“Continued fiscal restraint is also essential given the still sizable overall deficit. The strong macroeconomic outlook provides a favorable environment for it. Following the substantial fiscal adjustment in 2005/06, we expect a further modest narrowing of the overall deficit relative to GDP in 2006/07. After the sharp increase in spending during 2002/03-2005/06, the targeted slowing this year is welcome. However, the spending pattern thus far means strong discipline through the remainder of the year is needed. With the overall deficit close to 3 percent of GDP, the Pre-Budget Report contains plans for the further adjustment needed to halt, in the medium term, the rise in net debt as a share of GDP. We broadly agree with the Treasury that tax buoyancy alone should result in a modest increase in revenue relative to GDP. Also, we strongly support the government's plans to first stabilize and then lower spending as a share of GDP. This will require tough choices in the Comprehensive Spending Review, particularly as important infrastructure needs argue for maintaining capital spending as a share of GDP at its present level. With the implementation of these plans, we expect the overall deficit to decline gradually to 1½ percent of GDP by 2011/12, a level consistent with maintaining debt below 40 percent of GDP and only slightly higher than the forecast in the Pre-Budget Report. We welcome the proposed pension reform to address the long-term challenges of the pension system without jeopardizing fiscal sustainability.
The fiscal framework is supporting the improvement in public finances. The fiscal rules—the sustainable investment rule and the golden rule—have helped to constrain discretion and protect investment. Continuing commitment to the framework during the prospective period of strong growth will help ensure that good times are indeed used to reduce the underlying fiscal deficit. As experience grows, further improvements to strengthen the framework should be considered. An important pillar of the framework is the auditing by the National Audit Office of certain key assumptions underpinning the fiscal projections. Broadening the reach of this auditing process would further enhance confidence in the fiscal projections. And, once current balance is regained, consideration should be given to alternative formulations of the golden rule that preserve its constraint on discretion and fit likely future circumstances.
Fiscal policy needs to have sufficient cushions to permit a response to shocks. During the global downturn of 2000-03, a large fiscal expansion played an important role in moderating the slowdown in the United Kingdom. At present, the capacity for similar action is narrowing. First, we expect net debt to rise to around 39 percent of GDP before it stabilizes, leaving little room even for automatic stabilizers to operate fully in a downturn if debt is to remain below 40 percent of GDP. Second, the tax-to-GDP ratio has risen in recent years to about its level in the second half of the 1980s. Further tax increases would risk adversely affecting incentives to work and invest. Finally, favorable global financial conditions may be providing a temporary boost to the financial sector; in this case, some of the recent strength in revenue would not be permanent. Against this background, realizing the government's medium-term projection of an overall fiscal deficit below 1½ percent of GDP is essential to stabilize and then gradual reduce the ratio of net debt to GDP. This would ensure—even through difficult times—that debt remains below 40 percent of GDP, a limit that has served the economy well."
Related;
Pre-budget report- Gordon's manifesto
Bagehot- The man with the plans
Listen to Pre-Budget Report Speech
Fiscal policy in the UK;
The Government has also specified two key fiscal rules that accord with the principles. These are:
the golden rule: over the economic cycle, the Government will borrow only to invest and not to fund current spending; and
the sustainable investment rule: public sector net debt as a proportion of GDP will be held over the economic cycle at a stable and prudent level.
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