1 Budget Overview

Introduction

1.01 The Budget sets new and long-term ambitions for Britain and responds to the major challenges facing the economy. It is a Budget to ensure economic stability, reward work, encourage enterprise and promote fairness:

• the Government's macroeconomic policies will secure economic stability based on low inflation and sound public finances;

• an extension of the New Deal programmes, radical tax and benefit reforms and a skills package will promote employment and make work pay;

• a package of enterprise reforms, including major corporation tax changes and support for small and growing businesses, underline the Government's commitment to promote a more dynamic business sector; and

• the fairness measures will help to support families with children, tackle child poverty, improve public services and the environment and ensure that people and companies pay a fair share of tax by tackling avoidance.

Prospects facing the incoming Government

1.02 The short-run economic prospects and the underlying structural weaknesses confronting the incoming Government in 1997 highlighted that much needed to be done to secure economic stability and respond to the challenges facing the UK economy.

Economic developments and prospects

1.03 Although growth averaged around 3 per cent a year in the current upswing, this gives a misleading picture of the underlying strength of the economy. In large part this has reflected the fact that the economy was recovering from a deep recession - the sustainable rate of growth remained lower.

1.04 By early or mid 1997 the economy had more or less exhausted its spare capacity and was growing at an unsustainable pace with emerging skill shortages and upward pressure on inflation. Urgent measures - including the steps to put in place a new monetary policy framework and a deficit reduction plan - have therefore been taken to put the economy on course to get back to a sustainable growth path.

1.05 With GDP currently judged to be above its trend level (a positive output gap), inflation is expected to rise slightly this year. GDP will need to grow at a below-trend rate for a time, generating a negative output gap, in order to get inflation back down to its target.

1.06 The degree of slowdown required will depend in part on pay trends. Responsible pay bargaining combined with the Government's Welfare to Work measures would allow the economy to grow towards the upper end of the forecast ranges set out in Table 1.1.

Table 1.1: Summary of economic forecast

1.07 The forecast shows that:

• GDP growth slowed at the end of last year. It is slightly weaker this year, at 2 to 2 1/2 per cent, than forecast at the time of the Pre-Budget Report (PBR). The financial difficulties in Asia are forecast to reduce GDP growth by up to half a percentage point this year. Growth in 1999 is forecast to be a little stronger than in the PBR;

• inflation is forecast to peak at 3 per cent in the middle of the year, before falling back to its 2 1/2 per cent target by the end of 1999;

• rapid domestic demand growth has as yet shown little sign of slackening off, but is expected to slow through the course of this year in response to the increases in interest rates since last May and fiscal policy tightening;

• net trade is expected to continue to make a negative contribution to growth through this year and the first half of next, reflecting the continuing effects of sterling's appreciation and the impact of the financial difficulties in Asia. These are examined in more detail in Annex A;

• the exchange rate remains high: in trade-weighted terms, sterling has appreciated by around 25 per cent since August 1996. The Government is committed to delivering the sound, long-term economic policies which are essential to achieve and sustain a stable and competitive pound in the medium-term.

Longer-term challenges

1.08 The Government has taken effective steps in order to get the economy on course to achieve sustainable growth consistent with the inflation target. But more needs to be done to respond to the longer-term challenges facing the UK economy which are set out in the box below.

Structural weaknesses

1.09 The scale of the challenge facing the UK economy is highlighted by the extent to which it is currently lagging behind other major industrial countries. For example, as Chart 1.1 shows, output per head is around 50 per cent higher in the US than in the UK.

CHART HERE

1.10 The output per head gap reflects a number of factors including:

• low employment rate: around one in four of the working-age population are either unemployed or economically inactive. Around one in five working-age households have no one in work, double the level in 1979 and higher than most other developed economies;

• capital stock per employee in other leading economies such as Japan, Germany and the US is at least 50 per cent higher than in the UK;

• Business enterprise Research and Development (R&D) fell in the UK relative to almost every other G7 country between 1981 and 1995.

Increasing inequality

1.11 It is also significant that the structural weaknesses have deepened as income inequality has grown. By the mid-1990s the UK had, along with the US, the widest disparity of the leading industrial economies between high and low incomes. The income share of the bottom 20 per cent of households fell from 9.6 per cent in 1979 to 6.3 per cent in 1994-95. By contrast, the share of the top 20 per cent increased from 35 per cent to 43 per cent. The impact has been felt hardest on families with children who make up a significant proportion of those on the lowest incomes.

The New Agenda

1.12 A radical new agenda is therefore needed to achieve the Government's declared objectives of raising the long-term sustainable growth rate, increasing employment and promoting a fairer society. It requires co-ordinated action using the full range of the Government's economic, tax and spending instruments. And it also requires an active partnership with other leading industrialised countries to maximise the long-term benefits.

July Budget

1.13 Last July's Budget laid the foundations: it mapped out the economic framework that will help deliver these goals. It set out a five year deficit reduction plan, began to reform corporation tax to promote investment and announced a New Deal to get the young and long-term unemployed into jobs. The health service and schools also received a major boost, reflecting the Government's priorities.

Response to the Pre-Budget Statement

1.14 The Chancellor's November Pre-Budget Statement signalled the key next steps on the economy, jobs, enterprise and creating a fairer society, and launched a wide-ranging consultation exercise. The debate that followed has helped to inform the Budget and shape some of the key measures, including the enterprise and savings measures, contained within it. The Pre-Budget consultation will now be a feature of all future Budgets.

A Budget for work and families

1.15 This Budget - the first full-scale Budget of the new Government - is a further major step forward. It focuses mainly on the economy and tax reform as the Comprehensive Spending Review - the results of which will be published in the summer - will map out the Government's spending priorities for the years beyond 1998-99. But the underlying principles will be common to both: to develop a long-term strategy for increasing economic growth and employment and tackling poverty and social exclusion.

Four elements of the strategy

1.16 The Budget is designed to link four key elements of the Government's economic strategy. These are highlighted below and set out in detail in the following chapters:

• securing economic stability based on low inflation and sound government finances for the long-term;

• encouraging work by extending the New Deal, making work pay, providing child care support, tackling skill shortages and promoting life-long learning;

• promoting enterprise through a range of tax reforms to boost investment and small firms; and

• creating a fairer society, now and in the future.

Economic Stability (see chapter 2)

1.17 A platform of economic stability is an essential precondition for high levels of growth and employment. That is why, accompanying the reforms of the Bank of England to ensure stability in monetary policy, in this Budget, the Government brings forward a Code for Fiscal Stability whose statutory basis will be enacted in the Finance Bill. The Code sets out the requirements for a disciplined, transparent and accountable approach to managing the public finances.

1.18 The Government has also put in place tough rules for spending and borrowing:

1.19 The golden rule promotes a prudent and long-term approach to current spending and helps to promote fairness between generations because it means that the cost of public investment is met by those who benefit from that investment. The debt rule will ensure that fiscal policy is run in a responsible way and does not threaten the stability of the economy. 1.20 The Budget also demonstrates that the Government remains well on course to meet the rules on borrowing and spending which will help ensure the long-term stability that Britain needs. Progress towards these rules has been more rapid than expected. The current balance, which has been substantially in deficit since 1991-92, is expected to be close to balance in 1997-98, and the debt burden, which increased over the first half of the 1990s, is now falling, as it should at this stage of the economic cycle.

1.21 Table 1.2 shows the effects on the PSBR forecast of Budget measures and other changes. As a result of the Government's disciplined approach, public spending has been lower than expected in 1997-98, while tax receipts, particularly from self-assessment, have also been higher than expected. The underspend on the Control Total will allow higher spending in 1998-99, but the higher level of tax receipts is projected to carry through only partly to later years. More information on the public finances can be found in Annex B.

Table 1.2: Fiscal Aggregates and changes to the PSBR forecast(1)

1 The PSBR, GGFD and current balance exclude windfall tax and associated spending.

2 General government financial deficit on UK National Accounts definitions.

3 Figures are based on illustrative case in which Control Total grows at 2 1/4 per cent in real terms after 1998-99.

1.22 Firm control of public spending is a key requirement for economic stability. In the short term, the Government has committed itself to work within existing spending ceilings for the first two years of the Parliament.

1.23 This has made it possible to undertake a Comprehensive Spending Review (CSR) which will lead to prudent and sustainable plans for the medium-term. The CSR obliges every department to review its spending, to improve efficiency and effectiveness and to reallocate resources towards the Government's priorities. The Budget includes some early outputs from this process, with additional money allocated to spending priorities including health, education and transport in 1998-99.

1.24 This has been made possible by the success of the Government's spending discipline in its first year in office. Thanks to prudent control of spending in 1997-98, calls on the Reserve have been smaller than anticipated, releasing £1.5 billion of extra resources which can be carried forward to 1998-99. A part of these extra resources has been allocated to spending priorities, and a part retained in the Reserve to deal with unforeseen needs. The full results of the CSR, including spending plans for years after 1998-99, will be announced this summer.