two months later, Gordon Brown published projections showing a surplus of £4 billion for this year. In other words, there was a £14 billion gap between the chancellor and the IFS.

Since those projections were made in 2005 there have been four Budgets or pre-Budgets, which have between them announced tax rises raising £4 billion this year.

So, if we do end up borrowing £5 billion this year, the IFS will be seen to have been almost bang on back in 2005, while the chancellor was overly-optimistic by about 13 billion.

Ironically, at the time the Treasury said of its forecasts “The use of cautious assumptions audited by the National Audit Office builds a safety margin into the public finance projections to guard against unexpected events”. This was seen as incredible at the time, and with hindsight people were right to have viewed the use of the word “cautious” with scepticism.

However, a consequence of those overly optimistic Treasury forecasts was that inadequate action was taken to sort out the borrowing problem, and the borrowing has persisted.

Of course, deficits don’t always matter. Governments expect to run surpluses in the economically buoyant years and run deficits in the downturn years. Then the two average out over the cycle as a whole.

But we have been in deficit for the last six years and these do not feel like they have been sluggish. Observing strong corporate profits, the private equity boom, the way house prices have moved and consumer spending, it doesn’t feel as though we have been in years of famine with the feast about to start and with tax revenues now just starting to ready themselves to walk through the door of the exchequer.

If anything, with the credit crunch biting in the City it feels as though the boom is coming to an end and normality is about to return. That’s why forecasters universally think growth next year will be slower than this year.

If the economy is in for a few slower years, (and that is still a big “if”) the new chancellor might wish his predecessor had sorted out the borrowing earlier on.

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