Economic Stimulus Plan

STATES OF JERSEY

ECONOMIC STIMULUS PLAN

Lodged au Greffe on 9th April 2009

by the Minister for Treasury and Resources

STATES GREFFE

2009   Price code: D  P.55

PROPOSITION

THE STATES are asked to decide whether they are of opinion

to refer to their Act dated 5th December 2006 in which they approved the establishment of a Stabilisation Fund, the purpose of which was to make fiscal policy more counter-cyclical and create in the Island a more stable economic environment with low inflation; and

1. to agree to transfer the £18 million surplus funds currently available from the special fund known as the Dwelling House Loans Fund established  under  the  Building  Loans  (Jersey)  1950  to  the Stabilisation Fund;
2. to agree, in accordance  with Article 4A(2) of the Public Finances (Jersey) Law 2005, to transfer £44 million from the Stabilisation Fund to  the  Consolidated  Fund  to  provide  funding  for  the  proposed discretionary economic stimulus package (following advice from the independent Fiscal Policy Panel) and also to earmark the balance of £112 million  in  the  Stabilisation  Fund  to  cover  the  impact  of  the economic downturn on States finances (where tax income is lower and expenditure on items such as income support will be higher – the so-called automatic stabilisers) forecast for 2010 and 2011;
3. to  agree,  in  accordance  with  Article 11(8)  of  the  Public  Finances (Jersey)  Law  2005,  to  amend  the  expenditure  approval  for  2009 approved by the States on 23rd September 2008 in respect of the Treasury and Resources Department to permit the withdrawal of up to £44 million from the Consolidated Fund to be re-allocated for the net revenue expenditure of a number of departments in order to fund the proposed discretionary economic stimulus package with the funding only  being  made  available  to  departments  from  the  allocation following referral to the Corporate Services Scrutiny Panel and by public  Ministerial  Decision  of  the  Minister  for  Treasury  and Resources.

MINISTER FOR TREASURY AND RESOURCES

REPORT

DEALING WITH THE ECONOMIC DOWNTURN: POLICY FOR USE OF THE STABLISATION FUND AND DISCRETIONARY FISCAL STIMULUS

Summary

1. This report sets out proposals by the Minister for Treasury and Resources agreed by the Council of Ministers to use the Stabilisation Fund in response to the economic downturn. The Stabilisation Fund will reach £156 million (if a transfer of £18 million is made from the Dwelling House Loans Fund) and the recommendation is that £112 million is used to cover the unexpected increase in financial deficits in 2010 and 2011 due to the economic downturn and £44 million of new initiatives (discretionary policy) in 2009 and 2010.
2. The unforeseen increase in financial deficits will come about largely because of the automatic stabilisers – the loss of personal and corporate tax revenue and increase in expenditure in areas such as income support as a result of the deterioration in the economic outlook for the Island. The package of new (discretionary) initiatives will provide an extra stimulus to the economy and support employment and businesses in Jersey through the downturn.
3. The report builds on work done by Treasury and Resources in identifying the impact of the economic downturn on the States finances and the assessment of funds available for stabilisation purposes. It also complements the initial work lead  by  the  Economic  Development  Department  in  tandem  with  other departments to determine what policies might be desirable and deliverable in terms of fiscal stimulus. It considers in more detail –

The objectives for using the Stabilisation Fund; Is the time right for using the Stabilisation Fund? How much fiscal stimulus is appropriate?

The most suitable policy options;

The process going forward;

4. The main conclusions under each of these headings are summarised below. Objectives for use of the Stabilisation Fund
5. The overarching objective in using the Stabilisation Fund is to put additional money back into the economy (through both the automatic stabilisers and discretionary policy) that will add to demand and mean that the fall in output and extent of job losses will be less severe than would otherwise have been the case.
6. The Minister for Treasury and Resources and the Council of Ministers have agreed that the overall objective of supporting demand in the economy breaks down into 3 objectives –

Provide a stimulus to the Jersey economy as conditions deteriorate, to

help support employment and businesses in Jersey;

Support employment in the Island by assisting individuals affected by

the economic downturn;

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Create new opportunities for businesses in Jersey, to support them

through the downturn and mitigate job losses.

Why the time is right for using the Stabilisation Fund

7. The Minister for Treasury and Resources has accepted the advice from the Fiscal Policy Panel (FPP) and agreed that the time is now right for use of the Stabilisation Fund. Global economic forecasts from the IMF and World Bank show that the world economy will experience the worst economic conditions since the 1930s. The Economics Unit's central estimates for economic growth in Jersey in 2009 and 2010 are -4% and -2% indicating a significant and prolonged  downturn.  The  qualitative  information  from  Economic Development confirms that sectors including retail, tourism and construction are likely to enter recession this year.
8. It is recognised that there is significant uncertainty surrounding the local and global economic outlook and it cannot be ruled out that the downturn in Jersey will be steeper or more shallow than currently forecast. However, the Council of Ministers agree that this is not an argument for inaction. If fiscal stimulus is designed to be effective it will not matter if the economy performs more strongly than expected. Similarly if the economy performs more weakly that actually strengthens the arguments for acting swiftly and decisively. Policy must be flexible going forward to be able to adapt to outcomes different to those currently forecast, especially given the significant uncertainties around the forecasts.

The scale of fiscal stimulus

9. The new Fiscal Framework agreed by the States in 2006 sets out that the Stabilisation  Fund  is  only  to  be  used  to  make  fiscal  policy  more countercyclical. That means it should not be used to address structural deficits, which should be tackled through other means, i.e. changes in taxation or spending. Drawing on the advice from the FPP, the Council of Ministers propose that the Stabilisation Fund should only be used to address the deficits in 2010 and 2011 (not beyond) and to fund discretionary policy in 2009 and 2010.
10. The Minister for Treasury and Resources and Council of Ministers agree that given the significant uncertainties surrounding the financial forecasts going forward – both in terms of the impact of the downturn and the structural position in the medium-term – that their preference is to avoid resorting to borrowing  (either  from  the  Strategic  Reserve  or  money  markets)  to  fund discretionary policy at this early stage and as part of the initial response to the downturn.
11. Once the unforeseen deterioration in the deficits for 2010 and 2011 is financed from  the  Stabilisation  Fund  there  will  be  an  approximate  £44 million remaining in the Stabilisation Fund. This would allow discretionary policy of just over 1% of GVA, which would meet the requirement to implement a significant  discretionary  stimulus  above  and  beyond  the  impact  of  the automatic  stabilisers  and  of  similar  scale  to  some  of  the  packages implemented in the larger economies. Overall, the Council of Ministers see

little economic justification in not undertaking discretionary fiscal policy of this scale in Jersey.

12. The  Council  of  Ministers  believe  that  by  acting  now –  quickly  and decisively – to implement discretionary spending in an effective manner, this will reduce the extent of future deficits. That is, discretionary policy by its very nature (it is above and beyond the automatic stabilisers) will help to offset the downturn and if successful should reduce the fall in GVA and therefore the cost of the automatic stabilisers.
13. If discretionary policy is to be implemented within the timeframe suggested by the FPP, it is recommended that £44 million is transferred immediately from the Stabilisation Fund to the Consolidated Fund to be available for discretionary policy.

The most suitable policy options

14. The Council of Ministers has developed a hierarchy of 4 policy options by combining  the  advice  of  the  FPP  with  the  results  of  research  on  the effectiveness of the various policies. That is, in order of priority the Council of Ministers favoured policy options are –

1. New programmes of maintenance/infrastructure spending

These  programmes  score  highly  in  terms  of  their  impact  on  the economy and score well in the FPP's assessment, although there is a clear need to ensure that any infrastructure investment is timely. This type of spending also has the advantage that already funded projects can  be  brought  forward  from  the  future  without  a  call  on  the Stabilisation Fund.

2. Supporting  employment  in  the  Island  by  assisting  individuals affected by the economic downturn

Policy targeted on those affected by the downturn and the less well off scores  well  in  terms  of  economic  impact  and  being  timely  and targeted, the real difficulty being to ensure that policy is temporary.

iii./iv.  Business  support  and  new  programmes  to  help  individuals

retrain/skills

Both these types of policy score well in terms of being timely to implement if they are extensions of exiting programmes but carry the risk of permanent budgetary implications. If done effectively they should bring longer-term economic benefits. The Council of Ministers sees these policies as being as much about preparing the foundations for economic recovery whilst accepting that in terms of pure stimulus the initial impact could be weaker than i. and ii. above.

15. While the exact nature of the fiscal stimulus package will be developed by the Minister for Treasury and Resources, the overall focus of policy will be on maintenance and infrastructure spending that will support employment and provide opportunities for businesses in the Island. This is because it is likely to be the most effective at stimulating new business and employment, and if done effectively will focus on projects that were required anyway. Where projects can be brought forward from within the 2009 Business Plan there will

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also be no call on the Stabilisation Fund. Supporting employment in the Island by assisting individuals affected by the economic downturn will also be a key priority, supported by new programmes of business support and skills training.

16. An  initial  assessment  already  undertaken  by  the  Economic  Development Department (see  Appendix 1) in co-ordination with other departments has already  identified  a  range  of  policies  that  appear  both  desirable  and deliverable under the 4 headings above. The total value identified under the four headings was as follows –

New  programmes  of  maintenance/infrastructure  spending =

£15.75 million (plus a further £10 million of projects that could be brought forward);

Supporting employment in the Island by assisting individuals affected

by the economic downturn = £2.0 million;

New programmes to help retrain/skills = £5.5 million;

Business support = £1.5 million.

17. The  total  fiscal  stimulus  outlined  above  is  £35 million  with  £25 million requiring funding from the Stabilisation Fund. With £44 million potentially available from the Stabilisation Fund for discretionary policy there is the potential to implement all the policies above and additional ones. However, this  is  not  sufficient  to  progress  all  the  policies  identified  in  the  initial assessment.  A  further  more  detailed  and  rigorous  evaluation  process  is required that can ensure all policies that are implemented have maximum impact and that can identify additional policies that score well under the chosen criteria.

The process

18. To ensure that any discretionary expenditure is based on a fully developed business  case  a  further  prioritisation  process,  that  is  independent  of  all Departments who have submitted proposals, will be completed. This process will  result  in  funds  being  allocated  to  Departments  by  the  Minister  for Treasury and Resources to fund delivery of the highest priority discretionary stimulus activity. The input of the Corporate Services Panel will be required at key stages of the process.
19. Departments  will  be  required  to  submit  detailed  business  cases  for  all proposals that should be signed off by the Chief Officer and the Finance Director. These business cases, that should include full justification of costs and  benefits  of  the  discretionary  expenditure,  will  be  submitted  to  the Treasury and Resources Department for independent validation.
20. Validated  business  plans  will  then  be  considered  by  an  independent Evaluation Team (ET) of key Officers whose departments do not benefit from the  spend.  Plans  and  the  ET  recommendations  will  be  shared  with  the Corporate  Services  Panel.  The  ET  will  assess  all  proposals  and  make recommendations to the Minister for Treasury and Resources who will make the  final  decision  on  allocation  of  funds  from  the Stabilisation  Fund  for discretionary purposes.

21. This process will ensure that the policies identified have the maximum impact and  that  additional  policies  can  be  identified  under  the  four  headings.  In addition, it will enable that policies will be implemented in a timely fashion, in  keeping  with  the  FPP's  advice  that  they  should  happen  in  the  next 6 to 9 months.  Failure  to  implement  policies  in  this  timeframe  will  put Islanders' jobs at risk.
22. The process with key dates is summarised in the table below.

Summary  of  the  process  for  developing  the  fiscal  stimulus  package  and involvement of Council of Ministers and Corporate Services Panel

Date  Process  Council of  Corporate Ministers  Services Panel

3 April  R&P agreed by CoM  CSP receives R&P and supporting

papers

7 April  Pro-formas for bids

sent to departments

9 April  R&P lodged by TRM  CSP Scrutiny process 1 May  Closing date for Pro- for R&P continues

formas and detailed  business plans  

1 -25  Independent  

May  evaluation process by  Evaluation Team (ET)  

25 May  TRM receives  CoM receives  CSP receives

recommendations  recommendations  recommendations from ET  from ET  from ET

1 June  TRM finalises initial  CoM receives TRM  CSP receives TRM

proposals following  initial proposals  initial proposals for advice from CSP  comment

11 June  CoM agrees

proposals

from ET

Monitoring of implementation by ET on monthly basis

POLICY FOR USE OF THE STABILISATION FUND AND DISCRETIONARY FISCAL STIMULUS

Introduction

23. The Fiscal Policy Panel (FPP) recommended in their November update that the  States  should  draw  up  contingency  plans  as  to  when  and  how  the Stabilisation Fund should be used. Since the FPP's subsequent briefings to States  members  and  the  Council  of  Ministers  in  January  it  has  become apparent  that  the  economic  climate  has  deteriorated  at  a  faster  rate  than previously expected.
24. As a result, the Minister for Treasury and Resources wrote to the FPP on 13th March 2009 asking them to update their previous advice and explicitly answer several key questions –

Whether  economic  conditions  now  justify  use  of  the  Stabilisation

Fund to support the local economy?

Should the States be doing more than just allowing the automatic

stabilisers to work and implementing discretionary policy to support the economy this year?

Further guidance on how the key options comply with the 3Ts criteria

(that policy should be Temporary, Targeted and Timely) and advice on their general advantages and disadvantages.

25. The FPP responded to the Minister for Treasury and Resources on 26th March 2009.  Their  advice  has  been  integral  to  the  formulation  of  what  will  be Jersey's first fiscal stimulus package. This paper sets out the approach taken by  the  Minister  for  Treasury  and  Resources  and  Council  of  Ministers  in developing the policy proposals.
26. This paper sets out a strategy for use of the Stabilisation Fund for fiscal stimulus in 2009. It considers in more detail –

The objectives for using the stabilisation fund; Is the time right for using the stabilisation fund? How much fiscal stimulus is appropriate?

The most suitable policy options;

The process going forward.

The objectives for using the Stabilisation Fund

27. The downturn in Jersey will be precipitated by falling demand across the economy. It will result from lower demand from outside the Island for Jersey goods  and  services  such  as  tourism  and  financial  services  as  the  large economies including the UK go through a severe recession. Businesses in the Island are likely to cut back on expenditure and investment in the Island in

uncertain  economic  times.  Consumers  are  also  likely  to  spend  less  as confidence falls with a faltering economy. The end product is that jobs in Jersey will be at risk.

28. The overarching objective in using the Stabilisation Fund is to put additional money back into the economy (through both the automatic stabilisers and discretionary policy) that will add to demand and mean that the fall in output and extent of job losses will be less severe than would otherwise have been the case. The Stabilisation Fund can be used to put extra demand back into the economy to compensate for some of the factors outlined above.
29. Additional government spending adds directly to demand in the economy and can  compensate  for  weaker  demand  from  consumers,  businesses  and/or customers abroad. It can be targeted at those people most likely to spend any benefit they receive and therefore encourage them to spend and add to demand in the economy. The additional demand created will mean that businesses in Jersey will employ more people than would have been the case if demand had fallen further.
30. The nature of the proposed interventions should also be determined by the specific objectives of the stabilisation policy. For example, the nature of the intervention would be different if the intention is to support demand in general across the economy or to help particular individuals or businesses.
31. The Minister for Treasury and Resources and the Council of Ministers have agreed that the overall objective of supporting demand in the economy breaks down into three objectives –

Provide a stimulus to the Jersey economy as conditions deteriorate, to

help support employment and businesses in Jersey;

Support employment in the Island by assisting individuals affected by

the economic downturn;

Create new opportunities for businesses in Jersey, to support them

through the downturn and mitigate job losses.

32. These objectives suggest that the fiscal stimulus will need to be delivered in a timely manner and when the economy is deteriorating, i.e. in 2009. The FPP said  in  their  letter  to  the  Minister  in  March  that  "Action  should  start immediately to have an impact as quickly as possible" and ideally within the next 6 to 9 months. Failure to get the timing right will mean that more jobs could be lost in the downturn or that spending takes places when it is not needed and the economy is recovering, with a risk that it will feed through into higher inflation.
33. Policy will need to target the people that are most likely to spend what they receive and in particular those on low incomes and those affected by the economic downturn through loss of their jobs or by the downturn in the housing market. Finally, to support Jersey businesses it will be important that stimulus feeds directly into the demand for their output and services and does not leak out the economy.

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Is the time right for use of the Stabilisation Fund?

34. An objective assessment of current and future economic conditions has been undertaken by the States Economic Adviser and included –

1. Qualitative assessment of how businesses and the different sectors are performing,  using  evidence  provided  from  the  Economic Development Department through their range of contacts with the business community and additional information from meetings with local businesses.
2. Quantitative macro forecasts – work has been underway since last year in the Economics Unit looking at how to better forecast the likely direction of GVA in both the current year and the following year. It explores  statistical  relationships  between  GVA  and  a  host  of economic variables – Jersey and external – to give more confidence in predicting the direction of the economy.

35. In future it is hoped that this analysis will be complemented by a Statistics Unit quarterly business survey that will give further information on how the various sectors are performing and expect to perform in coming months. Work is already underway as to what form this will take.
36. The conclusions from this analysis are that –

Global economic forecasts from the IMF and World Bank show that

the world economy will shrink this year and experience the worst economic conditions since the 1930s.

The Economics Units central estimates for economic growth in 2009

and 2010 are -4% and -2% indicating a significant and prolonged downturn.  There  is  significant  uncertainty  around  these  forecasts given  the  lack  of  detailed  data  on  the  Jersey  economy  and  the unusually uncertain economic times (see Chart 1 below).

The qualitative information from Economic Development confirms

that  sectors  including  retail,  tourism  and  construction  will  enter recession this year.

37. The FPP have also commented in their letter to the Minister on whether the economic situation merits use of the Stabilisation Fund: "If our assessment of the economic outlook is correct, such conditions merit offsetting policy action, which  the  Stabilisation  Fund,  as  part  of  the  new  Fiscal  Framework,  is designed to facilitate".

Chart 1: Jersey economic forecasts

% change in real GVA

10 5 0 -5 -10

-15

Source1:9E9c9on2o0m0i0cs 2U0n0i1t  2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

38. The Council of Ministers has accepted the advice of the FPP and in particular that "It is important to get the timing and content of any discretionary policy right. Although the cyclical impact of the downturn on the States finances will fall mainly in 2010 and 2011, the time to act is now".
39. The central forecasts for Jersey are for a downturn that lasts 2 years (2009 and 2010) with a recovery starting in 2011. If the Stabilisation Fund is to be used for the purposes agreed in 2006 as part of the new Fiscal Framework, then the Council  of  Ministers  believes  that  on  the  basis  of  the  current  economic forecasts it should only be used in those 2 years (or to address the financial implications for the States that arise from those years, i.e. 2010 and 2011).
40. Given the significant uncertainty around economic forecasts in general in Jersey and specifically in the current global climate, it cannot be ruled out that the downturn in Jersey will last more than 2 years. However, the Council of Ministers does not see this as a reason not to put significant discretionary policy in place now.
41. If economic conditions turn out worse than expected, the Council of Ministers believes that it would actually suggest more stimulus is required rather than less.  On  the  other hand,  should  economic  conditions  turn  out  better  than expected  if  policy  has  been  implemented  effectively,  it  will  help  support conditions for future economic growth. Policy must be flexible going forward to be able to adapt to outcomes different to those currently forecast, especially given the significant uncertainties around these forecasts.

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The scale of fiscal stimulus

42. The scale of the fiscal stimulus should be determined by a number of factors, not least the overall policy objectives. A stimulus put in place to prevent a fall in GVA and rise in unemployment will need to much larger than one that tries to mitigate the fall in activity. From the objectives set out by the Council of Ministers (see paragraph 29) it is clear that the policy objectives fall more into the latter category than the former.
43. The scale of the fiscal stimulus will be made up of 2 elements – that from the automatic  stabilisers  (the  loss  of  personal  and  corporate  tax  revenue  and increase in expenditure in areas such as income support as a result of the deterioration  in  the  economic  outlook  for  the  Island)  and  that  from discretionary policy (new initiatives implemented to put extra demand back into the economy).
44. The relative size of automatic stabilisers and discretionary policy are inter- related. For example, a larger element of automatic stabilisers may mean that there is a lesser need for discretionary policy. Also, the larger discretionary policy  is  the  smaller  the impact  of  the  automatic  stabilisers  (because discretionary policy should mitigate the deterioration in the economy and therefore reduce the automatic stabilisers).
45. There are a number of factors that should help determine what size of overall fiscal stimulus is appropriate –

Length of recession: basically how long the downturn lasts.

Depth  of  recession:  the  size  of  the  expected  fall  in  GVA  (and

ultimately the amount of spare capacity it creates).

Medium-term public finances: if government finances are not on a

sustainable path the response from businesses and consumers to the stimulus could be muted.

Size/openness: in small open economies like Jersey the impact of any

given  size  of  fiscal  stimulus  will  be  more  muted  than  in  larger economies  simply  because  some  of  the  impact  will  leak  out  the economy  through  spending  (by  consumers  and  businesses)  on imports.

46. In considering the overall scale of fiscal stimulus appropriate in Jersey it is necessary to first examine the scale of the automatic stabilisers (which is considered in detail in Appendix 2). Chart 2 (below) shows that the latest estimates  for  the  States'  financial  position  from  that  analysis,  which  still contain significant uncertainty. They predict a deficit of £57 million in 2010 and £67 million in 2011 (or about 1.5% of GVA in each year or 3% in total), with a deficit in subsequent years of around £60 million (although there is even greater uncertainty around this).
47. This  actually  means  that  the  extent  to  which  the  financial  forecasts  have deteriorated in 2009 and 2010 (a proxy for the automatic stabilisers) as result of the more pessimistic economic forecasts is £13 million in 2009, £50 million in  2010  and  £62 million  in  2011.  The  deficits  in  2010  and  2011  (the £13 million in 2009 is simply a smaller surplus) are effectively those which

are unfunded and would therefore need to be financed by the Stabilisation Fund.

48. It is hard to distinguish what is a cyclical and what is a structural deterioration in the deficit in 2010 and 2011. However beyond that period a deficit is forecast which could be largely structural, although that will depend to some extent on whether the world economy and financial markets return to previous levels or grow in line with trend from the current low base.

Chart 2: Latest financial forecasts budget surplus/deficit £ million

Budget surplus/deficit, £mn

100 50 0 -50 -100 -150

2008 2009 2010 2011 2012 2013

Budget years

Source: Treasury and Resources/Economics Unit

49. The new Fiscal Framework agreed by the States in 2006 sets out that the Stabilisation  Fund  is  only  to  be  used  to  make  fiscal  policy  more countercyclical. That means it should not be used to address structural deficits, which should be tackled through other means, i.e. changes in taxation or spending.  The  expected  balance  of  the  Stabilisation  Fund  this  year  is £156 million (see Appendix 2).
50. The chart below shows the balance in the Stabilisation Fund in terms of how it has been built up and looking forward as to what would happen to it if it was used to cover the unfunded proportion of the deficits in 2010 and 2011. The remaining balance would be £44 million in 2011.

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Chart 3: The balance in the Stabilisation Fund

£ million

Optimistic Central Pessismistic

200 150 100 50 0 -50 -100 -150

2006 2007 2008 2009 2010 2011

Year

 Source: Treasury and Resources/Economics Unit

51. The fact that the Stabilisation Fund may not be exhausted covering the deficits in 2010 and 2011 leaves the possibility of funding discretionary spending of up to £44 million directly from the Stabilisation Fund. This does beg the question as to what level of discretionary spending is appropriate in Jersey? The money in the Stabilisation Fund is a somewhat arbitrary number as it only reflects the funds that have been saved in recent years since the onset of the new Fiscal Framework and since money has been specifically earmarked for stabilisation purposes.
52. If discretionary policy is to exceed the residual in the Stabilisation Fund after financing the deficits in 2010 and 2011 then the only real source of funds will be borrowing (either from the Strategic Reserve or directly from the money markets). The Minister for Treasury and Resources and Council of Ministers agree  that  given  the  significant  uncertainties  surrounding  the  financial forecasts going forward – both in terms of the impact of the downturn and the structural  position  in  the  medium-term –  that  their  preference  is  to  avoid resorting to borrowing of this type at this early stage and as part of the initial response to the downturn.
53. The Council of Ministers accepts that should the economic conditions turn out worse than forecast and/or the deficits in 2010 and 2011 larger than expected there may be a need to revisit their position on borrowing to support the economy through the downturn. Any change in position would need to be on the basis of new and updated information not currently available and would be brought to the States for agreement.
54. The Council of Ministers believe that by acting quickly and decisively to implement discretionary spending in an effective manner this will reduce the extent of future deficits. That is, discretionary policy by its very nature (it is above and beyond the automatic stabilisers) will help to offset the downturn

and if successful should reduce the fall in GVA and therefore the impact of the automatic stabilisers.

55. The table below looks at what other larger economies are planning in terms of discretionary  policy  in  response  to  the  economic  turmoil.  The  range  is between 0.2-2% of GDP in 2009 or 0.3-4.8% over 2009 and 2010.

Table 1: Discretionary fiscal stimulus packages in large economies

% of GDP

Source: IMF

56. The IMF attributes the differences in the scale of the packages across the larger economies to a number of different factors –

Automatic stabilisers: countries in which the automatic stabilisers

are larger will need smaller discretionary stimulus.

Economic conditions: the sharper the expected fall in output and the

greater the extent of spare capacity, the larger the required stimulus. Fiscal conditions: more favourable trends in deficits and public debt

will leave more room for overall fiscal and discretionary stimulus.

Other factors: the fiscal expansion will be larger if fiscal multipliers (i.e. the way policy feeds through into the economy) are lower.

57. How  does  Jersey  score  on  these  different  factors?  Firstly  the  automatic stabilisers will tend to be weaker in Jersey. Government spending and taxation are generally lower as a proportion of GVA than in the larger economies and the initial calculations above suggest that the automatic stabilisers are weaker and  delayed  in  their  impact.  Secondly,  the  deterioration  in  economic conditions  is  expected  to  be  as  large  (if  not  larger)  than  in  the  larger economies. Thirdly, with no borrowing and public debt Jersey has a better fiscal  backdrop  than  the  larger  economies,  although  there  are  clearly significant uncertainties  about the medium-term fiscal outlook. Finally, in small open economies the fiscal multipliers will tend to be smaller than in the larger economies.
58. Jersey could take the option that as a small open economy it could free ride on the  benefits  from  fiscal  stimulus  elsewhere.  However,  the  Council  of Ministers view is that such inaction in Jersey would not help mitigate the impacts  of  the  downturn  in  the  Island  and  that  it  is  necessary  to  act independently now.

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59. Overall, the Council of Ministers believe there is little economic justification for not undertaking discretionary fiscal policy in Jersey. The £44m remaining balance in the Stabilisation Fund would allow discretionary policy of just over 1% of GVA and be in the region of packages implemented in the UK and France, although significantly below the larger packages of US, China and Germany.
60. If discretionary policy is to be implemented within the timeframe suggested by the FPP it is recommended that £44m is transferred immediately from the Stabilisation Fund to the Consolidated Fund to be available for discretionary policy. The Council of Ministers believe that the extent of the economic downturn in Jersey and the wider global economy suggests that this size of discretionary policy is both appropriate and required urgently. Discretionary policy needs to be timely and economic forecasts suggest that time is in 2009 and early 2010.
61. There is a significant risk that if the economic downturn turns out to be more severe than forecast, longer in duration or have a greater impact on States finances that the Stabilisation Fund will be  exhausted just addressing the deficits  that  result  before  the  end  of  2011.  This  will  mean  that  further discretionary policy could only be financed by other means i.e. borrowing (from the Strategic Reserve or money markets). The Council of Ministers does not see this as an argument for less discretionary policy now but rather that the need for discretionary policy would be even greater than currently assessed.
62. The  next  section  goes  on  to  consider  what  the  most  suitable  options  for discretionary policy are.

The most suitable policy options

63. The FPP have recommended that when considering the alternative uses of the Stabilisation Fund it is important to bear in mind the 3Ts. That is policy should be –

Timely. Action should start immediately to have an impact as quickly

as possible and ideally within the next 6 to 9 months.

Targeted.  Policy  should  hit  the  intended  target  whether  it  is  to

support activity and employment in the Island, support those most adversely affected by the downturn or implement projects which have intrinsic benefit.

Temporary. There should be no negative long term implications for

the public finances, i.e. no long term damage to the tax base and no long term spending commitments.

64. Whatever the type of policy that is used in Jersey, there will always be a significant risk of leakage as money spent by businesses or consumers can be directed on imports. This means that in small open economies the impact of any change in fiscal policy can be more muted than in larger economies. It is also  important  to  recognise  that  stabilisation  policy  is  not  intended  to completely  offset  recessionary  forces  but  rather  to  work  in  the  opposite direction to those forces and cushion the impact.

65. The Minister for Treasury and Resources asked the FPP to comment publicly on six broad options for discretionary policy. The FPP in their response to the Minister  for  Treasury  and  Resources  highlight  how  they  feel  the  policy options score relative to the 3Ts and set out their general advantages and disadvantages. Their response is repeated in full below.

1. Supporting people on low incomes

This type of policy can be timely, provided that the income support system can be  altered  quickly.  It  is  by  definition  targeted  on  the  least  well  off  and therefore those who are most likely to spend. However, it is difficult to see how such a measure would be temporary as it would be hard to reverse such a decision unless it was directed only to the newly unemployed.

2. Direct tax cuts

Given the lags in the Jersey tax system it is hard to see how such a policy could be timely and impact in 2009, without being complex. It may also be harder to target the less well off or those worst affected by the downturn because quite simply they may not pay tax. It would then be less effective at holding up demand in the economy than direct support for the less well off. A pre-announced commitment to reverse the cut would be essential to meet the temporary criterion, but this is unlikely to be credible, and without a credible commitment, this proposal carries a serious risk of aggravating medium term budget problems.

3. Indirect tax cuts

This type of tax change could be timelier than a direct tax change. But such a tax change would not be well targeted as it would benefit everybody, rather than those most likely to spend on the Island. It would be less effective at holding up demand in the economy than direct support for the less well off. Furthermore  a  pre-announced  commitment  to  reverse  the  cut  would  be essential to meet the temporary criterion, but is unlikely to be credible.

Like direct tax cuts, this option carries a serious risk of aggravating medium term budget problems and a real risk of undermining the tax base. Changes to GST so soon after introduction should be avoided.

4. Spending on skills/training

This option may be timely, especially if it only requires changes to existing policies. Spending on the programme itself has immediate benefits. It can be targeted on Jersey residents, those losing their jobs or low income groups. If measures  also  included  support  payments  to  participants,  these  could  be targeted towards those most likely to spend. Care would have to be exercised to  ensure  that  those  elements  of  such  schemes  that  do  not  bring  lasting benefits could be made credibly temporary.

Investment  in  skills –  if  done  effectively –  should  bring  lasting  economic benefits  beyond  the  life  of  this  downturn.  Improving  the  skills  base  is important for supporting future productivity and economic growth. However, there will be permanent budgetary implications.

5. Additional infrastructure/maintenance expenditure

If these options are to meet the timely criteria, then it is vital that projects are identified that are ready to go in the next few months i.e. are shovel ready'.

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The  most  likely  projects  to  meet  this  requirement  are  maintenance expenditure. Such measures should also meet the targeting criterion since maintenance projects are likely to utilise local labour. The scale is dependent on  the  amount  of  spare  capacity  in  the  local  construction  sector.  It  is important to avoid excess demand pushing up prices.

Making  sure  maintenance  of  the  infrastructure  (including  public  housing stock, schools, and hospitals) is up to date and bringing forward maintenance scheduled for the near future does not increase the overall cost to public finances, and so meets the temporary criterion.

Large infrastructure projects may struggle to be timely. They score better on the targeting criterion as it should be possible to target such spending on supporting local employment in the Island and the scale of the intervention should consider the amount of spare capacity in the local construction sector. Any such interventions should be designed to be temporary, and each policy should be assessed for any future expenditure commitments such as ongoing maintenance or further investment.

As maintenance and infrastructure investment leads to improvements in the stock of States assets, it can be considered as an investment in the supply-side of the economy that will bring returns beyond the life of this downturn. The basic question to address is do the projects have intrinsic merit?

6. Small business support

This option may be timely especially if it only requires changes to existing policies. Policy could be targeted on businesses particularly affected by this downturn for example by focusing on those that are not able to obtain or maintain credit solely as a result of problems in the financial sector. Policy would have to be designed carefully to be temporary and not stand in the way of inevitable structural change.

66. As well as the advice of the FPP it is important to bear in mind what research and  experience  from  elsewhere  tell  us  about  the  various  options  for discretionary policy.

Experience elsewhere

67. The policy choice should also reflect the expected economic impact of the various  measures.  A  key  consideration  is  what  is  the  fiscal  multiplier associated with the various types of policy. The IMF considered these issues in a recent paper "The case for global fiscal stimulus". There is not enough information on the Jersey economy to estimate the likely fiscal multipliers of different policy options. That means it is important to look at the conclusions from elsewhere, always bearing in mind the different nature of the Jersey economy.
68. Empirical estimates of fiscal multipliers are dispersed over a broad range. The IMF believes there are several factors which cause such diverse estimates –

The extent of leakages into savings; The extent of leakages into imports;

The monetary policy response;

The ability of countries to finance stimulative fiscal policy and keep

medium-term finances on a sound footing.

69. So  for  a  closed  economy  with  few  or no  financing  constraints  the  fiscal multiplier may be large, while for small open economies more susceptible to financial constraints it would be smaller.
70. Multiplier  effects  differ  with  the  fiscal  instruments  adopted.  Expenditure measures tend to have the larger effects than others, followed by targeted transfers.  Government  investment  expenditures  have  a  direct  effect  on aggregate  demand  as  well  as  secondary  multiplier  effects  on  household spending as incomes increase as a result of the initial investment spending and due  to  the  higher  productivity  of  the  economy.  The  downside  with  such policies is the ease and speed with which they can be put in place.
71. Transfers in general are less effective because if they are temporary they will have only a limited effect on household behavior. Untargeted transfers are less effective than targeted transfers because if the consumers are on low incomes they will be more likely to spend what they receive. Targeted transfers have the advantage of ease and speed of implementation although they carry the risk that they may be difficult to reverse. Reductions in personal tax rates appear to be only slightly more effective than general transfers but less so than for targeted transfers, as they do not focus on those most likely to spend the benefit they receive.
72. The IMF highlight that one of the key risks to the large scale fiscal packages being considered is that they create a perception of lack of fiscal discipline. They explain that such packages must be complemented by credible medium- term frameworks if they are to be successful.

The options for Jersey

73. Work lead by the Economic Development Department has identified the areas that are practical for policy development in Jersey and has drawn up a list of options under each heading. They fall into the following four key categories of fiscal policy (with a fifth relating to non-fiscal measures) –

1. Supporting employment in the Island by assisting individuals affected by the economic downturn;
2. New programmes of maintenance/infrastructure spending;
3. New programmes to help individuals through retraining and skills development;
4. Increased business support, particularly for small businesses.

74. When the advice of the FPP is combined with the analysis of the effectiveness of the various policy options by the IMF it is possible to develop a hierarchy from the four options above. That is, in order of priority the Council of Ministers have identified the following policy options –

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1. New programmes of maintenance/infrastructure spending

These  programmes  score  highly  in  terms  of  their  impact  on  the economy and score well in the FPP's assessment, although there is a clear need to ensure that any infrastructure investment is timely. This type of spending also has the advantage that already funded projects can  be  brought  forward  from  the  future  without  a  call  on  the Stabilisation Fund.

2. Supporting  employment  in  the  Island  by  assisting  individuals affected by the economic downturn

Policy targeted on those affected by the downturn and the less well off scores  well  in  terms  of  economic  impact  and  being  timely  and targeted, the real difficulty being to ensure that policy is temporary.

iii./iv.  Business  support  and  new  programmes  to  help  individuals

retrain/skills

Both these types of policy score well in terms of being timely to implement if they are extensions of exiting programmes but carry the risk of permanent budgetary implications. If done effectively they should bring longer-term economic benefits. The Council of Ministers sees these policies as being as much about preparing the foundations for economic recovery whilst accepting that in terms of pure stimulus the initial impact could be weaker than i. and ii. above.

75. Work lead by EDD in coordination with other departments has identified policies that were initially considered both desirable and deliverable under the four  headings  above  (see  Appendix 1).  The  total  value  under  the  four headings was as follows –

New  programmes  of  maintenance/infrastructure  spending =

£15.75 million (plus £10 million of already funded projects that can be brought forward from the 2009 Business Plan);

Supporting employment in the Island by assisting individuals affected

by the economic downturn = £2.0 million

Increased  business  support,  particularly  for  small  businesses =

£1.5 million

New programmes to help individuals through retraining and skills

development = £5.5 million.

76. The total fiscal stimulus which would require funding from the Stabilisation Fund is £25 million (with a further £10 million of already funded projects from the 2009 Business Plan that could be potentially brought forward). With £44 million potentially available from the Stabilisation Fund for discretionary policy there is the potential to implement all the policies above and additional ones. However, the initial assessment of desirability and deliverability does not  mean  that  the  Minister  for  Treasury  and  Resources  and  Council  of Ministers are recommending them for implementation.
77. A further more detailed process needs to be developed to ensure that the projects meet the 3Ts, a more detailed cost/benefit analysis is undertaken, the business case is made and the options represent efficient use of states funds and are value for money. The next section sets out a rigorous evaluation

process that will identify which of the above projects are suitable and any other projects or policies that need to be considered.

The process

78. The work by EDD summarised in  Appendix 1 represents a first stage in developing  a  discretionary  policy  package.  However,  to  ensure  that  any discretionary expenditure is based on a fully developed business case and relative priorities that maximise the impact and comply with the "Three Ts" a further prioritisation process, that is independent of all Departments who have submitted proposals, will be completed.
79. This  process  will  result  in  funds  being  allocated  to  Departments  by  the Minister for Treasury and Resources to fund delivery of the highest priority discretionary stimulus activity. The input of the Corporate Services Panel will be required at key stages of the process.
80. Departments will set out a business case for proposed expenditure that will be signed off by their Chief Executive and Finance Director. The business case will set out in as much detail as possible –

• What the money will be spent on (and what will be on- and off- Island);

• The costs and benefits of the proposal;

• When the activity and/or spending will start;

• The length of time the activity and spending will last;

• When the final payments will be made and/or activity finishes;

• What the manpower implications are for the States.

81. The Treasury Department will prioritise all the expenditure proposals received to  obtain  value  for  money.  In  addition,  the  submissions  and  reporting requirements will be to follow best practice defined in Financial Direction 5.4 that is normally used to define conditions for grants issued to States funded bodies.
82. Proposals will also be assessed in terms of their overall economic impact. In order to do this the proposals will be validated with reference to the FPP's 3Ts (Timely, Targeted and Temporary). In addition proposals will be assessed in terms of the scale of the economic impact. That is, how much the proposal costs and the likely impact it will have on employment and business activity in the Island. Proposals will score lowly if they are not shown to support jobs (in a cost effective manner) in the Island and/or the benefits are likely to leak quickly out of the economy.
83. Validated business plans will then be considered by an independent executive group (Evaluation Team – ET) which will be chaired by the Chief Executive of the States and comprised of the States Treasurer and the States Economic Adviser who will base their judgements on advice from the Fiscal Policy Panel. Plans and the ET recommendations will be shared with the Corporate Services Panel.

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84. The ET will assess all proposals and make recommendations to the Minister for Treasury and Resources who will make the final decision on allocation of funds from the Stabilisation Fund. Funds for approved projects will then be transferred to Departments who will be responsible for delivery and reporting outputs and outcomes in a timely manner. Department Chief Officers and Finance Directors will be accountable for delivery within their departments and reporting to the Minister for Treasury and Resources.
85. The process with key dates is summarised in the table below.

Summary  of  the  process  for  developing  the  fiscal  stimulus  package  and involvement of Council of Ministers and Corporate Services Panel

Date  Process  Council of  Corporate Services

Ministers  Panel

Financial and manpower implications

There are no manpower implications involved with the initial transfer of £44 million from the Stabilisation Fund to the Consolidated Fund. However, once the stimulus package is finalised by the Minister for Treasury and Resources, there may well be manpower implications for both the public and private sectors, but at this stage it is not possible to identify them. Any manpower implications for the public sector will be made clear when the stimulus proposals are evaluated.

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APPENDIX 1 PAPER BY THE ECONOMIC DEVELOPMENT DEPARTMENT

Economic Stimulus – Responding to an economic downturn in Jersey Determining the nature of economic stimulus

An Officer Group lead by the Economic Development Department has identified what might be deliverable and achievable under the priority areas identified below:

• Supporting people most affected by the downturn. When Income Support was introduced, a system of transitional protection was established which protected the benefit levels (in cash terms) of those whose benefit entitlement was greater under the systems replaced by Income Support. The first of the phased reductions in that protection is due to occur in October 2009. Taking the decision to delay this by at least a year (to October 2010) could postpone the  reduction  in  incomes  of  these  lower  middle  income  families.  Other measures could also, if required, include ensuring adequate support for those losing their jobs or even those facing mortgage arrears/repossession should house prices fall significantly.

• New programme of maintenance/infrastructure spending. Maintenance and small capital projects can be identified capable of being brought forward to 2009 thus timely, be targeted as projects that would have happened anyway, have a lasting economic benefit and create local employment whilst of a fixed duration therefore temporary in nature.

• New programmes to help support those coming to the employment market for the first time, retrain those made unemployed, improve the skills base of the  island.  If  policy  can  be  implemented  quickly  will  be  timely,  can  be directed on those people affected by downturn, and can be temporary as long as the programme is designed in that manner.

• Increased business support including small business advisors, Small Firms Loan Guarantee Scheme, marketing support for finance and tourism. Can be timely because largely extending or enhancing existing services, can be directed at businesses most affected/where spending most effective and can be designed to be temporary.

• Non-fiscal measures. The States must be quick to act, adopt a leadership role and  be  more  responsive  in  difficult  times  in  such  areas  as  RUDL,  early invoice  payments,  planning  procedures,  adopting  a  pro-active  stance  to training placements and monitoring the need to support the housing market through  changes  to  housing  policy.  As  examples,  Planning  could  be streamlined and speeded up to allow activity of an appropriate nature to take place now rather than in future.

• Communications  with  respective  audiences  and  the  making  information available regarding the types of support freely and easily available. There will be a clear need to develop a full communication strategy at political, consumer or business levels, clearly highlighting the types, nature and scope

of the various elements of the stimulus package, and how these differ from, but add value to, the ongoing States agenda and priorities outlined within the 2009 Business Plan.

In terms of preparing the list of policy options, Economic Development has taken the Priorities outlined above, briefed Chief Officers from the most appropriate States Departments, plus the Skills Jersey Board and in turn commissioned from them, bids' outlining the types of activity that could be brought forward to provide an appropriate stimulus effect.

Full proposals were subsequently received from each of the Departments and a long- list of potential stimulus actions drawn up. A prioritisation exercise was undertaken by EDD and the States Economic Advisor to ascertain the fit' of proposals in terms of both Desirability' and Deliverability'.

This gave a much clearer indication of the type of projects that were possible and evaluated in much greater detail in follow up meetings with appropriate Departments. The output of these consultations has been the drawing up of a consolidated list of potential stimulus investments.

Overview of potential proposals

Within the prioritised stimulus actions, the following investments by Departments are identified –

Supporting people most affected by the downturn:

Social Security:  Maintaining Transitional Relief for Income Support

The  rate  of  transitional  relief  for  people  receiving  income  support  is  due  to  be decreased in October 2009. One way of best supporting those most in need would be to maintain transitional relief at its current level for another year.

Investment:  £2,008,000

Supporting  those  coming  to  the  employment  market  for  the  first  time, retraining those made unemployed, improve the skills base of the Island

Skills Jersey:  Supporting those seeking to gain access to employment

A full package of measures has been put forward by the Skills Jersey Board designed to assist those seeking to find work, help young people & graduates and those seeking to upskill or change career.

Investment:  £2,016,240

Health Department:  Nursing Apprenticeship scheme

Introduction of a nursing apprenticeship scheme that would upskill current health workers and provide guaranteed employment for new entrants.

Investment:  £3,500,000

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Increasing business support and access to finance.

Jersey Enterprise:  Providing a package of measures to support Jersey companies Enhancing and introducing new initiatives that will provide local companies with the appropriate levels of support and opportunity that they will require to help them survive the effects of the downturn.

Investment:  £1,530,000

Bringing  forward  a  programme  of  States  maintenance/infrastructure spending

Housing Department:  Maintenance

The department has a current backlog of works that could be brought forward that would provide valuable future workload for a variety of tradesmen, primarily within smaller companies.

Investment:  £1,700,000

Housing Department:  Bringing forward Housing Stock refurbishment

Three extensive refurbishment schemes could be brought forward by the department that would provide for large contractors and sub-contractors.

Investment:  £9,000,000

Property Holdings:  Bringing forward capital works

The  department  has  up  to  eight  medium  to  large  projects  that  could  be  brought forward giving a range of work an opportunities for large and medium construction companies, plus sub-contractors.

Investment:  £1,750,000

Property Holdings:  Maintenance

States buildings have an extensive backlog of works required in order to make them compliant in terms of the most basic standards. Funding here would only allow an element of this to be tackled, however would create a significant amount of work for smaller tradesmen on the Island.

Investment:  £3,300,000

Total additional investment:  £24,796,240, split

Total value of economic stimulus:  £35,931,240 including Business Plan Funds Derived  £10,000,000

APPENDIX 2

PAPER FROM TREASURY AND RESOURCES DEPARTMENT

Estimating  the  cost  of  "automatic  stabilisers"  and  identifying  funding  for discretionary fiscal stimulus

Executive Summary

The FPP have advised that in the face of a significant economic slowdown there are two types of fiscal stimulus. Firstly automatic stabilisers, in the form of reduced tax receipts and revenues and also increased expenditure, for example on social benefits. Secondly,  discretionary  fiscal  stimulus  in  terms  of  planned  injections  into  the economy to stimulate activity.

An updated estimate of the automatic stabilisers has now been produced, including an improved method of forecasting income tax revenues.

The central range of the updated estimate predicts a reduced surplus by just over £10 million in 2009, compared to the Budget 2009, and deficits increasing by around £50 million in 2010 and over £60 million in 2011.

At  this  central  range  of  the  updated  estimates  and  assumptions  the  cost  of  the automatic stabilisers would require a significant proportion of the Stabilisation Fund balance of £138 million to be earmarked by 2011. This would leave some scope for additional discretionary fiscal stimulus (i.e. above and beyond that delivered by the automatic stabilisers) before any other sources of funding are considered.

The Minister for Treasury and Resources has, with officers, considered other sources of funding for the discretionary fiscal stimulus and at this stage is able to identify a further £18 million which can be transferred into the Stabilisation Fund. This balance is available from the Dwelling Houses Loans Fund and the Minister is proposing that £18 million is transferred to the Stabilisation Fund bringing the balance available to £156 million.

The States is therefore asked in the proposition to consider whether this sum of £156 million  is  earmarked  firstly  for  the  estimated  cost  of  the  automatic stabilisers, with the balance transferred to the Consolidated Fund to allow a discretionary fiscal stimulus package as advised by the Fiscal Policy Panel and the States Economic Adviser.

What is clear from the scale of the likely costs of automatic stabilisers is that every opportunity must be taken to reprioritise existing expenditure allocations as an initial means of providing for any discretionary fiscal stimulus.

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1. Purpose

The FPP have advised that in the face of a significant economic slowdown there are two types of fiscal stimulus. Firstly automatic stabilisers, in the form of reduced tax receipts and revenues and also increased expenditure, for example on social benefits. Secondly,  discretionary  fiscal  stimulus  in  terms  of  planned  injections  into  the economy to stimulate activity.

This  paper  provides  an  indication  of  the  scale  of  the  automatic  stabilisers  and identifies any balance of funding in the Stabilisation Fund that might be available for discretionary fiscal stimulus. A separate Appendix identifies the likely scale and make up of the options for a discretionary fiscal stimulus package if funding were available.

2. Background

Initial work was carried out in late January and early February to provide an initial estimate of what the cost of the automatic stabilisers might be in 2009 and future years.  This  was  presented  in  outline  to  the  Council  of  Ministers  and  all  States Members at briefings in early February.

Significant further work has now been completed, particularly in respect of forecasting income tax revenues. An updated estimate of the automatic stabilisers, incorporating the improved assessment of income tax revenues, has now been developed.

Notwithstanding the comprehensive analysis of income tax revenues, it should be stated at the outset that these estimates must still be presented with a "health warning". The current set of circumstances and uncertainties facing the Island and the global economy are unprecedented, such that past trends may not prove to be reliable, and so a range of assumptions have had to be made to produce a best estimate from the information available.

In  addition,  the  outcomes  for  income  tax  have  been  vetted  by  the  Income  Tax Forecasting  Group  (ITFG),  a  group  of  officers  who  are  currently  responsible  for income  tax  forecasts  including;  Comptroller  of  Income  Tax,  Chief  Adviser – International Affairs, Director of International Finance and the Treasurer of the States. Work will continue to improve and refine the estimates, but at this stage, and with the caveats above, the range of the improved estimates is the best information on which these proposals can be based.

3. Economic Assumptions

A significant piece of work has also been carried out by the States Economics Unit to forecast potential movements in the Island's economy over the next few years. The central range of forecasts of GVA has been used for the purpose of the estimates for automatic stabilisers, however it should be recognised that there is a much wider range of possible outcomes as referred to in the main body of the report.

In addition to forecasts of Real and Nominal GVA, the Economics Unit, now informed by the relationships identified with income tax revenues, has also provided a further set of assumptions which cover:

• future RPI (x)

• compensation of employees

• company profits

• movement in house prices

• forecasts of interest rates

• forecasts of FTSE 100 – equity prices.

Advice has also been taken from the States Investment Advisers (Hewitts) on potential returns  from  types  of  investment  income  which,  together  with  the  economic assumptions, have been used where appropriate in these estimates.

4. Estimating the cost of "automatic stabilisers"

The potential effects on States income are summarised as follows:

The effects on Income tax receipts show falls in tax on investment

income and company profits but with tax on earnings remaining more robust. With the retrospective income tax regime there will be a time lag before these factors translate into reduced revenues for 2010, 2011 and beyond.

There are a number of additional factors in this downturn, as opposed

to that experienced in the early 1990's and 2000-2004, not least the

major uncertainty of the nature of any recovery in the global economy

but also the additional impact of extraordinarily low interest rates. As

a result these forecasts have to be treated with caution and with the

caveat that they are best estimates based on the information available. The updated forecasts draw on past relationships and trends between

income  tax  revenues  and  economic  factors  and  identify  the  most

positive  correlations.  Where  these  correlations  are  economically

sound and pass the vetting of the ITFG then these have been used as

the basis for future forecasts.

But, because of the uncertainty in the global economy it may prove

that past relationships are not an accurate guide to future performance so a combination of assumptions from the data analysed and then the views of the ITFG have been used.

What is apparent is that there will be a significant reduction in income

tax revenues, in addition to the effects already forecast for the move to a 0/10 corporate tax structure. The reduction is estimated in the central range at between £30 million and £45 million in 2010 and 2011 with only a slow recovery in future years.

The effect of a recession on GST and Impôts duties is less direct than

with income tax, as both are based on consumer demand and many of these commodities will still be required. A broad estimate would be that these revenues will remain static with any nominal growth (RPI) being offset by the downturn (GVA). While past trends in GST are not available, this assumption is supported by an analysis of UK VAT receipts which have remained fairly constant during times of past economic downturn.

An analysis of the trend of Impôts duty revenues over a twelve year

period, including the last downturn in 2000-2004, was also carried out which showed no significant effect on the trend of revenues for this period.

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Stamp duty revenues are likely to fall as a result of the weaker

housing market. A fall in volume was already evident in the second half of 2008 and this was reflected in a significant reduction of some £10 million –  £12 million  in  the  forward  forecasts  included  in  the 2009 Budget.

Latest assumptions are for a further fall-off in demand and perhaps a

slower recovery during 2010. The December 2008 quarter's house price index showed the first quarterly fall in prices for two years and the most significant in a quarter since 2003. It has been assumed that there will be a further fall in house prices over the next two years reducing stamp duty revenues over the forecast period.

The States will also see a significantly reduced return from its cash

balances  in  2009  and  2010  as  a  result  of  the  impact  of  forecast deficits and the current projections for interest rate levels over the next two years. The assumptions provided by the States investment advisers have been used to improve the immediate forecasts and in the medium term the Bank of England forecasts are used.

Any effects on other States income may be seen in a reduced demand

for certain of the services provided by the States, such as sport and leisure,  planning,  harbours  and  airport.  However,  discussions  with these departments suggest that this is unlikely to be significant.

In  terms  of the  effects  on  States  expenditure  these  are  perhaps  more  difficult  to forecast. In particular, it is difficult to predict the extent to which small changes in demand could be managed within the capacity of existing budgets.

Undoubtedly the major impacts are likely to be seen in increased

social  benefits  and  social  housing  as  people's  incomes  and employment are affected. This will translate to pressures on income support  which  now  includes  the  allowances  for  social  housing benefit. While the average cost of support is in the order of £6k p.a. per household, the department estimates that the cost of support to working families likely to be most affected by the downturn would have a much higher average cost of support of £13.5k per annum.

Conversely, the employment situation may serve to reduce the cost of

the  supplementation  budget  (broadly  £2k  per  capita)  which  may partly offset some of the benefit costs anticipated. The challenge is not only to estimate the impact of the downturn on employment, but also  what  proportion  of  those  forecast  to  be  unemployed  would qualify for income support or currently generate a supplementation charge. At this stage it has not been possible to adjust the calculation for the implications of any change in the relationship between the increase in the ceiling and the growth of earnings.

Increased demand is also likely in relation to higher education due to higher staying on rates and on grants funding from more applications

and the effect of reduced family incomes. However, at present this area of the service is underspent and may be able to absorb some of this  effect.  Similarly,  education  may  see  increases  in  demand  for adult  and  further  education  and  general  activity  at  Highlands College related to increased unemployment and individuals pursuing retraining  and  re-skilling.  Consideration  of  these  effects  and  an analysis of trends has been carried out which also considers existing

capacity. This is more likely to be an area where additional demand could initially be prioritised within existing capacity or if funds are provided could be addressed through any discretionary and targeted stimulus.

The  effects  on  household  incomes  may  also  be  seen  in  reduced

demand for fee paying schools and a consequent increase in places at States schools. The effect of this will depend on the levels of waiting lists at the private schools and capacity at States schools.

At this stage it is assumed that the area most likely to see additional

demand and funding pressure within education would be at Highlands College,  but  in  the  first  instance  this  would  be  managed  within existing funding.

The various arms of economic development in relation to the Skills

Executive, support for small businesses, and training and workforce development  are  likely  to  come  under  pressure  for  funding. Separately,  these  areas  are  likely  to  provide  a  number  of  new initiatives that will be launched as part of the discretionary economic stimulus package.

Other areas of spending may receive increased demand but depending

on the scale of these pressures departments may be able to adapt to accommodate and absorb these changes in the short-term. However, it is important to note that if a more significant or extended recession is experienced then these pressures are likely to need more funding.

6. Summary of estimates of the automatic stabilisers

The latest estimates of the cost of automatic stabilisers will result in significant deficits in all the forecast years.

The  graph  at  Annex A  compares  the  updated  range  of  forecast  deficits  with  the financial position in the Budget 2009. The graph and table at Annex B shows, as an illustration, the impact of the various components of the automatic stabilisers on the forecast deficits for 2010.

The central range of the updated estimate predicts a reduction to the surplus in 2009 by just over £10 million and increases to the deficits by around £50 million in 2010 and by over £60 million in 2011.

The potential impact on the Stabilisation Fund of funding the range of forecasts of the updated estimates of automatic stabilisers is shown at Annex C.

Work will continue to improve the forecasts and assumptions and further information will also become available directly from the performance of businesses, employment and other key indicators as the year progresses.

At  this  stage  it  is  reasonable  to  assume  that  at  the  central  range  of  the  updated forecasts and assumptions the likely cost of the automatic stabilisers would require a significant proportion of the Stabilisation Fund balance of £138 million to be earmarked by 2011.

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This would leave some scope for additional discretionary fiscal stimulus (i.e. above and beyond that delivered by the automatic stabilisers), but will also require further discretionary stimulus to be achieved by reprioritising existing expenditure allocations or for other sources of funding to be explored.

It is more evident in these updated estimates that the budget deficit appears to be persistent. This suggests that the deficit is at least partially structural, rather than purely cyclical. This might suggest focussing the use of the Stabilisation Fund during the recession in 2009-2010 and considering other ways to re-balance the budget for 2011 onwards, such as reducing expenditure or increasing taxation.

7. Funding for Discretionary Fiscal Stimulus

The Minister for Treasury and Resources has with officers considered other sources of funding for the discretionary stimulus and at this stage is able to identify a further £18m  which  can  be  transferred  into  the  Stabilisation  Fund.  This  balance  is available from the Dwelling Houses Loans Fund and the transfer is proposed in the attached proposition.

Together with the transfer of £63 million agreed in the 2009 Budget the balance on the Fund would then stand at £156 million.

The States is therefore able to consider the proposal that this sum of £156 million is firstly earmarked to provide funding for the automatic stabilisers in 2010 and 2011, with the balance available for any discretionary fiscal stimulus as advised by the Fiscal Policy Panel and the States Economic Adviser.

What is clear from the scale of the likely costs of automatic stabilisers is that every opportunity must be taken to reprioritise existing expenditure allocations as an initial means of providing for any discretionary fiscal stimulus.

Annex A

Comparison of Updated Estimates (March 09) and financial forecast from Budget 2009 (Oct 08)

Budget surplus/deficit, £mn

100 50

0 -50 -100 -150

2008 2009 2010 2011 2012 2013

Budget years

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Illustration of the Impact of individual Automatic Stabilisers on the Range of Forecast deficits in 2010

0 -5 -10 -15 -20 -25 -30 -35 -40 -45

Optimistic Pessimistic

Annex B [cont'd.] Impact of individual Automatic Stabilisers on the Range of Forecast deficits

Impact on States Forecast 2009 2010 2011 2012

Updated estimates £m £m £m £m

States Revenues

Income Tax

Low range effect (3) (22) (32) (21) Mid range effect (3) (30) (44) (39) High range effect (7) (39) (56) (57)

States Investment Income

Low range effect (3) (4) (3) (3) Mid range effect (4) (5) (3) (3) High range effect (5) (5) (3) (3)

Stamp Duty and GST (3) (6) (7) (6)

States Expenditure

Income Support and Supplementation

Low range effect (2) (4) (2) 3 Mid range effect (3) (9) (9) (6) High range effect (7) (13) (16) (16)

2009 2010 2011 2012 £m £m £m £m

Summary of Total Impact

Low range effect (11) (36) (44) (27) Mid range effect (13) (50) (63) (54) High range effect (22) (63) (82) (82)

Budget 2009 Forecast 66 (7) (4) (3) Total Revised Forecasts

Mid range effect 53 (57) (67) (57)

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Impact on Stabilisation Fund of Range of Forecasts for Automatic Stabilisers

200 150 100 50

0 -50 -100 -150

2006 2007 2008 2009 2010 2011 2012 Year

Optimistic Central Pessismistic

Note:  Balance of Stabilisation Fund at £156 million in 2009 includes £63 million

transfer agreed in Budget 2009 and proposed transfer of £18 million from the Dwelling Houses Loans Fund.