When City A.M. asked Robert Chote, chairman of the Office for Budget Responsibility, how much the OBR’s borrowing forecast depends on its economic growth outlook, he quite rightly pointed out that it is not real GDP, which economists tend to focus on, but nominal GDP that is more important for predicting tax revenues and state borrowing.
Nominal GDP is the amount of cash spent on goods and services, whereas real GDP tells you about the volume of goods and services. Over any lengthy period of time, it is reasonable to expect tax revenues to climb roughly in line with nominal GDP.
But unfortunately for the OBR, its forecasting record on nominal GDP leaves a lot to be desired.
In 2010, the OBR predicted a swift rebound in nominal GDP’s annual growth rate to five per cent, roughly what it had been for the 15 years prior to the recession.
Not only did nominal GDP undershoot the forecast, it continued to undershoot successive forecasts. Tax revenues, which were expected to increase, virtually stagnated. Combined with persistently high spending, this has resulted in George Osborne missing his fiscal targets by a mile – several miles, in fact. Even this week’s optimistic forecasts do not expect the government to make a surplus until 2019-20.
In September, the OBR said its borrowing projections had been £60bn out due to problems with its nominal GDP forecast. If it cannot accurately forecast growth in nominal GDP, its predictions for tax revenue are not going to be worth the paper they are written on. Unfortunately for the UK, the amount the chancellor is allowed to tax and spend is dictated by the OBR’s forecasts.
In its latest round of predictions, the OBR gave Osborne an extra £27bn to spend. Why? Because it suddenly felt more optimistic on tax revenues and made some tweaks to some of its models. It is amazing that major decisions on tax, welfare and spending on government departments – decisions which impact every household and business in the UK – relies so heavily upon what can only be described as fickle and speculative economic forecasting.
Osborne’s spending and borrowing is a huge gamble, based on statistical guess-work rather than existing economic facts.