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Chapter C: The Public Finances

INTRODUCTION

C1 Chapter 2 describes the Government's fiscal policy framework and shows how the projections of the public finances are consistent with meeting the fiscal rules. This chapter explains the latest outturns and the fiscal projections in more detail. It includes:

• five-year projections of the current budget and public sector net debt, the key aggregates for assessing performance against the golden rule and the sustainable investment rule respectively;
  
• projections of public sector net borrowing, the fiscal aggregate relevant to assessing the impact of fiscal policy on the economy;
  
• projections of the cyclically-adjusted fiscal balances; and
  
• detailed analyses of the outlook for government receipts and expenditure.

C2 The fiscal projections continue to be based on deliberately cautious key assumptions audited by the National Audit Office (NAO).

MEETING THE FISCAL RULES

C3 Table C1 shows five-year projections for the current budget and public sector net debt, the key aggregates for assessing performance against the golden rule and the sustainable investment rule respectively. Outturns and projections of other important measures of the public finances, including net borrowing and the cyclically-adjusted fiscal balances, are also shown.

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C4 As explained in Chapter 2, the Government's provisional view is that the current economic cycle started in 1999-2000. Based on the assumptions used in these projections, the economy will next return to trend levels, ending the current cycle, in 2005-06.

The golden rule

C5 The projections show that the Government is firmly on track to meet the golden rule. Over the period of this cycle, from 1999-2000 to 2005-06, the current budget is comfortably in surplus. Similarly, the average surplus on the current budget is positive since the start of the cycle and throughout the projection period. The same is true were the current cycle thought to have started in 1997-98. The cyclically-adjusted surplus, which allows underlying or structural trends in the indicators to be seen more clearly by removing the estimated effects of the economic cycle, temporarily shows a deficit in 2002-03, before returning to surplus for the rest of the projection period.

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C6 Following a deficit of 3 per cent of GDP in 1996-97, current budget surpluses of more than 2 per cent were recorded in 1999-2000 and 2000-01 and of around 1 per cent of GDP in 2001-02. Largely as a result of cyclical and other temporary factors, the current budget moves into a deficit of 1.1 per cent of GDP in 2002-03, before gradually returning to surplus in 2005-06 and reaching a surplus of 0.6 per cent of GDP by 2007-08.

The sustainable investment rule

C7 The sustainable investment rule is also comfortably met over this economic cycle. In 1996-97, public sector net debt stood at 44 per cent of GDP. The tough decisions on taxation and expenditure taken by the Government, including the decision to use the proceeds from the auction of spectrum licences to repay debt, reduced net debt to around 30 per cent of GDP by the end of 2001-02. It is now projected to grow slowly, but to remain below 34 per cent of GDP, as the Government borrows modestly to fund increased investment in public services. The projections for core debt, which exclude the estimated impact of the economic cycle, increase more slowly to 32 per cent of GDP.

Net worth

C8 Net worth is the approximate stock counterpart of the current budget balance. Current budget surpluses of over 2 per cent of GDP in recent years increased net worth to 26.2 per cent of GDP in 2001-02. Modest declines are projected for later years. At present, net worth is not used as a key indicator of the public finances, mainly as a result of the difficulties involved in measuring accurately many government assets and liabilities.

C9 Chart C1 shows public sector net debt and net worth as a per cent of GDP from 1989-90 to 2007-08.

Chart C1: Public sector net debt and net worth

Net investment

C10 As a result of decisions taken in the 2002 Spending Review, public sector net investment is projected to rise steadily to 2¹/₄ per cent of GDP in 2007-08. These increases are sustainable and fully consistent with the Government's long-term approach and the fiscal rules, since net debt is being held at a stable and prudent level, well below 40 per cent of GDP.

Net borrowing

C11 This increase in net investment, together with the new projections for the current budget, mean that public sector net borrowing is expected to increase to a maximum of 2¹/₂ per cent of GDP in 2003-04, helping monetary policy maintain economic stability while the economy is below trend, before decreasing to around 1¹/₂ per cent of GDP in later years as the economy moves back to trend. Cyclically-adjusted public sector net borrowing is around 1³/₄ per cent of GDP or lower in every year from 2003-04.

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Financing

C12 The central government net cash requirement was 0.3 per cent of GDP in 2001-02. It is projected to increase in 2002-03 and subsequent years, mirroring the profile of net borrowing.

European commitments

C13 Table C1 also shows the Treaty measures of deficit and debt used for the purposes of the Excessive Deficit Procedure - Article 104 of the Treaty. Both the reference levels of 3 per cent of GDP for the deficit and 60 per cent of GDP for gross debt are achieved throughout the projection period.

CHANGES TO THE FISCAL BALANCES

C14 Table C2 compares the latest estimates for the main fiscal balances with those in the Pre-Budget Report and in Budget 2002.

C15 In the Pre-Budget Report, receipts for 2002-03 were revised down significantly - mainly as a result of the effects of the global economic downturn. An explanation of the impact of the slowdown on different taxes was included in the Pre-Budget Report.

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C16 As explained in Chapter B, the short-term outlook for the world economy has weakened further since the Pre-Budget Report. This has had important implications for the fiscal projections. Table C2 shows that, since the Pre-Budget Report, the current budget has been revised down from a deficit of £5.7 billion to a deficit of £11.7 billion in 2002-03, including provision of £3 billion to meet the cost of the war in Iraq, and from a deficit of £5 billion to a deficit of £8 billion in 2003-04. It also shows that net borrowing has been revised up since the Pre-Budget Report, from £20.1 billion to £24 billion in 2002-03 and from £24 billion to £27 billion in 2003-04. However, the tough decisions on taxation and spending taken by the Government over the course of the last Parliament to reduce debt to low and stable levels, means that even after these revisions, the Government remains on track to meet its strict fiscal rules.

C17 The underlying strength of the fiscal position means that the changes in the fiscal balances in 2003-04 are consistent with the Government's aim of allowing the automatic stabilisers to support monetary policy in maintaining economic stability while the economy is below trend. This interaction between the economic cycle and the public sector finances also explains why there is little difference between the cyclically-adjusted balances in 2003-04 from the Pre-Budget Report projections.

FORECAST DIFFERENCES AND RISKS

C18 The fiscal balances represent the difference between two large aggregates of expenditure and receipts, and forecasts are inevitably subject to wide margins of uncertainty. Over the past ten years, the average absolute difference between year-ahead forecasts of net borrowing and subsequent outturns has been around 1 per cent of GDP. This difference tends to grow as the forecast horizon lengthens. A full account of differences between the projections made in Budget 2000 and Budget 2001 and the subsequent outturns is provided in the End of year fiscal report, which was published alongside the Pre-Budget Report.

C19 There are both upside and downside risks to the economic outlook. On the upside, the various uncertainties currently affecting the global economy could dissipate more quickly, and confidence recover more sharply, than anticipated. This would, in turn, help support a stronger than expected improvement in UK economic prospects.

C20 A period of prolonged uncertainty, accompanied by continued volatility in financial markets, weaker equity prices and higher oil prices poses the clearest downside risk to G7 activity. The Government will remain vigilant in the face of these risks. The public finance projections will continue to be based on cautious assumptions, including those for equity prices and the trend rate of growth, and to be 'stress tested' against the cautious case, described in paragraph C23, which builds in a margin for safety in the public finances. The Government remains on track to meet its strict fiscal rules over the economic cycle, including in the cautious case.

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C21 Short-term forecasts of the public finances are critically dependent on the path of the economy, as most tax revenues and some public expenditure - notably social security - vary directly with the economic cycle. Earlier work¹ suggested that if GDP growth were one percentage point higher or lower than assumed over the coming year, net borrowing might be lower or higher by 0.4 per cent of GDP in the first year and by a further 0.3 per cent of GDP the following year. These figures are now closer to 0.5 and 0.2 per cent respectively, as the introduction of the corporation tax instalment system has reduced the lag between profits and tax receipts. However, not all cycles will conform exactly to these parameters, notably because the estimates are based on historical data (since which time both the state of the economy and the tax regime have changed) and because cycles differ in respects other than magnitude.

C22 Projected differences in short-term growth forecasts may have only a temporary effect on the public finances. For a given path of trend output, higher or lower growth in the short term will be followed by lower or higher growth later on, and the public finances may be little affected on average over the cycle.

C23 However, changes in the estimated cyclical position of the economy in relation to its trend - the output gap - will have a permanent effect on prospects. For this reason, the public finances projections are 'stress tested' against an alternative cautious case, in which the level of trend output is assumed to be 1 percentage point lower than the Government's central view. This scenario would imply that a greater proportion of any projected surplus on the current budget was due to the cyclical strength of the economy - a 1 per cent larger positive output gap reduces the structural surplus on the current budget by about 0.7 per cent of GDP per year. This is illustrated in Chart C2. Even in this cautious case, the cyclically-adjusted current budget is estimated to have been comfortably in surplus over the past four years. The impact of the temporary fall in receipts means that it is projected to move into a modest deficit over the short term, before returning towards balance by the end of the projection period. The average cyclically-adjusted current budget is in surplus in the cautious case over the economic cycle, meeting the 'stress test' of the golden rule.

Chart C2: Cyclically-adjusted surplus on current budget

ASSUMPTIONS

C24 The fiscal projections are based on the following assumptions:

• the economy follows the path described in Chapter B. In the interests of caution, the fiscal projections continue to be based on the deliberately prudent and cautious assumption of trend output growth of 2¹/₂ per cent a year up to 2006-07, ¹/₄ percentage point lower than the Government's neutral view. Beyond 2006-07, projections by the Government Actuary imply a slowdown in the growth in the population of working age, due to demographic effects. The Government's neutral view of trend output growth is reduced to 2¹/₂ per cent in 2007-08, and so, to maintain a cautious approach, an assumption of 2¹/₄ per cent is used in the public finance projections in that year, still ¹/₄ percentage point lower than the Government's neutral view;
  
• there are no tax changes beyond those announced in or before this Budget and the indexation of rates and allowances. Consistent with the Code for fiscal stability, the forecast does not take account of measures that cannot be costed accurately, including the Graduate Contributions scheme, described further in Chapter 3;
  
• firm Departmental Expenditure Limits (DEL) as set out in the 2002 Spending Review up to 2005-06, but adjusted for the impact of policy decisions and DEL/AME reclassifications;
  
• Annually Managed Expenditure (AME) programmes through to 2005-06 have been reviewed and further additions made for new spending measures announced in this Budget. Following usual practice, the Government has decided to reset the AME margin to £1 billion in 2003-04, £2 billion in 2004-05 and £3 billion in 2005-06;
  
• prior to spending plans being set in the next Spending Review, assumed real growth in DEL after 2005-06 is in line with the economic growth assumption used for the public finances, supplemented by an addition to allow for the five-year health settlement of the difference between planned health growth and health's long-term average growth of 3.6 per cent. Other current spending in AME is forecast to grow from 2005-06 onwards at 1³/₄ per cent in real terms in line with its recent trend; and
  
• within these aggregates, net investment is forecast to increase from 2 per cent of GDP in 2005-06 towards an assumption of 2¹/₄ per cent in 2007-08, while remaining consistent with the sustainable investment rule.

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C25 The key assumptions underlying the fiscal projections are audited by the National Audit Office (NAO) under the three-year rolling review process. Details of the audited assumptions are given in Box C1. The rolling review for Budget 2003² covers the assumptions relating to privatisation proceeds, interest rates and tobacco anti-smuggling measures. In addition, the Comptroller and Auditor General was asked to examine a change to the assumption dealing with tobacco revenues, and the revenue impact of a new direct taxation and national insurance contributions compliance and enforcement package.

C26 The Comptroller and Auditor General concluded that the privatisation proceeds assumption was reasonable and not incautious in operation, and that it remains a reasonable and cautious one to use for the purposes of projecting the public finances. Similarly, he concluded that the convention for interest rates was reasonable and cautious over the rolling review period. For the tobacco assumption, he concluded that the fiscal projections over the rolling review period were cautious as tobacco revenues have been greater than forecast.

The new tobacco assumption

C27 The tobacco assumption used in previous forecasts was developed at a time when cigarette smuggling was increasing and all the indications were that, with no action, this trend would continue. At the time it was not clear what the impact of the tobacco strategy would be in mitigating the trend because many of the elements were untried in a UK context. For this reason, a cautious assumption was adopted which involved for forecasting purposes:

• taking as a base a hypothetical assumed rise in smuggling in the absence of a strategy; and
  
• subtracting from this only the more certain of the expected impacts of the strategy.

C28 The situation in 2003 is different. The strategy has now been in place for three years. After a long period of decline, UK duty paid consumption has recently stabilised. The growth in smuggling has been halted and recent data suggests it is now in decline. In light of this evidence, the NAO audited a revised tobacco assumption for the Pre-Budget Report³. However, the Government considers that continued application of this assumption would still result in unduly pessimistic projections of revenue from tobacco duties. In particular, it would result in significant increases in the projected smuggled share of the cigarette market, from 21 per cent in 2001-02 to 28 per cent by 2005-06, despite HM Customs and Excise's target to reduce the share to 17 per cent.

C29 In addition, continuing with the existing assumption would mean that the future change in the smuggling share would continue to be driven by the assumed change in the share in the absence of an anti-smuggling strategy at all. As time passes it becomes much more difficult and less relevant to assess what would have happened without the strategy, making this approach increasingly unsatisfactory.

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C30 As a result of these recent trends in smuggling and the success of HM Customs and Excise's strategy, a new assumption has been adopted for Budget 2003, under which the underlying market share of smuggled cigarettes will be set at least equal to the latest published outturn, which currently stands at 21 per cent. The new assumption is intended to be more closely aligned with observed trends in the smuggled market share and HM Customs and Excise's targets to reduce it. The Comptroller and Auditor General has audited the new assumption and concluded that it currently represents a reasonable approach and is cautious to the extent that no account is taken of expected further reductions in the smuggled market share. The impact of applying this new assumption on the projections of tobacco receipts is an extra £³/₄ billion a year by 2005-06 and £1¹/₄ billion a year by 2007-08.

Inland Revenue compliance and enforcement package

C31 As described in Chapter 5, Budget 2003 launches a new compliance and enforcement package for direct tax and national insurance contributions. An additional £66 million is being provided to the Inland Revenue over the next three years to support implementation of the package. The package is expected to produce £1.6 billion in total additional revenue over the next 3 years, but in line with the Government's cautious approach to the public finances a lower figure of under £1.4 billion over three years with the annual figure rising to just over £0.6 billion in 2005-06 has been included in the forecast. The Comptroller and Auditor General has audited the projections and concluded that they are based on a reasonable approach and incorporate caution.

FISCAL AGGREGATES

C32 Tables C4 and C5 provide more detail on the projections for the current and capital budgets.

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C33 The current budget surplus is equal to public sector receipts minus public sector current expenditure and depreciation. The current budget is expected to show deficits from 2002-03 before returning to surplus in 2005-06 and remaining in surplus throughout the rest of the projection period. These temporary deficits are consistent with allowing the automatic stabilisers to operate fully over the economic cycle, while continuing to meet the golden rule.

C34 Underlying the projections of the current budget are steady increases in the ratios of public sector receipts and current expenditure to GDP, shown in Table C5, largely reflecting measures announced in Budget 2002 and the 2002 Spending Review. By 2005-06, when the current cycle ends under the assumptions used in these projections, the accumulated total surplus over this economic cycle will be £32 billion.

C35 Table C4 also shows that net investment is projected to more than double, from £12.2 billion in 2002-03 to £31 billion in 2007-08, as the Government seeks to rectify historical under-investment in public infrastructure. These increases are sustainable and fully consistent with the Government's long-term approach and the fiscal rules, as debt is being held at less than 34 per cent of GDP throughout the projection period, well within the 40 per cent limit set by the sustainable investment rule, as shown in Table C5.

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¹Fiscal policy: public finances and the cycle, HM Treasury, March 1999.
²Audit of Assumptions for Budget 2003, 9 April 2003.
³Audit of Assumptions for the 2002 Pre-Budget Report, National Audit Office, 27 November 2002.

RECEIPTS

C36 This section looks in detail at the projections for public sector tax receipts. It begins by looking at the main determinants of changes in the overall projections since the Pre-Budget Report, before looking in detail at changes in the projections of individual tax receipts. Finally, it provides updated forecasts for the tax-GDP ratios.

Changes in total receipts since the Pre-Budget Report

C37 Table C6 provides a detailed breakdown of the main factors that have led to changes in the overall projections since the Pre-Budget Report.

C38 Changes to tax determinants that are projected using assumptions audited by the NAO add around £2 billion per year to current receipts by the end of the projection period, compared with the Pre-Budget Report. As described in paragraphs C27 to C31, this is mainly the result of the new assumption regarding the level of tobacco smuggling, and the Inland Revenue compliance and enforcement package.

C39 The revenue impacts of these new assumptions are partly offset by changes in equity prices since the Pre-Budget Report, which reduce receipts by around £¹/₂ billion from 2003-04 onwards. Under the audited assumption, equity prices increase in line with money GDP from the existing level of the FTSE All-Share Index, 1778 in these projections compared with the Pre-Budget Report starting point of 1963, a fall of 9 per cent. The impact on receipts of the recent stock market increases over the past week have therefore not been incorporated into the forecast published today.

C40 Also included in the audited assumptions line is the impact of changes in the oil price forecast. The audited oil price assumption is based on the average of independent forecasts for 2003 ($26.6), as this is lower than the high average levels seen over the last three months, which partially reflected uncertainty over events in the Middle East. This is $1¹/₂ a barrel higher than assumed in the Pre-Budget Report and leads to slightly higher tax revenues.

C41 As set out in Chapter B, growth in real GDP is expected to be lower in 2003 and this, coupled with recent changes in the composition of GDP in particular lower wages and salaries, has adverse effects on tax receipts in 2003-04 and 2004-05. In later years, the impacts are much smaller as the economy moves back to trend.

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C42 The remaining change to current receipts in 2002-03 is explained by other factors. In particular, lower than expected taxes on income and wealth, and stamp duties. From 2003-04 onwards, these impacts are partly offset by higher forecasts of business rates receipts, and lower income tax credits, although the latter has little impact on the overall fiscal balances as they are largely matched by increases in the public expenditure element of the tax credits, and by higher council tax receipts, which reflect the convention of forward projections based on the average of recent years' council tax increases.

Tax-by-tax analysis

C43 Table C7 shows the changes to the projections of individual taxes since Budget 2002 and the Pre-Budget Report for 2002-03 and 2003-04. Table C8 contains updated projections for the main components of public sector receipts for 2001-02, 2002-03 and 2003-04.

Income tax

C44 Income tax receipts in 2002-03 are expected to be around £0.8 billion lower than forecast in the Pre-Budget Report. Much of this is the result of downward revisions to wages and salaries in the current financial year reflecting lower growth in private sector average earnings. In addition, self assessment tax receipts due at the end of January, which relate to tax liabilities in 2001-02, were also lower than expected. Full details on the shortfall will not be available until later in the year, however, early indications are that it may partly reflect lower than expected income from dividend payments.

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C45 Income tax receipts in 2003-04 have been revised down by similar amounts, although this revision is also due to lower tax revenues from interest receipts as a result of the lower interest rate forecast that is audited by the NAO. As a result of these developments, income tax as a per cent of GDP is slightly lower than in the Pre-Budget Report projection in every year.

Non-North Sea corporation tax

C46 Non-North Sea corporation tax receipts in 2002-03 are estimated to be around £26 billion, slightly higher than the Pre-Budget Report projection. After 2002-03 there have been a number of changes to the determinants of Non-North Sea corporation tax. Profits of non-financial companies have been revised downwards slightly in 2003-04 and 2004-05, but then recover. The lower equity price assumption has a negative impact on projected corporation tax on gains. Financial companies' profits are assumed to recover more slowly than was the case in the Pre-Budget Report, reflecting the ongoing uncertainty in financial markets, but to rise to similar levels by 2005. The overall forecast for corporation tax as a per cent of GDP is broadly as published in the Pre-Budget Report.

Tax credits

C47 The tables in this section show the amounts of tax credits classified as negative tax in line with OECD Revenue Statistics guidelines. The public expenditure amounts are included in Table C11. In the Pre-Budget Report, the estimated split of total tax credits between that scored as tax and that scored as public expenditure was revised, with the negative tax element about £2 billion a year higher from 2003-04 onwards. These revisions were balanced by changes in the public expenditure element of tax credits, such that there was no overall impact on the fiscal balances. Further revisions to this split account for much of the changes in Budget 2003.

North Sea revenues

C48 North Sea revenues in 2002-03 are estimated to be £5 billion, broadly in line with the Pre-Budget Report projection. In 2003-04, the Budget projection is £0.2 billion higher than was anticipated at the time of the Pre-Budget Report and there are slightly larger increases in subsequent years. Higher oil prices explain most of these increases. The oil price assumed in these projections is based on the average of independent forecasts for 2003, which is $26.6 per barrel, compared with $25.1 per barrel in the Pre-Budget Report.

Capital taxes

C49 Receipts from capital taxes in 2002-03 are expected to be around £0.3 billion lower than projected in the Pre-Budget Report, largely as a result of lower capital gains taxes. These receipts relate to gains realised in 2001-02, and are therefore not a result of recent movements in asset prices. Information on the tax liability underlying the gains realised in 2002-03 will become available in 2004.

C50 The reduction in the capital taxes forecast from 2003-04 onwards is largely explained by the reduction in the equity price forecast, along with new information on the composition of assets liable for inheritance tax.

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Stamp duty

C51 Stamp duty receipts in 2002-03 are estimated to be around £0.6 billion lower than forecast in the Pre-Budget Report, as a result of lower revenues from land and property transactions. This partly reflects lower than expected volumes of residential transactions and prices. Downward revisions to the projected levels of these tax determinants, along with lower forecasts for commercial prices explain most of the downward revisions to revenues in future years.

C52 Although equity prices were lower than expected at the time of the Pre-Budget Report in 2002-03, higher trading volumes have meant that revenues from stamp duty on shares are broadly in line with expectations. This pattern is expected to continue throughout the projection period.

Social security contributions

C53 Receipts from social security contributions in 2002-03 are expected to be around £1.2 billion lower than projected in the Pre-Budget Report. This is partly a result of lower wages and salaries, but also because personal pension rebates have been higher than expected. These two factors also explain much of the revision in 2003-04. Measured as a per cent of GDP, receipts remain slightly below their Pre-Budget Report levels in later years.

VAT receipts

C54 VAT receipts in 2002-03 are estimated to have been £63.6 billion, around £0.9 billion lower than projected in the Pre-Budget Report. This is largely because of lower than expected receipts in recent months. The forecast of VAT revenues from 2003-04 onwards continues to be governed by an assumption that is audited by the NAO, which stipulates that the ratio of VAT to consumers' expenditure should decline gradually, by 0.05 percentage points a year, after the effects of VAT policy decisions are taken into account. Therefore, the shortfall in 2002-03 automatically depresses receipts in future years. However, this is partly offset by the Budget forecast of higher consumers' expenditure growth from 2003-04 onwards and the VAT measures described in Chapter A. Therefore, VAT receipts are expected to be around £0.7 billion a year lower than their Pre-Budget Report levels from 2003-04 onwards.

Excise duties

C55 Excise duties in 2002-03 are estimated to be around £0.3 billion lower than forecast in the Pre-Budget Report, and around £0.1 billion higher in 2003-04. Fuel duty receipts were around £0.2 billion lower than forecast in the Pre-Budget Report in 2002-03. This is mainly because the later than usual date of the Budget means that the additional receipts associated with the forestalling of road fuel duties will now be received in the early part of 2003-04. This timing issue decreases receipts in 2002-03 by around £0.2 billion with an offsetting increase in 2003-04. This increase in 2003-04 is offset by the fuel duty measure described in Chapter A, and higher oil prices that are assumed to increase pump prices and decrease demand. Alcohol duty receipts are broadly as forecast in the Pre-Budget Report.

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C56 Tobacco duty receipts in 2002-03 are slightly lower than projected in the Pre-Budget Report as a result of downward revisions to the level of overall consumption. However, from 2003-04 onwards, receipts are expected to be higher than in the Pre-Budget Report. This is the result of the revised assumption regarding the levels of tobacco smuggling discussed in paragraphs C27 to C30, which has been audited by the NAO to ensure that it remains reasonable and cautious.

Other receipts

C57 Receipts from business rates in 2002-03 are estimated to be £0.7 billion higher than forecast in the Pre-Budget Report. This reflects new information on in year receipts. Other receipts in 2003-04 have also been revised up by similar amounts, largely as a result of higher council tax receipts, which reflect the convention of forward projections based on the average of recent years' council tax increases.

Tax-GDP ratio

C58 Table C9 shows projections of receipts from major taxes as a per cent of GDP, and Table C10 sets out current and previous projections of the overall tax-GDP ratio.

C59 Table C10 shows that the tax-GDP ratio is now expected to fall to 35.6 per cent of GDP in 2002-03, compared with the Pre-Budget Report projection of 36.3 per cent and the Budget 2002 projection of 36.7 per cent. Similarly, the tax-GDP ratio is expected to be well below the Pre-Budget Report and Budget 2002 projections throughout the projection period.

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C60 Chart C3 shows the tax-GDP ratio from 1978-79 to 2007-08.

Chart C3: Tax-GDP ratio

PUBLIC EXPENDITURE

C61 Table C11 shows projections for public expenditure up to 2005-06, the last year covered by the 2002 Spending Review. The projections cover the whole of the public sector, using the National Accounts aggregate Total Managed Expenditure (TME). TME is split into Departmental Expenditure Limits (DEL) - firm three year limits for departments' programme expenditure - and Annually Managed Expenditure (AME) - expenditure that is not easily subject to firm multi-year limits.

C62 Chart C4 shows TME as a per cent of GDP from 1970-71 to 2005-06.

Chart C4:Total Managed Expenditure

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C63 The 2002 Spending Review was the first to be conducted on a full resource basis. Resource accounting and budgeting (RAB) replaces the previous approach of planning and controlling public expenditure on a cash basis and applies the best financial and disclosure practices of commercial accounting to central government finances. Resource budgeting was introduced in two stages, and prior to the 2002 Spending Review budgets were set on a 'near cash' basis - a hybrid of resource budgeting and the previous cash management system.

C64 From 2003-04 onwards, departmental budgets will be controlled on a full resource budgeting basis, which means that the full economic cost of departmental activity will be recognised in budgets. Table C12 shows DEL in terms of resource and capital budgets. These figures have been adjusted to reflect classification changes since the Pre-Budget Report. These include: the reduction in the cost of capital charge that, under RAB, reflects the opportunity and financing costs of capital; and changes to the discount rate applied to future liabilities, as agreed with the independent Financial Reporting Advisory Board (FRAB). Both of these changes are TME neutral.

C65 Defence estimated outturn in 2002-03 has increased by £9.5 billion since the Pre-Budget Report. The majority of this increase is a result of changes arising from the quinquennial revaluation of its asset base in line with Generally Accepted Accounting Practice, the continued implementation of the asset management plan following on from the Strategic Defence Review and recognition of future liabilities. These items are all non-cash and TME neutral. An additional allocation of £1 billion was also made from the special reserve.

Chapter C, part 2

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Budget Report 2003 index