THERE’S a hole in our finances. To be exact, a £125 million hole – at least.
The warnings have been out for some months, but all was finally revealed last week in the Council of Ministers resources statement updating their Strategic Plan.
- States acting Treasurer Richard Bell
- Comptroller of Taxes David Le Cuirot
- Director of Financial Services Joe Moynihan
- Economic Development chief officer Mike King
- Social Security chief officer Ian Burns
- Adviser on international affairs Colin Powell
- States economist Dougie Peedle
- External adviser Kevin Keen[/breakout]
To be fair, the impact of the full £125 million will not be felt until 2019, and that’s only if the politicians sit on their hands and do nothing about it. Plans are already under way to cut public sector jobs, join departments together, defer plans, make efficiencies.
In addition, taxpayers are likely to be asked to pay for things we have had for free, including the disposal of liquid and solid waste and some health services.
But many seem to be wondering why this financial hole has appeared at all. Prior to the draft Budget last August, everything seemed to be hunky-dory. Only then did we see a predicted £34 million shortfall for 2014, followed by a £50 million shortfall for 2015. Questions were raised by Scrutiny as to why the deficit was not recognised earlier.
The answers, as often happens, are somewhat complex and multi-faceted. The Income Forecasting Group (IFG) – which has recently been joined by several new members, including external adviser Kevin Keen – has now produced its first formal report and, combined with revised updates from the States Treasury, paints an increasingly bleak – and uncertain – picture of the prospects for the Island’s economy.
The main factors the group consider will have an impact on the economy over the next four years are:
Income forecasts
When the last Medium Term Financial Plan forecasts were prepared in early 2012, the impact of the eurozone crisis had not been fully realised. This, the group says, has resulted in significant reductions to the forecasted income revenues (down by £34 million in 2014 and £50 million in 2015). The latest updates show a further reduction for 2015 and lower tax take is also likely from 2016 to 2018, based on lower assumptions for average earnings and financial services profits growth. A further reduction in income is expected in 2018 due to a low or zero trend rate of economic growth.
The Income Forecasting Group have also revised down their assumptions in the light of changes to the taxation of shareholder income. Over the last three years the amount collected from GST was also lower than previously forecast.
Lower than predicted average earnings
Average earnings growth is expected to be weaker this year and next than was predicted in the 2015 Budget.
Lower than predicted financial services profits growth
There is currently uncertainty in the banking sector – by far the largest financial services contributor to the Island’s tax take – about a forthcoming programme of UK banking reforms, including the ‘ring fencing’ of non-retail banking activity.
Financial services profits are now expected to grow more slowly than predicted in the 2015 Budget, based on interviews with finance companies carried out at the end of last year.
Lower interest rate expectations
Interest rates in the UK are expected to increase later and more slowly than was previously expected. This will affect the banking sector’s deposit-taking business in the Island.
Low inflation
Inflation is expected to continue to be generally lower than previously expected until 2017, in view of the fall in oil prices. This is helpful for consumers but will also keep earnings growth low.
External relations
There are concerns about an impact on business decisions if the planned UK referendum on European Union membership results in a breakaway from the EU. This would mean that the Island would need to renegotiate its ‘special relationship’ with both Europe and the UK, although there could also be business opportunities.
Low employment growth
Relative to the 2015 Budget forecasts, employment is expected to grow more quickly this year, but then more slowly in 2016 and 2017.
Higher expenditure
The departments requiring major additional expenditure over the coming four years are Health (£52 million) and Education (£9 million), based on projections for an ageing population and the need to develop skilled workers locally.
Low or zero economic growth in real terms from 2018
Real economic growth is expected to be slightly stronger in 2014 and 2015, but slightly weaker in 2016 and 2017. For 2018, the Fiscal Policy Panel of senior economists have advised that the States should plan on the basis of a 0% trend rate of real growth.
What happens next?
The Council of Ministers say they have learned from the previous Medium Term Financial Plan and have already taken steps to improve their forecasting in time for the next four-year plan, which is to be presented to the States at the end of June. In particular there will be more frequent updates and an upper and lower range of forecasts, to provide greater accuracy.
As a first step, the Income Forecasting Group will be reporting back again in May, prior to the MTFP debate in the autumn.
This is not the first time that Islanders have been talking about financial black holes.
Way back in the mists of the early 2000s a £100 million black hole emerged following a demand via the UK government that the Channel Islands and Isle of Man should be forced to comply with European Union rules on corporate tax.
In essence, this meant that all companies registered in the Island would need to pay the same tax rate, whether they were non-resident or carried out trading activity here.
In practice, in order to keep the rules simple and to prevent an exodus of existing business, the States decided to reduce all corporate tax to zero, with the exception of financial services businesses, which pay ten per cent, and utility companies, which pay 20%.
Thus zero-ten was born, but not without pain for Island residents.
The loss of corporate tax resulted in the introduction of the Goods and Services Tax and the ’20 means 20′ cuts to tax allowances for higher earners.
A scheme to rake back tax from the profits accrued by Jersey-resident company shareholders – called ‘deemed distribution’ – was later rejected by the EU.
