The Chancellor said this is a budget for makers, doers and savers. But the economic backdrop for these changes is poor productivity growth.
THE PRODUCTIVITY GAP
For makers the Chancellor has doubled the annual investment allowance for plant and machinery at a cost of almost £2bn by the end of the scheme. This is important because a large proportion of business investment is usually for land and buildings, up to three quarters by some estimates. The Chancellor is making it easier for other capital investment to compete for financing against property investment. This could be good news for productivity.
Other measures going more directly to increasing productivity – such as funding for apprenticeships or innovation – are modest in ambition. The extra tax credit for SMEs to invest in R&D costs is about the same (£50m in 2015-16) as the reduction in bingo duty (£40m). The extra funding for Catapult centres for cell therapy and graphene is a mere £25m (a fraction of what a country like China is spending on graphene alone, a material on which it has 2,200 patents compared to 50 in the UK even though it was discovered here).
SMF Chief Economist, Nida Broughton said:
“When the Chancellor gave his speech today, he talked about GDP growth being revised up from 2.4% to 2.7% this year. He also talked about the deficit coming down. Tellingly, he was silent on the structural deficit – the number he is actually targeting – and the OBR’s estimate of the output gap on which the estimate is based on.”
“A quick look at the OBR’s Economic and Fiscal Outlook shows why. The OBR have indeed revised GDP up this year, but they have revised it down for future years – from 2.7% to 2.5% in 2018. There has been a quicker recovery than expected, but there is no evidence to show that the underlying health of the economy has improved, and that growth will be sustainable in the long-term. Stronger private consumption has been facilitated by lower savings, not higher incomes. Once households deplete their savings, they won’t be able to continue spending.”
“The OBR sees little change in the UK’s long-term prospects. Even worse, they now expect rising population to contribute more to growth, and less to come from increases in productivity, which they see as “exceptionally weak. On a per head of population basis, GDP is not expected to return to its pre-crisis peak until 2017.”
“With the poor productivity numbers, the OBR sees less potential for more growth in the coming years. And that means the structural deficit doesn’t look much better than it did a few months ago. And whilst there is tremendous uncertainty about the estimate of the structural deficit – with the OBR itself conceding that its models are not coming out with plausible results – the fact that we have a productivity problem is clear.”
THE PENSION REVOLUTION
The package for savers is the most aggressive, with the increase in size of tax free ISAs, a cut in the tax on other savings and new bonds for pensioners. These are more than paid for, within a fiscally neutral Budget overall, by reducing the tax rate on withdrawing money from a defined contribution pension.
But the logic here is unclear. Pensions are often used to fund investment, indeed the Government has been working hard to get pension funds to invest more in infrastructure. Giving people incentives to take money out of pensions may not be wise. And the system of ISAs that is being replaced included separate Stocks and Shares ISAs which ensured that savers were investing in business growth rather than leaving their money with the banks.
The risk of the changes is that pensioners’ savings go into financing government via the new pensioner bonds that have been announced – or, via banks, into mortgages – rather than into productive investment in the economy.
SMF Research Director, Nigel Keohane said:
“The Chancellor set out a really poor case for removing the requirement to annuitise. There are significant failings in the annuities market, but the Government would be much better to address these head-on than steer people away from the market.”
“This is for two reasons: first, annuitising means a steady level of income over a pensioner’s life (reducing the risk that they spend it all at once). The Government offers people tax incentives to save into pensions – a 40% tax relief for those earning at the higher rate. The purpose of this incentive is to help ensure that the individual can look after themselves in old age and that the burden does not fall back on the state. These reliefs are uniquely generous – even when compared to ISAs. Abolishing the requirement to annuitise completely goes against these principles.”
“Second, it is not clear who this policy is directed at. We have to bear in mind that the average pension pot is £36,800. So, most people don’t have much money at all to play with. In contrast, it should be noted that possession of pensions savings is highly correlated with possession of liquid savings – so, many of those who would have decent pension pots to draw down, already have cash available that they can spend.”
“Instead, the Government should address head-on the inadequacies of the annuities market. The proposal to offer free financial advice to those hoping to annuitise is an excellent one. But, the biggest problem is inertia. Six out of ten savers are sticking with their existing pension provider rather than seeing what rate they can get on the open market. The vast majority of these would have got a better deal if they had switched. So, we would be better developing policies to make people go to the open market when they annuitise.”
THE WELFARE CAP
Doers will benefit from the increase in the personal tax allowance which this time will provide equal gains to higher rate taxpayers. Strangely though, other help for doers – including working tax credits and childcare tax relief – will be part of the welfare cap. The logic of trying to squeeze down on these in-work benefits is unclear. If the welfare cap forces future restrictions on those benefits in a way that weakens the incentives for being in work, then that would be a perverse outcome for productivity.
SMF Research Director, Nigel Keohane said:
“This measure was sold as a means of countering the belief that ‘it pays not to work’. It doesn’t do this.”
“Much of the expenditure that is capped goes to those in work: tax credits (more than two thirds of which goes to the in-work); housing benefit (a significant proportion of which goes to households in-work); and, a large part of the Child Benefit bill. It also includes statutory maternity pay and tax free childcare.”
“Instead, it is a cap imposed as much on those in-work and those incapable of working. So, even as a rhetorical device it doesn’t work.”
THE SOCIAL MARKET FOUNDATION (SMF) is a leading independent UK think tank which develops innovative ideas across a broad range of economic and social policy, champions policy ideas which marry markets with social justice and takes a pro-market rather than free-market approach.
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