Growth set to continue: Pre-Budget Report 2004

The Chancellor's Pre-Budget Report predicts that the economy will continue to expand, thus allowing Gordon Brown to maintain that his "golden rule" will not be broken. But not everyone is convinced by his arithmetic.

The 2004 Pre-Budget Report¹ presents updated assessments and forecasts for the UK economy and public finances. It also describes the measures the government is considering ahead of the 2005 Budget, widely predicted to be Chancellor Gordon Brown's last before the next general election. This being the case, it has an unashamedly vote-catching tinge, not least the announcement of a new, 10-year, national childcare strategy and an increase in the duration of paid maternity leave.

On the economic fundamentals, the Chancellor maintains that the economy will continue to expand against a background of low and stable inflation and falling unemployment - the so-called "golden scenario". However, many commentators feel that Gordon Brown has erred very much on the optimistic side when doing his sums.

Growth set to continue . . .

According to the Treasury, the global recovery gained momentum during 2004, with the UK's gross domestic product (GDP) also growing strongly. While there are, it says, a number of risks surrounding the international economic outlook, the Pre-Budget Report notes that "sound macroeconomic fundamentals, recent strong and more broadly based growth and continued expansion in the world economy point to a period of relatively strong UK output growth". This being the case, the Chancellor expects GDP to expand by 3.5% over 2004 as a whole. Growth of between 3% and 3.5% is predicted for 2005 as the remaining slack in the economy is absorbed.

The Pre-Budget Report also contains an update on the public finances. These projections remain broadly in line with those made at the time of the 2004 Budget and show that, according to Treasury estimates, Gordon Brown is still on course to meet the most prominent of his fiscal targets - the "golden rule". This states that, over the economic cycle, the government will only borrow to invest, and not to fund current spending. Using what the Treasury maintains are "cautious assumptions" about, among other variables, the future prospects for economic growth, the Chancellor expects an average surplus of 0.1% of GDP over the rest of the current economic cycle, due to end in 2005/06. Thereafter, the average annual current account surplus from 2005/06 to the end of the forecast period in 2009/10 is predicted to be a more comfortable 0.25% of GDP.

Public sector net debt, another of the Chancellor's measures of fiscal prudence, is projected to be "low and stable" over the forecast period, settling at a level below the 40% of GDP ceiling set under the Treasury's sustainable investment rule.

On the revenue-raising side, the Pre-Budget Report states that personal allowances for income tax purposes applicable those aged under 65 will increase in line with inflation in 2005/06. The national insurance contribution (NIC) threshold and limits will also increase in line with inflation. There will be no change in the NIC rates for either employers or employees, nor the profit-related NICs paid by the self-employed.

. . . but doubts remain

Despite Gordon Brown's bullish outlook, not everyone is convinced that the economy will continue to grow as strongly as the Treasury predicts, casting doubt on whether the golden rule will indeed remain unbroken. This raises the uncomfortable possibility of post-election public spending cuts or, perhaps more likely, tax increases. For example, the Financial Times quoted Peter Young, chief economic adviser to the Ernst & Young ITEM Club, as saying that: "The way the Pre-Budget Report is put together, everything possible goes right for the Chancellor. But if you believe that, you'll believe anything."

Indeed, the consensus among independent commentators is that Gordon Brown may have been too optimistic in his forecasts for growth and spending. In essence, this means that he will be facing a deficit of up to £12 billion in current spending, rather than the £8 billion surplus the Treasury is counting on. This, many suggest, means that taxes will inevitably have to rise to cover the shortfall. The key advantage the Chancellor has is that the true picture is unlikely to become clear until well after the next general election.

Inflation to be held in check

On monetary policy, the Pre-Budget Report boasts that the full operational independence granted to the Bank of England's Monetary Policy Committee (MPC) with regard to the setting of interest rates has helped the government achieve its target of 2% for the 12-month increase in the consumer prices index (CPI), its preferred measure of inflation. This target continues to apply and remains unchanged.

In recent months, CPI inflation has actually fallen below target, an outcome the government says it treats as seriously as it would if CPI overshot the 2% mark. Indeed, if inflation deviates by more than one percentage point above or below target, the Governor of the Bank of England is required, in an open letter, to explain to the Chancellor the reasons for the deviation; the expected period of the deviation; and the actions the MPC proposes to take. However, the figures contained in the Pre-Budget Report suggest the Governor will be spared this ignominy as CPI inflation is expected to rise gradually back to target by mid-2006 as the government's monetary policy takes effect and as the upward pressure from import prices, accentuated by the recent depreciation of sterling, feeds through.

New childcare strategy announced

Chapter 5 of the Pre-Budget Report, entitled "Building a fairer society", outlines the steps the government proposes to take to "promote fairness alongside enterprise, so that everyone can take advantage of the opportunities to achieve their full potential". These include the introduction of a new 10-year childcare strategy designed to help families strike the right balance between work and family life, the details of which are published alongside the Pre-Budget Report². "Access to affordable, flexible, high-quality childcare is key to tackling deprivation," the government says, as well as "removing barriers to parents' employment and supporting children's long-term educational development - helping to provide the educated and highly skilled workforce that the UK needs to prosper in the global economy".

According to the government, the strategy sets out its "long-term vision to ensure that every child gets the best start in life", and to give parents greater choice in achieving an appropriate work-life balance through:

The government has stated that it wants to see a situation whereby all families with children aged up to 14 who need it can find "affordable, flexible, high-quality childcare places that meet their circumstances". This will be achieved by placing a new duty on local authorities, to be operational by 2008, requiring them to secure, "over time", a sufficient supply of childcare places to meet demand.

In addition, a target of 20 hours a week of free, high-quality care for 38 weeks a year for all three and four-year-olds has been set. The Pre-Budget Report announced a first step of 15 hours a week for 38 weeks to be available to all children by 2010. There will also be an out-of-school childcare place for all children aged between three and 14, to be provided between the hours of 8am and 6pm each weekday, again by 2010.

Key quality and affordability key issues

However, providing childcare places is only one part of the equation. The government has been keen to ensure that the places provided are both of good quality and affordable. On the quality issue, it has stipulated that all full daycare settings should be professionally led, with the Children's Workforce Development Council to consult during 2005 on the introduction of a new qualification and career structure which, the government hopes, will result in a radical overhaul of the childcare workforce.

On the question of affordability, the Pre-Budget Report announces that, from April 2005, the limits of the childcare element of the Working Tax Credit will increase to £300 a week (£175 for one child), together with an increase in the maximum percentage of childcare costs that can be claimed from 70% to 80%. This will take effect from April 2006, and will mean that, together with other administrative changes, a couple or family earning a combined income of £34,000 a year with both parents working and paying typical childcare costs for two young children will be around £700 a year better off.

There will also be additional government help for employer-supported childcare. The 2003 Pre-Budget Report announced that, from April 2005, where an employer offers childcare vouchers or childcare provision, the first £50 a week would be free of tax and NICs, subject to the benefit being offered to all employees for childcare that is registered or approved. The £50 a week exemption applied to the cost to the employer of providing the childcare benefit. According to the Treasury, for childcare vouchers this cost is normally the face value of the vouchers and any associated administration charges, up to a maximum of £50 a week. The 2004 Pre-Budget Report states that, from April 2005, the £50 a week limit will apply to the face value of the vouchers alone, and that associated administration costs and service charges will also be exempt from both tax and NICs.

From incapacity benefit to employment

The government has stated that its long-term aim is to achieve "employment opportunity for all" - its updated definition of full employment. The latest Pre-Budget Report includes a number of measures that, it hopes, will result in a higher proportion of people being in work than ever before by 2010.

The government has frequently expressed its concern about what it sees as the "high and rising" number of incapacity benefit claimants, and the seemingly low rate at which people leave these benefits for work. According to official figures, 2.7 million people - some 7.5% of the working age population - are claiming an incapacity benefit. While this is close to the Organisation for Economic Co-operation and Development average, it represents a three-fold increase since 1979.

This being the case, the Pre-Budget Report signals what is described as a "fundamental change in the way that people with a health condition or disability, but who want and are able to work, are given support to find, remain and progress in employment". These include:

Additional help for the unemployed

The government argues that the Jobseeker's Allowance (JSA) regime "has been effective in helping the unemployed move rapidly back into work, maintaining low unemployment and reducing the risk of long-term detachment from the labour market". Indeed, the figures show that around 60% of claimants now leave the JSA within 13 weeks, and almost 80% leave within six months, compared with 75% leaving within six months in 1997.

The Chancellor has stated that he wishes to build on this success. In addition to the measures he announced in the 2003 Pre-Budget Report , Gordon Brown has now revealed that there will be further measures aimed at "increasing the personal responsibility for job search activity, and improving the capacity of local managers and personal advisers to hold jobseekers to account for that activity". Measures to be tested include:

"An effective balance between rights and responsibilities also requires effective penalties for non-compliance," the government warns. It therefore plans to review the current JSA "sanctions regime to ensure that the penalties for failure to carry out responsibilities are timely, fair, practical and effective".

Elsewhere, the £40-a-week In-Work Credit for lone parents will be extended to a further six pilot areas.

Cracking down on tax avoidance

One of the less reported measures contained in the 2004 Pre-Budget Report of interest to pay practitioners is an end to schemes designed to avoid income tax and NICs on remuneration, notably in relation to bonuses received by highly paid employees. The government has stated that it is now prepared to bring forward legislation to counter any such avoidance schemes devised in the future. If necessary, it adds, this legislation will be retrospective, and will take effect from 3 December 2004.

¹"Opportunity for all: The strength to take the long-term decisions for Britain", Pre-Budget Report, December 2004, Cm 6408, available from HM Treasury, tel: 020 7270 4558, price £45. Also available, free of charge, at www.hm-treasury.gov.uk.

²"Choice for parents, the best start for children: a ten year strategy for childcare", available free of charge, at www.hm-treasury.gov.uk.

Table 1: Economic growth and net borrowing, 2004/05-2007/08

Source: HM Treasury.