Years of low earnings growth have hurt public finances

Taking a longer view, public finances have diverged considerably from government expectations


Today’s public finance statistics are worth reading. They show a fall of £6bn in net government borrowing between April 2014 and January 2015 and the same period a year ago.

January is usually a good month for the public finances, as the self-employed complete their income tax returns. The rapid growth in the numbers of self-employed over the last two years has now fed into higher receipts, with £12.3bn collected from the self-employed last month, versus £10.7bn collected in January 2014.

This good month of data means that the government is on track to meet their borrowing forecasts.

But taking a longer view, the public finances, and income tax receipts in particular, have diverged considerably from government expectations. In their March 2014 forecast, the Office of Budget Responsibility predicted that £167bn would be collected in income tax in 2014-15. Poor earnings growth throughout 2014 led them to revise down their expectations for income tax to £163bn, a fall of £4bn.

These may not sound like big numbers, but over the course of this parliament low growth in earnings among both employees and the self-employed and income tax cuts have made the job of deficit reduction much harder.

Earlier this week the TUC published some modelling by IPPR that unpicks this effect. The study finds that earnings have consistently performed worse than OBR forecasts. For example, when they made their first forecasts at the time of the June 2010 budget, the OBR predicted earnings growth in 2013/14 would be 5.3 per cent. In fact, earnings only managed average growth of 1.5 per cent in that year.

A similar pattern holds across the current parliament.

Lower earnings translates into less income tax paid to the exchequer. The TUC research finds that the weak performance of earnings from 2010 to 2014 has led to £21bn less income tax, and £12bn less National Insurance Receipts being collected.

Cumulatively, this £33bn represents around a third of the deficit. This impact has been compounded by the coalition’s program of tax cuts, in particular above-inflation increases in the value of the personal allowance (the amount that can be earned before starting to pay income tax). The TUC’s numbers show this led to a further £10bn less in income tax collected.

The Institute for Fiscal Studies recently calculated that £110bn of deficit reduction has already taken place, and that structural government borrowing will have risen since the crisis by around £160bn in 2019-20. This means that had earnings growth performed according to the OBR’s predictions, we would have very little deficit reduction left to do to bring borrowing into balance.

How and when earnings growth picks up will have big implications for the course of deficit reduction in the next parliament. While in recent months inflation has fallen below average earnings growth, leading to a welcome boost in purchasing power for workers, there still hasn’t been much of an up-tick in cash earnings (the key determinant of income tax receipts).

If low inflation leads to similarly low annual cost of living increases in workers pay packets, we could be in for another poor year of income tax receipts, and even more cuts to come.

Spencer Thompson is senior economic analyst at IPPR. Follow him on Twitter

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