https://cpes.org.uk/om/files/original/dbe0a71d58006fcd2a3a8d45dbcb625e.pdf 07c6a518eddbb0a626ff221ce741d014 Dublin Core The Dublin Core metadata element set is common to all Omeka records, including items, files, and collections. For more information see, http://dublincore.org/documents/dces/. Title A name given to the resource Economic Policy Review Volume 1 Description An account of the resource February 1975 No 1 Text A resource consisting primarily of words for reading. Examples include books, letters, dissertations, poems, newspapers, articles, archives of mailing lists. Note that facsimiles or images of texts are still of the genre Text. Text Any textual data included in the document Economic Policy Review CHAPTER 6 PUBLIC SPENDING AND TAXATION (I) by Terry Ward and Robert Neild Introduction The purpose of this chapter is to analyse public expenditure and revenue in order to present a forecast of the public sector financial balance in the coming financial year, 1975-76. If present tax rates and other features of fiscal policy remain unchanged, taking the January 1975 White Paper forecast of public expenditure and assuming the behaviour of the other major economic variables is as projected elsewhere in this study, the financial deficit in 1975-76 will be £M4 billion. This represents an increase of £2 billion over the latest estimate of the deficit in the current fmancial year, 1974-75. The chapter begins by examining in more detail the changes made to the estimate of public expenditure for 1974-75 since last March and the reasons for the revisions. Secondly, the course of public expenditure over the next four years, as presented in the January 1975 White Paper is considered in relation to previous forecasts. Thirdly, estimates have been made of what the financial deficit is likely to be both for the current financial year and, on the assumption of unchanged tax rates, for the coming year, 1975-76. In addition, an appendix is devoted to examining whether, given the present structure of taxation, a higher rate of inflation leads to an increase of the excess of public expenditure over revenue rather than the reverse. Public Expenditure in 1974-75 In his budget speech last March, Mr Healey announced that one of his main priorities in formulating fiscal policy was a reduction in the size of the public sector financial deficit, (2) which by 1973-74, had risen to £3 billion. This increase, he argued, was a major factor underlying the collapse of the previous Government's growth policy and the deterioration in the U.K. balance of payments position. The budget changes he made in March were forecast to reduce the financial deficit to £1.2 billion in the current financial year, 1974-75. In November 1974, however, this forecast, before the changes in taxation made in Mr Healey's second budget, was revised upwards to £4.1 billion, an increase of £2.8 billion (after allowing for the cut in the rate of VAT in July) between March and November. Such an enormous revision represents the equivalent of some 4 per cent of GDP and indeed is greater than any policy change in the financial balance introduced in any budget since 1950-51. (1) This chapter presents the first results of the project, "Full Employment Balance in the Budget," financed by the Institute of Fiscal Studies. (2) Defined as public expenditure, excluding transactions in financial assets, minus current receipts, capital taxes and transfers. An examination of the March and November estimates, published in the Supplementary Financial Statement and Budget Report, 1974-75, reveals that while anticipated revenue was revised upwards only slightly, the estimate of public expenditure was increased by almost £3.4 billion in total or by 9 per cent. One reason for this increase, Mr Healey claimed in his Budget speech, was "wage increases and other cost increases", which "increased public expenditure as outlined in the March budget in current price terms - but not in volume terms". This statement is by no means unambiguous, because it does not make it clear whether the estimates of volume had or had not been changed. In fact, as later acknowledged by the Treasury (in evidence to the Select Committee on Public Expenditure( 1)) part of the increase took the form of an unplanned addition of £550 million to the volume of expenditure on goods and services a rise of about three per cent. Nevertheless the apparent impact of unforeseen cost increases on the fmancial balance of the public sector has opened up the question whether it is a valid general proposition that an acceleration in inflation will increase government outgoings by more than receipts (see Appendix 6.2). Table 6.1 sets out the changes that have been made to the estimate of public expenditure in the present financial year, 1974-75, since the March 1974 budget. The overall percentage change between the two sets of estimates as far as goods and services are concerned has been approximately divided between that arising from a change in the volume of expenditure and that arising from a change in price - a division made possible by the details on changes to programmes given in the January 1975 White Paper. In total, the estimate of public expenditure for 1974-75 was revised upwards by 8.9 per cent between the March and November budgets, and subsequently seems to have been reduced slightly between November and January though this must be regarded as a very tentative observation given that it rests on what has happened to only part of the total - goods and services and debt interest. The main elements underlying the revision between March and January were increases in subsidies, which were raised by over 50 per cent, and in local authority expenditure, which, on current and capital account combined, was raised by over 12 per cent. As regards local authorities, it is clear that there was a very substantial upward revision to the March estimate of capital expenditure and that this was entirely the result of an increase in volume terms of almost 20 per cent. Of this, however, a large part consists not of additional construction, but of purchases of houses from the private sector coupled with fewer sales to council house tenants, both of which are included as capital formation by the public sector. (1) On 16 December, 1974. 46 - Public Spending and Taxation Table 6.1 Changes to the Estimate of Public Expenditure in 1974-75, between March 1974 and January 1975 £ million at Current Prices March 1974 January 1975 Percentage Change Real Price Total Current expenditure on goods and services of which: central government local authorities 15863 9441 6422 16993 9883 7110 0.8 6.3 7.1 0.7 4.0 4.7 1.5 9.1 10.7 Subsidies Debt interest Current grants to personal sector Current grants abroad Total current expenditure Gross domestic fixed capital formation plus increase in value of stocks of which: local authorities other Capital grants plus transfers Total capital expenditure, excl. financial transactions Total public expenditure, excl. financial transactions 2171 3429 8198 395 30056 6888 2574 4314 962 7850 37906 3302 3800 8250 375 32720 7402 2984 4418 937 8339 41059 52.1 10.8 0.6 -5.1 8.9 7.9 -0.4 19.7 -3.2 0 2.4 7.5 15.9 2.4 -2.6 6.2 8.3 Notes: The March estimates relate to the budget forecast published in Financial Statement and Budget Report, 1974-75. The January estimates are derived from the White Paper Public Expenditure to 19 78-79, Cmnd 5879, published in January 1975, especially Table 3.3. These estimates are supplemented by those contained in Supplementary Financial Statement and Budget Report, 1974-75, published at the time of the November budget. The breakdown of the total change into real and price terms is estimated from the details given in Cmnd. 5879, Table 3.13 and in the individual programmes. A revlSlon to the forecast of prices was the prime reason for the increase in the estimate of local authorities' current spending. Indeed, it would appear that the expected level of costs for 1974-75, which in this case are mainly wages and salaries, was over 9 per cent higher in January than was anticipated the previous March. In comparison, the price of central government current expenditure was revised upwards by only 4 per cent over the period. This would suggest significantly higher wage claims being granted to local authority workers than to those under the control of central government; alternatively, the possibility exists that the March estimate of pay and price rises was lower for the latter than for the former. There is certainly evidence that public sector wage rates increased relative to those in the private sector during 1974, as the differential between the two sectors, which had widened over successive attempts at wage restraint, was narrowed. While this catching-up process occurred at a more rapid rate than could have reasonably been expected in March, there is no evidence that it disproportionately affected the pay of local authority workers relative to central government employees. How- ever, local authority treasurers were told by the government in November 1973 to assume a rate of inflation of 9 per cent when computing their estimates of expenditure for the 1974-75 financial year, and there seems to have been no subsequent instruction to amend this assumption.(1) The possibility therefore exists that the 9 per cent rate originally intended for control purposes, was built into the March budget estimates and treated, quite inappropriately, as a forecast of local authority consumption. Less than a third of the total change between March and January shown in table 6.1 is the direct result of price increases. The remainder can all be regarded as a real change, though in part it is undoubtedly an indirect consequence of the acceleration in inflation - the subsidies required to hold prices at a given level increasing with the rise in cost. (1) This instruction helps to explain why the increase in domestic rates was so unexpectedly large for the 1974-75 financial year; at the time the rates were set it was already very clear that a considerably higher level of costs would prevail in the financial year than the government had advised. 47 - Economic Policy Review Table 6.2 Indices of Public Expenditure by Economic Category, at Constant Survey Prices, 1970-71 to 1978-79 (a) Expenditure on goods and services: December 1973 White Paper January 1975 White Paper Transfer payments (excluding grants to businesses): December 1973 White Paper January 1975 White Paper Total public expenditure, (excluding grants to businesses and financial transactions): December 1973 White Paper January 1975 White Paper 1970-71 1971-72 1972-73 1973-74 1974-75(b) 1975-76 1976-77 1977-78 1978-79 100.0 100.0 100.9 100.9 103.9 103.7 106.7 105.4 109.7 (102. 7) 107.4 112.8 112.2 115.0 114.0 117.8 115.1 117.2 100.0 100.0 104.7 104.5 107.4 107.6 116.3 119.8 120.3 133.2 120.0 140.1 122.0 141.0 124.9 144.0 146.8 100.0 100.0 102.3 102.2 105.2 105.2 109.0 110.8 ~113.6 (109.1) 117.1 115.4 122.7 117.6 124.1 120.4 126.0 128.3 Notes: (a) The figures are derived from Table 3.2 of Cmnd. 5519 and Table 3.4 of Cmnd. 5879. Expenditure on goods and services cov;~s fall 1~ dweadguecstaen~dfrsoamlartihe~isa!Itl<d:mo.thTerrancusfrerrenptaycomsetsnatsnm~ cclaupdietaltheexpceonndtm!tugreencinycrleusdeirnvge.thGerainnctsretaosebuinsitnheessveasluareeobfessttorcekgsa;r'dsehdorats- negative taxes smce changes m grant arrangements are closely related to changes in business taxes and tax allowances. (b) Figures in brackets show Treasury predictions after the December 1973 cuts. Public Expenditure to 1978-79 In the preceding section, it was seen that the estimate of public expenditure in 1974-75 has been raised by over £3 billion since last March and most of this is an increase in real, rather than in purely monetary, terms. In December 1973, it may be recalled, the then Chancellor, Mr Barber, announced cuts to the existing programme of expenditure for 1974-75 amounting to £1200 million. These cuts have clearly been more than offset by the addition to expenditure made since the March budget, which itself boosted the planned volume of spending by almost £1 billion. Table 6.2 presents a comparison, in terms of index numbers, taking 1970-71 as a base, of the proposals published in the January 1975 White Paper with those contained in the previous White Paper of December 1973. Table 6.2 shows so far as 1974-75 is concerned how the December 1973 White Paper estimates were first cut and later increased, though to a somewhat lower level. The table also shows that expenditure on goods and services is now planned to increase much faster between 1974-75 and 1975-76- by over 4}2. per cent- than was intended in the 1973 White Paper, with the result that in the coming financial year this element of public expenditure is forecast to be only slightly below (about £125 million at 1974 survey prices) the level planned in December 1973, before the Barber cuts were made. In subsequent years, the average growth rate of direct expenditure is only about 1}2. per cent a year. As regards transfer payments (subsidies, grants and debt interest) the level of expenditure in 1974-75 is very substantially above that envisaged in the 1973 White Paper. Indeed, excluding grants to business (investment grants, REP and RDG), the net addition to expenditure on this element in 1974-75 is of the order of £2.3 billion (at 1974 survey prices) since December 1973. Moreover the addition is even greater with respect to the coming financial year, 1975-76, transfer payments being forecast to be over five per cent higher than in 1974-75 and almost 17 per cent higher than was planned in the 1973 White Paper. From 1975-76 on, expenditure again grows at a very slow rate. The revisions to the estimates of transfer payments result in total public expenditure (again excluding lending and other capital transactions) in 1974-75 being considerably higher than was intended in December 1973, before the Barber cuts. Moreover Table 6.2 shows that the excess is even greater for 1975-76, there being a much more rapid growth between these two years than was indicated by the 1973 White Paper- arise of 4.8 per cent as against only 1.6 per cent. Thereafter the White Paper forecast is for a much slower rate of increase. The Public Sector Financial Balance in 1974-75 and 1975-76 Receipts in 1974-75 The approach to estimating the financial deficit in the current year is to take public expenditure (at current prices) as given by the latest official estimates discussed above and to confront these with our own estimates of receipts. These have been constructed from an analysis of the main components of revenue. It should be emphasized that the analysis of particular taxes is still at an intermediate stage, and work will continue in the future with the object of improving our understanding of the way the tax system operates and refining our estimates. Table 6.3 presents estimates of the receipts side of public sector transactions by economic category in 1974-75 and 1975-76 (ignoring transactions in financial assets), together with the most recently published comparable figures for 1973-74 and the Treasury forecast for 1974-75 contained in the November Financial Statement. If the latter forecast is compared with our 48 Public Spending and Taxation Table 6.3 Public Sector Receipts by Economic Category, 1973-74, 1974-75 and 1975-76. (£m) 1973-74 (1) 1974-75 (2) (3) 1975-76 (4) %Change 1974-75 (3) to 1975-76 (5) Taxes on income National insurance contributions Taxes on expenditure : Central government (a) local authorities Gross trading surplus Rent Interest, dividends, etc. 9600 13314 13000 16750 4099 5353 5321 6757 7089 8462 8452 9147 \ 2716 3099 3099 3950 2242 2687 2687 3100 1690 1951 1951 2244 672 671 671 700 28.8 27.0 8.2 27.5 15.4 15.0 4.3 Total Current Receipts 28008 35537 35181 42648 21.2 Taxes on capital Capital transfers 829 776 846 779 -7.9 27 28 28 28 - Total Receipts 28864 36340 36055 43455 20.5 Source: The 1973-74 figures are taken from Fil'lllncial Statistics, December 1974. The 1974-75 figures in (2) come from Supplementary Financial Statement and Budget Report, 1974-75 and those in (3) are our estimates, details of which are shown in the Appendix to this chapter. The f"Jgures for 1975-76 are again our estimates, the derivation of which is also described in the Appendix, on the assumption that tax rates, allowances, etc. remain unchanged and that the forecasts of income and expenditure contained elsewhere in this study are realised. (a) The f"Jgures for central government taxes on expenditure relate to receipts rather than accruals as in the government accounts, in order to correspond with our estimates. The adjustment for accruals, which needs to be added in order to get a financial deficit basis, was £454 million in 1973-74 and is estimated at £108 million in 1974-75. own estimates for 1974-75- set out in Column 3- it can be seen that in total there is an insignificant divergence, the sum of the two sets of figures being within one per cent of each other. The forecasting procedures for the various items are described in the Appendix to this chapter. Some divergence between our estimates of revenue in 1974-75 and those of the Treasury is to be expected to the extent that they are based on different assumptions about the behaviour of the economy over the relevant period. For our part, we have used the forecasts set out in Table B of the Statistical Appendix as a basis. As can be seen, the main reason why our estimate of total receipts is slightly less than the Treasury's is that we derive a lower figure for taxes on income. This applies both to personal income tax, our estimate of which is two per cent lower than the official one, and to corporation tax, which, apart from the advance corporation tax element payable on dividend distributions, is collected with an average lag of about 18 months. With regard to the latter, our calculations indicate some past build-up of tax losses which has arisen from the inability of companies, taken as a whole to absorb against income the depreciation allowances (to which they were entitled on the investment undertaken) which were increased substantially over a very short space of time in 1971 and 1972. These 'losses· are available to be offset against tax liabilities both in the current year and in the future. In total, therefore, taking the estimate$ of public expenditure in 1974-75 as given in Table 6.1, the estimate of the current year's financial deficit is not significantly different from the official forecast, at about £4.8 billion. Receipts in 1975-76 The estimates for 1975-76 in Table 6.3 are, in the case of taxes, derived using the same procedures as for 1974-75. The assumptions are that tax rates, allowances and other such features remain as they are at the moment and that the change in income and consumers' expenditure and the rate of price and wage increase are as forecast in Table B of the Statistical Appendix. In other words, the estimates for 1975-76 show what the implications for revenue would be if there were no changes in fiscal policy and if the economy followed the path forecast. On these assumptions, total receipts in 1975-76 will be 20 per cent higher than in the preceding financial year, 1974-75. Income Tax and Corporation Tax Looking at the component parts of the estimate, taxes on income are forecast to yield 27 pe~ cent more revenue than in the current year, but this conceals a very divergent pattern as regards personal income tax and corporation tax. While the former, assuming an increase in money income of about 22 per cent, is estimated to 49 - Economic Policy Review increase by almost 44 per cent, the yield of corporation tax on our calculations declines dramatically, the revenue collected in 1975-76 being approximately £800 million below the 1974-75 level. The reason for this is twofold. Firstly, the additional advance corporation taxation which companies are required to pay during the present financial year - a measure introduced by Mr Healey in March of last year - and which is estimated to amount to over £300 million, represents a deductable item from corporation tax demands issued from January 1976. Secondly, under the tax concession, introduced in November, with regard to the rise in the value of company stocks, companies are allowed to defer the tax payable on the amount by which an increase in the value of stocks exceeds trading profits less expenses (but gross of depreciation) by 10 per cent. This concession is estimated to have a full year effect on tax revenue of just over £1 billion when computed with respect to income earned by companies during their 1973-74 financial years. However, when computed with respect to income earned in 1974-75, which is the basis for tax paid in 1975-76, the full year effect, because of the large amount of stock appreciation, increases to an estimated £2 billion. In order to estimate corporation tax receipts in 1975-76 an assumption needs to be made about the form this particular scheme will take in the future. There are three possible alternatives in the light of what Mr Healey said on its introduction, that the whole repayment of the tax deferred from 1974-75 was not contemplated in. the coming financial year, 1975-76, but that 'the need for deferring tax in 1975-76 on abnormal stock appreciation in the present year's profits is likely to be even greater'. The first possibility is that the scheme will be applied as in 1974-75 without companies being asked to repay the tax deferred. Secondly, that while the scheme will continue, companies wil! have the tax deferred from will1974-75 debited against the credit due in 1975-76. Thirdly, that the scheme be discontinued, but companies will not be asked to pay back in 1975-76 the tax deferred from 1974-75. The second alternative seems the most plausible assumption to make, since the first involves a massive increase in the concession, the amount of tax deferred doubling from £1 billion to £2 billion, while the third means that companies would enjoy no relief at all for the cost of replacing stocks and work in progress at higher prices, in 1975-76. The second alternative results in companies enjoying a bigger concession in 1975-76 than in 1974-75, though the increase is small in comparison with the marked rise in the value of stocks. It nevertheless leads to a fall in corporation tax receipts of about 30 per cent between the two years. National Insurance Contributions National insurance contributions, at the present rates and assuming the same pattern of wage increases as in the immediate past,O) would increase by 23 per cent between 1974-75 and 1975-76, assuming wages rise by 25 per cent and that there is a further increase in (1) Some assumption about the distribution of income is necessary because graduated contributions account for 60 per cent of the total payments, and these are assessed as a percentage of income earned between £9 and £62 per week. Our estimate is based on the New Earnings Survey data for 1974. unemployment during the year (which reduces the rise which would otherwise have taken place by some two percentage points). But this ignores the further increase in the rate of contributions which will almost certainly take place in December 1975 when the government have committed themselves to raising benefits. Assuming an increase of 15 per cent at that time implies that contributions will be 27 per cent higher in 1975-76 than in 1974-75. Taxes on Expenditure Taxes on expenditure, excluding local authority rates, are forecast to rise by little more than eight per cent over the coming year. There are two main reasons for the smallness of this increase. Firstly, specific duties now account for well over half of revenue collected through indirect taxation and, unlike ad valorem taxes, their yield does not significantly increase with inflation. Secondly, receipts of VAT plus car tax are estimated to be only 15 per cent higher in 1975-76 than in the current financial year, which represents a much smaller increase than the projected growth of consumer expenditure between 1974 and 1975 of about 22 per cent. This is despite the raising of the rate of VAT on petrol to 25 per cent last November, which is estimated to add some £250 million to revenue (almost 10 per cent of the 1974-75 yield of VAT) in the coming financial year. It arises because of the cut in the rate of VAT to 8 per cent in July, 1974, the main effect of which, because of the three month lag in collection, will come through in 1975-76. Had this cut not been made, receipts of VAT would have increased by an estimated 32 per cent between the two years. Rates Local authority rates are forecast to increase by over 27 per cent over the period from the projected growth of local expenditure, from what is known of government grants - in particular the rate support grant agreed for the next financial year - from an analysis of the ratio of local authority borrowing in relation to capital expenditure in past years, and from an assumption about the likely increase in rents. This forecast increase in rates is slightly more than the average 25 per cent rise which Mr Crosland said would occur as a result of the rate support grant settlement. The reason for this may be that we have projected a higher rate of growth of costs than the Minister with regard to current expenditure, which we see as keeping pace with the rise in average wages over the economy as a whole. In view of the wage claims granted in the public sector in 1974, this seems a plausible assumption. Fuller details of the expenditure estimates are described below. Other receipts The gross trading surplus of the public sector, which is mainly earned by public corporations, is estimated to be some 15 per cent higher in 1975-76 as compared with the present financial year. This estimate is derived from an analysis of the operating account of public corporations since 1960 and in particular of the mark-up implied by the relationship between sales and costs, which remained fairly constant over the 1960's, but which has declined significantly during the period of price restraint. 50 Public Spending and Taxation Table 6.4 Public Expenditure by Economic Category, 1974-75 and 1975-76 (£million at current prices) 1974-75 1975-76 Percentage Change Real Price Total Current expenditure on goods and services Subsidies Debt interest Current grants Current grants abroad 16993 3302 3800 8250 375 21972 3497 4440 10096 441 3.4 25.0 29.3 -11.7 20.0 5.9 -2.6 20.0 16.8 8.6 12.7 22.4 22.5 22.5 Total current expenditure 32720 40446 23.6 Current surplus 2461 (a) 2202(a) Gross domestic fixed capital formation plus increase in value of stocks Capital transfers Less Taxes on capital and other capital receipts 7402 937 -874 9075 1002 -807 6.7 15.0 22.6 6.9 6.9 Financial deficit 5004 (a) 7068 (a) Notes: (a) The 1974-75 figures are taken from Supplementary Financial Statement and Budget Report, 1974-75 and from Public Expenditure to 19 78-79, Cmnd. 58 79. The 1975-76 figures are derived by applying the real change shown by Cmnd. 5879, Table 3.4, inflated by our price forecasts, to the 1974-75 figures. T~e figures are not entirely comparable with the figures in the Financial Statement, since no adjustment has been made for accruals of taxes on expenditure over receipts. The change over the year in the amount of tax in the hands of traders awaiting collection by the Customs and Excise is likely to be around £300 million, which would reduce the financial deficit to £6.75 billion in 1975-76 and to £4.8 billion in 1974-75. The basic assumption is that the subsidy to nationalised industries is gradually phased out by 1976, in line with the January 1975 White Paper, and that the price-cost relationship returns to what appears to be its nonnal historical one. Rents, a major component of which is rents on council houses, are assumed to increase by only 15 per cent overall, despite the rent freeze of 1974-75, since the government has stated that a special subsidy will be introduced to keep the rise below what it otherwise would have been. It is unlikely that there will be any iarge increase in interest and dividend receipts, and as regards taxes on capital - death duties and capital gains tax - the fall in asset values during the present financial year implies a marked decline in receipts in 1975-76. The overall picture The increase in total receipts is 20.5 per cent between 1974-75 and 1975-76, with the additional yield of personal income tax making by far the greatest contribution : of the £7.5 billion rise in revenue, personal income tax accounts for £4.3 billion, or almost 60 per cent. This is based on an assumption of unchanged allowances. If some adjustment is made to the amount of these in order to allow for the deterioration in their real value over the year, the yield of the tax would be lower, considerably so if an attempt were made fully to maintain their real value. If, for example, personal and child tax allowances were increased by only the same absolute amount as last year, the yield of income tax and total receipts would be reduced by about £600 million, which would by no means fully compensate for the decline in their real value. Expenditure in 1975-76 The estimates of public expenditure for 1975-76 are derived by taking the details in the January 1975 White Paper, which show the change at constant prices between 1974-75 and 1975-76, and inflating these by estimates of the movement in price for the various items. The results of this exercise are set out, by economic category, in Table 6.4, which shows expenditure at current prices in both 1974-75 and 1975-76, and the change between these two years, divided into that caused by changes in the volume of expenditure and that caused by changes in price or cost. In total, current expenditure is forecast to increase by over 23 per cent and capital expenditure by slightly less. Current spending on goods and services rises by 29 per cent between the two years, assuming an increase in price - mainly wages and salaries - of 25 per cent, in line with wage rates over the economy as a whole, not more rapidly (as has occurred in the present financial year). The estimate of subsidies in 1975-76 is slightly higher than in 1974-75, the fall in their real value - the consequence of subsidies to public corporations being phased out - being more than offset by inflation. The same 51 Economic Policy Review phenomenon is also evident with regard to debt interest, while current grants to the private sector increase in real as well as price terms. The main elements here are pensions and national insurance benefits, the former of which the government is committed to raising in line with wages and the latter in line with prices. For the first time a real increase has been built into the White Paper forecast and we have combined this with an assumed price rise of 15 per cent, on the expectation of the adjustment for inflation lagging behind the current rate. An additional amount has then been included to allow for the expected rise in unemployment between 1974-75 and 1975-76. For grants other than pensions and national insurance benefits a price increase of 10 per cent has been assumed. The net result of the above forecasts when combined with the estimate of current receipts shown in Table 6.3; is a current account surplus of £2202 million in 1975-76 which, if an approximate adjustment is made for the change in outstanding VAT over the year, becomes about £2500 million. As regards capital formation, the real change indicated in the White Paper, is inflated by an assumed price increase of 15 per cent between the two years. This is a little lower than our estimate of the overall rate of inflation in the economy, but is broadly consistent with the Treasury's view that construction costs, having got out of line with other prices, will show a relative decline in the immediate future.O) Subtrac~ing the estimate of taxes on capital from the forecast for capital formation and capital transfers produces an estimate of the public sector financial deficit of £7068 million in 1975-76, which is reduced to approximately £6750 million, if the Financial Statement procedure ofallowing for the change in outstanding VAT is adopted. This represents an increase over 1974-75 of almost £2 billion and a higher proportion of GDP than in the present fmancial year - 8~ per cent of GDP as opposed to 7 per cent. APPENDICES Appendix 6.1 Estimating public sector receipts The procedure adopted for estimating public sector receipts is briefly set out below. Estimates of the yield of the different taxes are set out in Table 6A.l. Income Tax: The procedure adopted is the relatively crude one of isolating for past years automatic changes in revenue from those resulting from discretionary measures, by using the information given in successive Financial Statement and Budget Reports. Automatic changes are then related to changes in cash income from employment, as derived from the National Income Blue Book. Though crude, the elasticity of tax yield with respect to changes in income calculated from this procedure has remained remarkably stable, at about 1.75, over the past few years. However with the increase in the standard rate of tax ftom 30 per cent to 33 per cent, we have assumed a proportionate increase in the elasticity to 1.925. In the future it is intended to adopt a structural approach to estimating yield, since this will enable distributional aspects to be considered in much more detail. Corporation Tax: Estimates are derived from an analysis of the Appropriation Account of Companies as published in the National Income Blue Book; the main elements of this have been projected for future years. Taxes on Capital Revenues from Capital Gains Tax, Stamp Duties and Death Duties are estimated by obtaining the lag between accruals of tax liabilities and tax receipts, and then fitting the movement in the prices of shares and other assets to accruals. The movement of the indices then indicates receipts ahead. Allowances, necessarily rather rough, are made for the transition from Death Duties to Capital Transfer Tax and for the introduction of the Development Land Tax. Value-added tax plus car tax: The method used is to compute what the yield of VAT, excluding specific duty items, would have been in each year since 1959, had it been applied at a constant rate and with the same coverage as at present. The main sources of information for this exercise are the figures for various items of consumers' expenditure published in the National Income Blue Book and details on the allocatio!l of taxes published in Economic Trends, November 1970. Inter-year changes in estimated receipts of VAT are then regressed on changes in consumer expenditure expressed both in money and real terms. The equation used for estimating future yield is: v= -2.959 + 1.019 cp + 1.240 c where v is the percentage change in estimated VAT between years, cp is the percentage change in consumers expenditure and c the percentage change in real consumption. This indicates that VAT receipts tend to increase more than in proportion to consumers' expen- (1) See Public Expenditure to 1978-79, Cmnd. 5879, p.l65. 52 Public Spending and Taxation Table 6A.l Estimated Receipts of Taxation in 1974-75 and 1975-76 (£million) 1974-75 1975-76 Income tax plus surtax Corporation tax Capital gains tax (a) Death duties Stamp duties Total Inland Revenue Value-added tax plus car tax Oil Tobacco Spirits, beer and wine Betting and gaming Other revenue duties Protective duties Total Customs and Excise Motor vehicle licences Total 10458 2613 410 365 210 14056 2604 1540 1350 1125 240 10 575 7444 541 7985 15034 1800 350 345 230 17759 2994 1515 1400 1235 288 10 650 8092 550 8642 (a) Including Development Land Tax %change 1974-75 to 1975-76 43.8 -31.1 -14.6 -5.5 9.5 26.3 15.0 -1.6 3.7 9.8 20.0 13.0 8.7 1.7 8.2 diture once real consumption growth exceeds a rate of about 2.23 per cent a year. Tobacco, beer and wines and spirits: For each of these three items (wines and spirits is taken as one item), duty is derived from estimated demand equations, using the statistics published on consumers expenditure and receipts of duty in the National Income Blue Book and in Customs and Excise, Annual Report, 1973. The equations used for estimating the future volume of sales are: Tobacco:- loge s=7.486 - 0.0028t - 0.0353Dloge P, where s is the volume of sales, t is a time trend, D is a dummy variable picking up the effect of anti-smoking campaigns and p is the relative price of tobacco. Beer:- lo~ s = 9.669- 0.6905loge p + 1.6126 loge y, where s is the volume of sales, p the relative price of beer and y is real disposable income. Wines and lo~ s = -11.685 - 1.3922 lo~ p + Spirits:- 1.7748 lo~ y,where sis the volume of sales, p the relative price of wines and spirits andy is real disposable income. Oil: The estimates of duty are consistent with the projections on energy usage and sources in Chapter 4. Within the aggregated forecasts of total deliveries of oil, future supplies of petrol and derv have been projected from the steady upward trend which prevailed over the period 1960 to 1973 and from the assumption that the savings on trend achieved in 1974 would be repeated in 1975. Fuel oil is obtained as a residual. Betting and gaming: Estimates are derived on the assumption that spending on this item would continue to increase in line with total consumers' expenditure, as has been the case in the past. Protective duties: Estimates are derived from the projected growth of imports of food and finished manufactures. National Insurance Contributions: Estimates are derived from an analysis of average contributions, the graduated element being calculated from the distribution of earnings data given in the New Earnings Survey for 1974. An allowance has been made for the loss resulting from the expected rise in unemployment. Gross trading surplus: Estimates are derived from an analysis of the operating account of public corporations for the years since 1960, as published in the National Income Blue Book. Local Authority Income Local authority rates and rents (and other similar income) for 1975-76 are estimated by taking the official statements on expenditure at constant prices, applying to them estimates of expected price and cost increases and then linking to the resulting estimates of local authorities' total expenditure at current prices the official statements made about the proportion of "relevant" expenditure to be financed by the Rate Support 53 Economic Policy Review Grant, making allowance for differences in coverage. The result is an estimate of total grants from the central government at current prices. Net borrowing by local authorities is then estimated as 65 per cent of capital expenditure. This proportion has been very stable in the past; local authorities apparently link borrowing closely to capital outlay. There remains a residual to be financed by rent or rates. Rent control on commercial buildings has been relaxed and new legislation is before Parliament which will permit local authorities to raise housing rents in response to rising costs, subject to a new regime of subsidies on capital charges, when the present freeze ends in March. In the light of this and such evidence as could be obtained as to the thinking oflocal authorities, it was assumed that rents would rise by 14 per cent between 1974-75 and 1975-76. That leaves a required increase in rates amounting to 2772 per cent between 1974-75 and 1975-76. This is rather above the figure of 25 per cent put forward by the Secretary of State for the Environment in November, when announcing the Rate Support Grant (1). The most likely explanations are that we may have assumed a higher rate of inflation than lay behind his estimate; and perhaps our estimate of the increase in rents is lower than his. The estimates are set out in Table 6A.2 together with figures for earlier years and the March and November Budget estimates for 1974-75. The extraordinary underestimate of local authorities' expenditure in the March Budget and its subsequent correction in November are largely matched by an extraordinary dip ib the borrowing ratio and its subsequent restoration to a figure slightly above normal. Appendix 6.2 Public Sector Accounts and Inflation The large revisions made during the year to the estimate of the public sector financial deficit for 1974-75 raises a number of questions about the behaviour of the fiscal system during a period of high inflation. This appendix examines whether under the present structure of taxation, a higher rate of inflation can be expected to lead to an increase in public expenditure relative to government receipts rather than the reverse. An addition to the rate of inflation will normally add an equal proportionate amount to public expenditure except where the outlays (for instance some interest payments) are fixed in money terms. It is well known that the "price" of goods and services bought by the public sector normally rises faster than prices on average, So long as public sector pay rises in line with pay in the private sector the 'relative price effect' is governed entirely by the relative growth of productivity in the two sectors and is completely invariant to the rate of inflation. In 1974-75, the pay of public sector employees increased more rapidly than that of workers in the private sector as a result of the catching-up process mentioned earlier. There was therefore a relative pay as well as a relative productivity effect, public spending (1) See Press Notice 899, Department of the Environment. increasing by more in relation to the rate of inflation than is normally the case. In future it can be expected that public sector wage rates will tend to increase in line with wage rates in the private sector, and the relative price effect will assume its normal value. (1 ). k far as public sector receipts are concerned there are two main points to make. Firstly, at a stable rate of inflation, fiscal drag is positive: at high rates of inflation the growth of government receipts will be proportionately greater than at lower rates of inflation. Secondly, an acceleration in inflation needs to be very rapid indeed in order to cause receipts to increase by less than expenditure; this phenomenon is extremely unlikely to occur except for short periods of time. To the extent that it does occur, it is wholly a consequence of lags in the collection process, and its significance is open to question, since much of the tax will indeed have been paid by the personal sector if not yet received by the government sector. The elasticity of public sector revenue with respect to changes in the rate of inflation is estimated at about 1.2 if account is taken only of automatic changes in revenue. Discretionary changes in such items as local authority rates and rents made in response to changes in inflation would, if included, clearly increase the elasticity. However, there are lags of varying lengths in the collection of all taxes. Table 6A.3 sets out the average lag between the time when income is earned or expenditure incurred and the time when the tax payments on that income or expenditure are received by the appropriate government agency. Income tax, which is almost wholly the cause of elasticity being greater than unity, is mostly received by the Inland Revenue after a lag of about four weeks. If inflation is accelerating, therefore, current tax receipts - as opposed to payments - will not fully reflect the current rate of wage increase. This gives rise to the possibility, exacerbated by the lags elsewhere in the system, that if the rate of acceleration in inflation is sufficient, then cash receipts in the hands of the government may increase less than in proportion to the rise in inflation and consequently less than in proportion to the rise in expenditure. The critical rate of acceleration in wage inflation at which this begins to happen is very rapid - approximately 30 per cent and while the phenomenon may well occur for short intervals, it is extremely unlikely to prevail with regard to a whole financial year (2). Collection lags in the tax system raise a number of further issues in a period of accelerating inflation. Firstly, the government may be forced to increase its borrowing in the short-term as expenditure rises faster than current receipts. Secondly, companies hold both income tax which they deduct from the pay of their employees and VAT for at least five \\eeks before paying these over to the Inland Revenue or Customs and Excise. Both represent interest-free loans from the government. The former, because of its progressive nature, increases more than in proportion to increases in wage costs and is therefore worth more in real terms the higher the rate of inflation. VAT tends to increase in (1) As mentioned earlier, Cmnd. 5879 assumes a negative price effect for the next few years as construction costs decline relative to other prices. (2) For this to occur, the average increase in taxable income over the period April to March needs to be 30 per cent higher than the average increase in the period February to January. 54 Public Spending and Taxation Table 6A.2 Local Authority Expenditure and the pattern of its financing 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 Expenditure Current Capital (i) Total Financed by Rates Rents etc. (b) Grants from Central Govt. £ million and percentages Capital exp. Borrowing Borrowing(c) as% as% of total cap. exp. Central Govt. Grants as% of current expenditure 2 34 5 6 7 8 9 10 2322 2526 2875 3245 3641 4009 4423 5032 5582 6356 7580 900 1132 1206 1365 1590 1734 1778 1899 2014 2341 2917 3222 3658 4081 4610 5231 5743 6201 6931 7596 8697 10497 1014 1096 1228 1374 1467 1548 1667 1824 2087 2377 2617 545 602 691 777 854 965 1105 1231 1320 1444 1690 1093 1232 1326 1563 1819 2042 2242 2606 3033 3505 4339 570 728 836 896 1091 1188 1187 1270 1156 1371 1851 27.9 63.3 47.1 30.9 64.3 48.8 29.6 69.3 46.1 29.6 65.6 48.2 30.4 68.6 50.0 30.2 68.5 50.9 28.7 66.7 50.7 27.4 66.9 51.8 26.5 57.4 54.3 26.9 58.6 55.1 27.8 63.5 57.2 1973/74 7935 Budget Estimate 1974/75 March(d) 8961 1974/75 Nov. 8828 9810 Cambridge Forecalfl 1975/76 12750 3277 2830 2737 3199 3450 11212 2688 1763 11791 11565 13009 3250 3099 1832 1841 16200 3950 2100 4508 5425 5371 5816 7900 2253 1284 1112 2253 2250 29.2 68.8 56.8 24.0 45.4 60.5 23.7 40.6 60.8 24.6 70.4 59.3 21.3 65.2 62.0 (a) Excluding net lending to private sector (b) Rent, dividends, interest and gross trading surpluses (c) Excluding lending to private sector and borrowing on that account (d) Change of classification due to separation of water and seage agencies Sources: National Income and Expenditure, 1963-1973, Table 43, and Financial Statement and Budget Report 1974-75 and Supplementary Financial Statement and Budget Report 1974-75. Table 6A.3 Average Lags in the Collection of Individual Taxes Tax Income tax: Schedule E ScheduleD Corporation tax Advance corporation tax Value added tax Customs and excise duties Average Lag 5 weeks 15 months 18 months 8 weeks 6 weeks 2 weeks Taxes on capital Capital gains tax Death duties Proportion collected in 1st year 2nd year 3rd year 4th year 0 .5 .4 .1 .5 .3 .1 .1 line with inflation. Wage earners lose out significantly as against the self-employed, and those paying higher rates of tax, who enjoy an average lag of about 15 months between earn- ing income and paying the tax on it. At the time of writing, the current bill for the latter two groups relates to a level of income of over 30 per cent, on average, below that now being earned. A similar situation exists with regard to corporation tax, which - except for the ACT element - is collected with an even longer delay, averaging 18 months. In a period of accelerating inflation, these groups not only enjoy an interest-free loan of increasing monetary value, but also experience a decline in their tax bill relative to current income. Although tax collection lags are shortest with respect to specific duties, these are important in reducing the sensitivity of the yield of the total tax system with respect to changes in the general price level. Specific duties account for over half of all indirect tax revenue and in the recent past there has been no attempt to adjust their rates in line with inflation. Before the March 1974 Budget, which increased the rate of duty on tobacco, beer, wines and spirits, rates had remained unchanged since 1969. The motor vehicle licence duty was last increased in March, 1968 and since then consumer prices have risen by about 80 per cent. Merely to restore the real value of the licence duty to its 1968 55 Economic Policy Review level would mean increasing it from £25 to £45, and this does not take account of projected inflation in the coming year. · Table 6A.4 shows the actual receipts of duty in 1969 and in 1973. Between those years, the rates of duty remained unchanged and consumer prices increased by 33 per cent - almost SO per cent more than the rise in the total yield of duty (23 per cent). If duties had been raised in line with the consumer price index in order to maintain their real value, total receipts in 1973 would have been an estimated £1.1 billion greater than they actually were, after taking account of the decline in the volume of sales associated with an increase in the relative price of dutiable items. Finally it should be noted that under the new rent regime now coming in, rents, as well as rates, can be expected to be adjusted annually in response to cost changes. Previously three years was the common interval. On present policies, local income therefore seems likely to follow costs (in greater or lesser proportion) subject to a discretionary adjustment lag less than that which has been normal for specific taxes controlled by the central government. Table 6A.4 Receipts of Specific Duties, 1969 and 1973 (£million) 1969 1973 Total receipts of specific duties 3729 4572 Consumer price index, 1969=100 100 132.7 Total estimated receipts if duties raised in line with consumer price index 3729 5683 Difference between actual and estimated receipts 1111 %Change 1969 to 1973 22.6 32.7 52.4 Notes: Specific duties cover beer, wines, spirits, tobacco, hydrocarbon oil and motor vehicle licences. The figures for 1973 include a small element of VAT, which was imposed on the first four items from April1973 in substitution for an equivalent part of the excise duty. The estimate takes account of price elasticities of demand. 56  Dublin Core The Dublin Core metadata element set is common to all Omeka records, including items, files, and collections. For more information see, http://dublincore.org/documents/dces/. Title A name given to the resource Chapter 6 Public Spending and Taxation Creator An entity primarily responsible for making the resource Terry Ward Robert Neild Source A related resource from which the described resource is derived Economic Policy Review Volume 1 pages 46-56 Date A point or period of time associated with an event in the lifecycle of the resource February 1975