Today the independent Office for Budget Responsibility (OBR) published its fourth fiscal sustainability report (FSR). This document meets their requirement to annually prepare an analysis of the sustainability of the public finances, and provides an important insight into the state of the public finances and the impact that demographic change will have. The report was laid before Parliament earlier today and copies are available in the Vote Office and Printed Paper Office.
According to the OBR’s analysis, policy action taken by the Government over the past year has had a substantial positive impact on long-term fiscal sustainability, reducing the projected level of debt in 2063-64 by 66% of GDP. As a result of demographic change, debt is projected to rise to 84% of GDP by 2063-64, and in the absence of policy change the OBR projects that net debt would have risen to 150% of GDP in 2063-64. This improvement is in the context of updated population projection from the Office for National Statistics which has revised up the projected scale of the demographic challenge.
Nevertheless, the FSR’s key conclusion is that,
“longer-term spending pressures, if unaddressed, would put the public finances on an unsustainable path".
As the OBR notes in its analysis, this is due to the spending pressure generated by an ageing population, which is projected to increase age-related spending by 4.8% of GDP from 2018-19 to 2063-64.
In addition to projecting the impact of demographic change on public spending, the FSR examines the long-term sustainability of tax revenues. It has projected that tax revenues will remain at a relatively constant share of GDP from 2018-19 onwards, but has highlighted the challenges faced by sources of revenue in decline, particularly revenues from North sea oil and gas.
Notably, the FSR’s projections of state pension expenditure incorporate the Government’s announcement at autumn statement 2013 that the regular reviews of the state pension age will be guided by the principle that people should expect to spend, on average, up to a third of adult life receiving the state pension.
Setting the state pension age with regard to life expectancy reduces the risk that future Governments would have to take emergency action to ensure sustainable public finances, as it allows the Government to respond regularly to changes in demographic data. The European Commission and the International Monetary Fund (IMF) have also advocated the introduction of linking pension spending to life expectancy. The OBR projects that this policy change will have a substantial positive impact on long-term fiscal sustainability, with state pension spending projected to be 0.9% of GDP lower and debt 17% of GDP lower by 2063-64 than if the state pension age had risen with currently legislated changes.
The new state pension age guiding principle complements reforms which have already been made to state pensions, such as the single tier. The new simple state pension for future pensioners, set at a level above the standard minimum guarantee in pension credit, will not cost any more than the current system overall and enable individuals to plan for retirement with greater certainty. The OBR projects that by 2063-64, the new system will generate savings of around 0.5% of GDP.
Reforms to the state pension come alongside the Government’s reforms to public service pensions, which will rebalance taxpayer and member contributions in the short term while ensuring costs are sustainable and fair in the long term. New scheme designs, the rebalancing of costs between members and taxpayers and switching to uprating by the consumer prices index (CPI) is projected to lead to savings of 0.6% of GDP a year by the 2060s.
The Government are committed to ensuring that our public finances are put on, and remain on, a sustainable path for the long-term. The OBR analysis makes it very clear that the Government’s medium-term fiscal consolidation plan is the most vital step towards achieving long term fiscal sustainability.
As part of this commitment, both parties of the coalition have agreed that once debt as a percentage of GDP begins to fall in 2016-17, it should continue to fall in future years. At autumn statement 2013 the Government announced that over the course of this year they will review the fiscal framework and that the outcome of this review will inform an updated Charter for Budget Responsibility to be presented to Parliament alongside autumn statement 2014.
As part of its public service reform seminar series announced at Budget 2014, the Government will hold a seminar on long-term sustainability with a focus on health care and technology, and how advances in technology can be harnessed to deliver efficient, cost-effective health services in the future.