[pic] | COMMISSION OF THE EUROPEAN COMMUNITIES |

Brussels, 12.9.2007

SEC(2007) 1155

Recommendation for a

COUNCIL DECISION

abrogating Decision 2006/125/EC on the existence of an excessive deficit in the United Kingdom

(presented by the Commission)

EXPLANATORY MEMORANDUM

1. BACKGROUND

Article 104 of the Treaty establishes that Member States should avoid excessive deficits and lays down a procedure for their identification and correction. Pursuant to point 5 of the Protocol on certain provisions relating to the United Kingdom of Great Britain and Northern Ireland (United Kingdom), the obligation to avoid excessive deficits does not apply to the United Kingdom unless it moves to the third stage of economic and monetary union. In the second stage, the United Kingdom is required to endeavour to avoid excessive deficits, pursuant to Article 116(4) of the Treaty. The excessive deficit procedure (EDP) is further specified in Council Regulation (EC) No 1467/97 on “speeding up and clarifying the implementation of the excessive deficit procedure”[1], which is part of the Stability and Growth Pact. According to Article 104(2) of the Treaty, the Commission has to monitor compliance with budgetary discipline on the basis of two criteria, namely: (a) whether the planned or actual government deficit exceeds the reference value of 3% of GDP (unless either the deficit ratio has declined substantially and continuously and reached a level that comes close to the reference value; or, alternatively, the excess over the reference value is only exceptional and temporary and the ratio remains close to the reference value); and (b) whether government debt exceeds the reference value of 60% of GDP (unless the debt ratio is sufficiently diminishing and approaching the reference value at a satisfactory pace).

In accordance with the Protocol on the excessive deficit procedure annexed to the Treaty, the Commission provides the data for the implementation of the EDP. As part of the application of this Protocol, Member States have to notify data on government deficits and debt and other associated variables twice a year, namely before 1 April and before 1 October, in accordance with Article 4 of Council Regulation (EC) No 3605/93[2],[3]. According to Council Regulation 1467/97, the relevant budgetary data for the United Kingdom are established in budgetary year (i.e. financial year) terms (running from 1 April to 31 March) but the reporting dates are the same as for the other Member States. Moreover, according to Article 7 of Regulation (EC) No 3605/93, Member States are expected to notify to the Commission revisions to their previously reported data.

On 21 September 2005, the Commission initiated the EDP for the United Kingdom with the adoption of a report under Article 104(3), based on a general government deficit of 3.2% of GDP in financial year 2004/2005[4],[5]. On 24 January 2006, the Council decided, on a recommendation from the Commission, that the United Kingdom was in excessive deficit according to Article 104(6)[6]. At the same time, and also based on a Commission recommendation, the Council addressed recommendations under Article 104(7) to the United Kingdom with a view to bringing the situation of an excessive government deficit to an end by 2006/07 at the latest. In particular, the Council recommended that the United Kingdom authorities bring the general government deficit below 3% of GDP in a credible and sustainable manner and to this end ensure an improvement of the structural balance by at least 0.5 percentage points of GDP between the 2005/2006 and 2006/2007 financial years. In addition, the Council invited the United Kingdom authorities to ensure that, after the excessive deficit has been corrected, budgetary consolidation is sustained towards a medium-term budgetary objective that (i) provides a safety margin with respect to the 3% of GDP deficit limit; (ii) maintains prudent debt ratios taking into account the economic and budgetary impact of ageing populations; and (iii) taking (i) and (ii) into account, allows room for budgetary manoeuvre, in particular considering the needs for public investment.

Table 1: Adjustment endorsed by the Council on 24 January 2006

% of GDP, unless indicated otherwise | 2004/2005 | 2005/2006 | 2006/2007 |

General government balance change in structural balance | -3.2 | / | deficit < 3 + 0.5 at least |

2004 | 2005 | 2006 | 2007 |

p.m.: Real GDP growth (%) | 3.2 | 1.6 | 2.3 | 2.8 |

Note : structural balance = cyclically-adjusted balance excluding one-off and other temporary measures

Source : Council recommendation under Article 104(7), quoting the Commission services’ autumn 2005 forecast and including subsequent evaluations

On 20 September 2006, after the expiry of the deadline of 24 July 2006 for the UK authorities to take action in response to the Council recommendations, the Commission adopted a Communication to the Council, which concluded that the United Kingdom seemed to be just on track to correct its excessive deficit by the end of 2006/2007, although the structural improvement of the budget balance between 2005/2006 and 2006/2007 could fall short of the minimum 0.5% of GDP recommended by the Council[7]. In its conclusions of 10 October 2006, the Council concurred with the Commission and confirmed its intention to continue together with the Commission to closely monitor budgetary developments in the United Kingdom.

Since the data notified in March 2007 for budgetary year 2006/2007 were based on government projections, the United Kingdom has decided to submit a supplementary notification in July 2007, reporting actual outturns for 2006/2007 and updated data for previous years, which has enabled the Commission to assess budgetary developments in the United Kingdom relative to the Council recommendation on bringing the excessive deficit situation to an end by 2006/2007 at the latest.

According to Article 104(12), a Council decision on the existence of an excessive deficit is to be abrogated, on the basis of a Commission recommendation, when the excessive deficit in the Member State concerned has, in the view of the Council, been corrected.

2. DEFICIT DEVELOPMENTS UNTIL 2006/2007

THE COUNCIL DECISION THAT THE UNITED KINGDOM WAS IN EXCESSIVE DEFICIT WAS BASED ON A DEFICIT ESTIMATE FOR 2004/ 2005 of 3.2% of GDP. However, the July 2007 notification shows a deficit for 2004/2005 of 3.4% of GDP[8]. Compared to the previous year, the structural balance is estimated to have deteriorated by 0.2 percentage points of GDP[9]. In 2005/2006, the deficit fell to 3.2% of GDP, notwithstanding a sharp slowdown in GDP growth. The improvement, however, partly reflected the imputation of a one-off transaction that reduced the deficit by 0.3% of GDP[10]; in structural terms, the consolidation is estimated to have been equivalent to 0.2 percentage points of GDP.

In 2006/2007 the deficit fell further to 2.7% of GDP, 0.1 percentage point less than the deficit forecast in December 2005 update of the convergence programme[11]. The ratio to GDP of government revenue rose by 0.4 percentage points to 41.6% of GDP, boosted by strong receipts of corporate taxes on financial sector profits and a doubling of the supplementary tax rate on profits from the extraction of oil and gas. Government expenditure, including a capital transfer of 0.1% of GDP in relation to the cancellation of debts owed by developing countries, remained stable at 43.9% of GDP. In structural terms, the deficit in 2006/2007 is estimated to have improved by 0.7% of GDP when compared to 2005/2006[12], in line with the Council's recommendation to achieve a structural improvement of at least 0.5% of GDP.

3. DEFICIT PROJECTIONS FOR 2007/2008 AND BEYOND

The Commission services' spring 2007 forecast projects continuing fiscal consolidation during 2007/2008 and 2008/2009, though of modest scale given expectations of continued robust economic expansion. In 2007/2008, the deficit is forecast at 2.6% of GDP, in a favourable macroeconomic context, with real GDP growth expected to reach 2.7%[13]. The latter, coupled with an increase in air passenger duty and some tax avoidance counter-measures, are expected to contribute to a rise in the revenue ratio by 0.4 percentage points of GDP. However, this will be almost completely offset by an increase in the expenditure ratio, largely on account of higher investment spending. The United Kingdom authorities also reported a planned deficit of 2.6% (adjusted for UMTS receipts) for 2007/2008 in their July 2007 notification, unchanged from the forecast in the 2007 Budget and in their notification of March 2007. However, the projected deficit ratio is 0.3 percentage points higher than in the December 2006 update of the convergence programme, on account of a downward revision in corporate taxation revenue from oil and gas extraction in the North Sea. According to the Commission services' spring 2007 forecast, with output growth matching potential the reduction in the structural balance is estimated to be of 0.2 percentage points of GDP in 2007/2008.

In 2008/2009, the fiscal stance is also expected to be tightened slightly, with the Commission services projecting a deficit of 2.4% of GDP under a no-policy change assumption. The revenue ratio is expected to increase by 0.2 percentage points of GDP, mainly as a result of fiscal drag. The tax reforms announced in the 2007 Budget, which will take effect as from 2008/2009, will have a neutral effect on the profile of the general government deficit, since the announced 2 percentage point reduction in the basic rate of personal income tax and in the main corporate tax rate will be offset by the abolition of the 10% starting rate of income tax and a reduction of capital allowances against corporation tax. On the expenditure side, although the Comprehensive Spending Review (CSR) 2007, which is expected to be published in October 2007, will establish the expenditure limits for the individual departments for the three-year period starting 2008/2009, the 2007 Budget already set overall spending limits that curtail real growth in current expenditure in 2008/2009 to 2.0% and maintain public sector net investment at 2¼% of GDP over the CSR period. These spending limits, which the Commission services' forecast assumes will be adhered to, imply a drop in general government expenditure growth from almost 6% in the previous financial year to 4.9% in 2008/2009, with the expenditure-to-GDP ratio remaining constant at 44.2% of GDP. In structural terms, the Commission services' deficit forecast for 2008/2009 implies an improvement of 0.3% of GDP.

The United Kingdom does not have a medium-term objective (MTO) for its budgetary position in the sense required by the Stability and Growth Pact. However, the 2007 Budget includes the government's projections on public finances beyond 2008/2009. These projections foresee a drop in the general government deficit (adjusted for UMTS receipts) to 2.0% of GDP in 2009/2010, 1.8% in 2010/2011 and 1.5% in 2011/2012. The estimated minimum benchmark – that is, the estimated budgetary position in cyclically-adjusted terms that provides a sufficient safety margin for automatic stabilisers to operate freely during normal economic downturns without breaching the 3% of GDP reference value – calculated for the UK as a deficit of around 1½% of GDP, is projected to be reached only in 2011/2012. In its opinion of 27 February 2007 on December 2006 update of the convergence programme[14], the Council noted that achieving the budgetary targets after 2007/2008 (marginally more demanding after 2008/2009 than in the 2007 Budget) required the effective implementation of the projected expenditure restraint. It invited the United Kingdom to: " pursue budgetary consolidation over the programme period, especially by implementing the projected reduction in expenditure growth after 2007/2008, and to strengthen further its fiscal position in order to address the risks to long-term sustainability of the public finances ".

4. DEBT DEVELOPMENTS AND PROJECTIONS

The general government debt ratio remains well below the 60% reference value, although it has risen from 39.6% of GDP in 2004/2005 to 42.5% of GDP in 2006/2007. The increase in the debt ratio since the beginning of the excessive deficit procedure in 2004/2005 is mainly due to primary deficits, although a positive stock-flow adjustment, chiefly reflecting loans to higher education students, also contributed. The 'snow-ball' effect, which refers to the changes in the debt ratio induced by differences between the average interest rate on government debt and nominal GDP growth, contributed to increase the debt ratio by about 0.5 percentage point in 2005/06 when nominal GDP growth decelerated abruptly.

Under a no-policy change assumption, the Commission services' spring 2007 forecast projects an increase in the debt ratio to 43.9% by the end of 2008/2009. This is 0.5 percentage point lower than projected in the 2007 Budget, on account of the carry-over effect from the lower debt outturn in 2006/2007. The modest improvement in the primary balance should curtail the increase in the debt ratio, whereas the snow-ball effect is expected to have a neutral influence on the ratio during the forecast period. However, a further strengthening of the fiscal position beyond that foreseen to 2008/2009 will be required to halt the increase in the debt ratio.

5. CONCLUSIONS

In 2006/2007 the general government deficit decreased from 3.2% of GDP in 2005/2006 to 2.7%, below the 3% of GDP reference value. The structural balance, i.e. the cyclically-adjusted balance net of one-off and other temporary measures, is estimated to have improved by 0.7% of GDP , in line with the minimum 0.5% of GDP structural adjustment recommended by the Council. According to the Commission services’ spring 2007 forecast, the headline deficit is expected to narrow to 2.6% of GDP in 2007/2008 and, on a no-policy change basis, to 2.4% in 2008/2009. This indicates that the deficit has been brought below the reference value in a credible and sustainable manner, although the projected path of future consolidation is modest relative to the benign economic environment forecast for 2007/2008 and 2008/2009.

General government gross debt rose from 39.6% of GDP in 2004/2005 to 42.5% in 2006/2007, but remaining well below the 60% of GDP reference value. According to the Commission services’ spring 2007 forecast, the debt ratio is expected to rise to 43.9% of GDP by 2008/2009 (on a no-policy change basis), with the modest improvement in the primary balance curtailing the increase in debt.

From an overall assessment, it follows that the excessive deficit situation in the United Kingdom has been corrected. Accordingly, the Commission recommends to the Council to abrogate its decision on the existence of an excessive deficit in the United Kingdom.

Table 2: Budgetary developments, 2004/2005-2008/2009

% of GDP, unless indicated otherwise | 2004/05 | 2005/06 | 2006/07 | 2007/08 | 2008/09 |

COM | UK notification/ Budget 07 (2) | COM(3) | UK notification/Budget 07 (2) |

General government balance | -3.4 | -3.2 | -2.7 | -2.6 | -2.6 (-2.3) (4) | -2.4 | -2.2 (-1.9) (4) |

- Total revenues | 39.5 | 40.8 | 41.2 | 41.6 | n.a. | 41.8 | n.a. |

- Total expenditure | 42.9 | 43.9 | 43.9 | 44.2 | n.a. | 44.2 | n.a. |

Of which : | - interest expenditure | 2.0 | 2.1 | 2.1 | 2.1 | 2.2 | 2.1 | n.a |

- gross fixed capital formation | 1.8 | 0.6 | 1.8 | 2.0 | 2.1 | 2.3 | n.a. |

Primary balance | -1.4 | -1.1 | -0.6 | -0.5 | -0.4 | -0.3 | n.a. |

One-off and other temporary measures | 0.0 | 0.3 | 0.0 | 0.0 | 0.0 | 0.0 | 0.0 |

Cyclically-adjusted balance | -3.5 | -3.0 | -2.6 | -2.4 | -2.3 | -2.1 | -1.9 |

Structural balance(1) | -3.5 | -3.3 | -2.6 | -2.4 | -2.3 (-2.1)(4) | -2.1 | -1.9 (-1.7)(4) |

Government gross debt | 39.6 | 41.6 | 42.5 | 43.3 | 44.3 | 43.9 | 44.4 |

Pm Real GDP growth (%) | 2.9 | 1.9 | 2.9 | 2.7 | 2½(5) | 2.4 | 2½(5) |

Pm Output gap(6) | 0.5 | -0.3 | -0.4 | -0.4 | -0.6 | -0.5 | -0.6 |

(1) Cyclically-adjusted balance excluding one-off and other temporary measures. (2) UK forecast provided to the Commission with the July 2007 notification and unchanged from the end-March 2007 notification, based on the projections in the Budget 2007 document of 21 March 2007. However, output gaps used to estimate the cyclically-adjusted and structural balances are calculated by Commission services. (3) No-policy change assumption. (4) Forecast by UK authorities in the December 2006 update of the convergence programme. (5) GDP forecast underlying the authorities' projections for public finances derived from a scenario whereby trend growth is one-quarter percentage point higher. (6) Commission services' estimates of the output gap on a calendar year basis, with the estimate for 2004 listed in the 2004/2005 column, and based on potential growth estimates of 2.8% in 2006, 2.8% in 2007 and 2.6% in 2008. Sources: Commission services’ spring 2007 forecast (COM), December 2006 update of the convergence programme, 2007 Budget and July notification. |

Recommendation for a

COUNCIL DECISION

abrogating Decision 2006/125/EC on the existence of an excessive deficit in the United Kingdom

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community, and in particular Article 104(12) thereof,

Having regard to the recommendation from the Commission,

Whereas:

(1) In its Decision 2006/125/EC of 24 January 2006[15], following a recommendation from the Commission in accordance with Article 104(6) of the Treaty, the Council decided that an excessive deficit existed in the United Kingdom. The Council noted that in financial year 2004/2005[16] the general government deficit was 3.2% of GDP, above the 3% of GDP Treaty reference value, while general government gross debt stood at 40.8% of GDP, well below the 60% of GDP Treaty reference value.

(2) On 24 January 2006, in accordance with Article 104(7) of the Treaty and Article 3(4) of Council Regulation (EC) No 1467/97 of 7 July 1997 on speeding up and clarifying the implementation of the excessive deficit procedure[17], the Council made, based on a recommendation from the Commission, a recommendation addressed to the United Kingdom that the excessive deficit situation should be brought to an end by 2006/2007 at the latest. The recommendation was made public.

(3) In accordance with Article 104(12) of the Treaty, a Council Decision on the existence of an excessive deficit is to be abrogated when the excessive deficit in the Member State concerned has, in the view of the Council, been corrected.

(4) In accordance with the Protocol on the excessive deficit procedure annexed to the Treaty, the Commission provides the data for the implementation of the procedure. As part of the application of this Protocol, Member States are to notify data on government deficits and debt and other associated variables twice a year, namely before 1 April and before 1 October, in accordance with Article 4 of Council Regulation (EC) No 3605/93 of 22 November 1993 on the application of the Protocol on the excessive deficit procedure annexed to the Treaty establishing the European Community[18]. In view of the fact that the data notified in March 2007 for budgetary year 2006/2007 were government projections, the United Kingdom has decided to submit in the context of its excessive deficit procedure a supplementary notification. This, received on 16 July 2007, reports actual outturns for 2006/2007, which has enabled the Commission to assess budgetary developments in the United Kingdom relative to the Council recommendation on bringing the excessive deficit situation to an end by 2006/2007 at the latest.

(5) Based on data provided by the Commission (Eurostat) in accordance with Article 8g(1) of Regulation (EC) No 3605/93 following the notification by the United Kingdom on 16 July 2007 and on the Commission services’ spring 2007 forecast, the following conclusions are warranted:

- the general government deficit was reduced from 3.2% of GDP in 2005/2006 to 2.7% in 2006/2007, below the 3% of GDP deficit reference value. This is slightly below the projection of 2.8% of GDP set in the December 2005 update of the United Kingdom's convergence programme,

- fiscal consolidation in 2006/2007 resulted from an increase in the revenue ratio of 0.4 percentage points of GDP, especially through higher corporate tax revenues. Total government expenditure between 2005/2006 and 2006/2007 grew in line with nominal GDP, although capital spending was lower than projected in the December 2006 convergence programme and current expenditure higher. Compared with 2005/2006, during which year the imputation of a one-off transaction reduced the deficit by 0.3% of GDP, the improvement in the structural balance (i.e. the cyclically-adjusted balance net of one-off and other temporary measures) in 2006/2007 is estimated at 0.7% of GDP,

- for 2007/2008, in line with the deficit projection published in the Budget of March 2007, the Commission services' spring 2007 forecast projects the deficit to be reduced further, to 2.6% of GDP, driven by a rise in the revenue ratio, specifically the tax burden, which is however almost completely offset by a rise in the expenditure ratio. This deficit ratio is higher than the official deficit projection of 2.3% of GDP set in the December 2006 update of the convergence programme, on account of a downward revision in corporate taxation revenue. For 2008/2009, the spring forecast projects, on a no-policy change basis, a further decline in the deficit to 2.4% of GDP. This profile indicates that the deficit has been brought below the 3% of GDP ceiling in a credible and sustainable manner. In structural terms, the general government deficit is projected to fall by 0.2 percentage points of GDP in 2007/2008 and, on a no-policy change basis, by 0.3 percentage points in 2008/2009. This indicates a rather modest path of future consolidation relative to the favourable economic environment forecast.

- government debt increased from 39.6% of GDP in 2004/2005 to 42.5% in 2006/07. According to the Commission services' spring 2007 forecast, the debt ratio is projected to increase to around 43.9% by end-March 2009, but remaining well below the 60% of GDP reference value. A further strengthening of the fiscal position beyond that foreseen for 2008/2009 will be required to halt the increase in the debt ratio.

(6) In the view of the Council, the excessive deficit in the United Kingdom has been corrected and Decision 2006/125/EC should therefore be abrogated.

HAS ADOPTED THIS DECISION:

Article 1

From an overall assessment it follows that the excessive deficit situation in the United Kingdom has been corrected.

Article 2

Decision 2006/125/EC is hereby abrogated.

Article 3

This Decision is addressed to the United Kingdom of Great Britain and Northern Ireland.

Done at

For the Council

The President

[1] OJ L 209, 2.8.1997, p. 6. Regulation as amended by Regulation (EC) No 1056/2005 (OJ L 174, 7.7.2005, p. 5).

[2] OJ L 332, 31.12.1993, p. 7. Regulation as last amended by Regulation (EC) No 2103/2005 (OJ L 337, 22.12.2005, p. 1).

[3] The most recent notification of the United Kingdom can be found at:

http://epp.eurostat.ec.europa.eu/portal/page?_pageid=2373,58110711&_dad=portal&_schema=portal

[4] SEC(2005) 1144. All EDP-related documents for the United Kingdom can be found at the following website: http://ec.europa.eu/economy_finance/about/activities/sgp/edp/edpuk_en.htm

[5] All United Kingdom general government balance data referred to in this Communication apply the Eurostat decision of 14 July 2000 on the allocation of UMTS receipts. The United Kingdom has generally not applied this decision in domestic publication of its public finance data, which results in a general government deficit measured on a Eurostat basis being around 0.1 percentage point of GDP per annum higher than reported in national accounts published by the United Kingdom’s Office for National Statistics from 2001/2002 onwards.

[6] OJ L 51, 22.2.2006, p. 14.

[7] SEC(2006) 1159.

[8] The upward revision in the deficit figure reflects the reclassification of proceeds on disposals of social housing from revenue to disposal of equity.

[9] Estimated by the Commission services, applying the common methodology on estimating output gaps.

[10] Following the restructuring of the nuclear energy sector, which led to the transfer to central government of assets held by a public corporation, the United Kingdom's Office for National Statistics classified the transfer in respect of central government as a deficit-reducing flow, valued at 0.3% of GDP in 2005/2006.

[11] Data provided by the Commission (Eurostat) (cf. Eurostat News Release No 113 of 17 August 2007) following the reporting by the United Kingdom in July 2007, in accordance with Council Regulation (EC) No 3605/93. Deficit ratios are usually revised – upward or downwards – after the publication of the first outcome. For the EU Member States as a whole, the revisions are usually relatively small and on average insignificantly different from zero. Given the track record of revisions in the UK and the distance between the currently reported deficit for 2006/2007 and the deficit reference value, there is a low probability that potential future revisions in government accounts would raise the 2006/2007 deficit ratio in excess of 3% of GDP.

[12] Commission services' estimate (cf. fn. 9).

[13] According to the United Kingdom's Public Expenditure Outturn White Paper published on 19 July 2007, in 2006/2007 government departments spent £10.0 billion (0.7% of GDP) less than the Departmental Expenditure Limits (DELs) for the year, raising the total amount of unutilised financial resources that departments are allowed to carry forward to 2007/2008 to £22.6 billion (1.5% of GDP). In principle, departments can draw on previous years' unspent financial allocations, constituting a risk of higher deficits than the budget projections for 2007/2008. However, parliamentary approval would need to be obtained by departments if they decide to draw upon allocations from earlier years. The degree of accumulated under-spend is also expected to be taken into account by government in the Comprehensive Spending Review scheduled for October 2007.

[14] OJ C 72, 29.3.2007, p. 20.

[15] OJ L 51, 22.2.2006, p. 14.

[16] According to Council Regulation (EC) No 1467/97, the relevant budgetary data for the United Kingdom are established in budgetary year (i.e. financial year) terms, running from 1 April to 31 March.

[17] OJ L 209, 2.8.1997, p. 6. Regulation as amended by Regulation (EC) No 1056/2005 (OJ L 174, 7.7.2005, p. 5).

[18] OJ L 332, 31.12.1993, p. 7. Regulation as last amended by Regulation (EC) No 2103/2005 (OJ L 337, 22.12.2005, p. 1).