IFS shows just 6% of planned cuts in current public service spending have been achieved

Ryan  Bourne

by Ryan Bourne

This morning’s launch of the IFS Green Budget contained little that would have surprised or worried the Chancellor. The IFS figures largely backed up the OBR’s previous forecasts, suggesting a difficult twelve months ahead, which could be considerably worse in the worst-case scenario of all of the PIIGS leaving the Euro.

The key points of the work, as outlined below, show:

  • that Osborne is tackling a much bigger problem than Darling envisaged
  • that the Coalition has increased taxes before addressing spending. 88% of the cuts to benefits and 94% of the cuts to current public spending are still to come.
  • that there might be £9 billion spare from the borrowing that Osborne set out in the November Autumn Statement (which the IFS wrongly in my view, suggested could be used for short-term stimulus measures).

Closing the deficit sooner rather than later is desirable, but if within that Osborne is willing to borrow for tax cuts, then he should start to shape the tax and regulatory systems towards sustained growth, not engage in short-term ‘stimulus’.

1) Comparing Darling vs. Osborne is not particularly helpful

The estimate of the public finance black hole - the structural component – has changed substantially since the last Labour Budget in March 2010. This makes comparisons between the plans for closing the deficit under the two Chancellors’ different forecasts pretty unhelpful. The structural deficit is now thought much larger (at £114 billion according to the OBR in November) than the £81 billion structural deficit Darling thought he was tackling.

If George Osborne wanted to meet a notional target of closing the deficit by a specific date, he would therefore have had to implement more spending cuts or increased tax rises sooner. In fact, what he has decided to do is to stick to his spending plans and roll forward his first fiscal mandate, meaning that now the structural component of the deficit will not be eliminated until 2016-17.

As I’ve written on this blog before, I’d have preferred him to have stuck to a target of reducing the structural deficit by the end of the Parliament – meaning deeper spending cuts to close the now larger estimate of the black hole.

2) What’s been achieved so far?

As a share of the total planned consolidation in borrowing by 2016/17, tax revenue increases will make up a fifth of the reduction, cuts to non-investment spending 48%, cuts to benefit spending 14%, cuts to investment expenditure 12% and 7% from lower debt interest payments. This is broadly in line with best practice for closing large deficits.

The worrying thing is that so far the bulk of the work has come from increased tax revenues. According to the IFS, by the end of this financial year, we will have seen 73% of the planned tax rises, 34% of the investment cuts, but just 12% of the benefit cuts and 6%, yes 6%, of cuts to non-investment spending on public services.

Or to put it another way – 88% of the cuts to benefits and 94% of the cuts to current public spending are still to come.

Consolidation

It seemed appropriate for the panel members to posit whether this would be achievable. Given that there has already been such a backlash about cuts so far, in part abetted by the Coalition’s tough rhetoric on their ‘austerity’ measures, it seems likely that when the bulk of the cuts do occur they will face a large backlash. Furthermore, this will likely be accompanied by greater noise for new or increased taxes on income or wealth.

Unfortunately, raising taxes before cutting spending is not in line with the best practice seen in Canada, who by cutting spending found that they were able to reduce tax rates which in turn generated a pro-growth virtuous circle.

3) Is there room for George Osborne to manoeuvre his deficit plan in search of growth?

Just as they did before last year’s Budget, the IFS stated that their default position would be for the Chancellor to not engage in any net giveaways in the forthcoming Budget. However, they did today imply that given the increased willingness for looser monetary policy now, and the weakness of the UK economy, the Chancellor might consider a small net giveaway in the Budget (emphasising all the time that it was essential to tread a path to keep interest rates low). The justification is to lower the chance of any long-term harm resulting from low activity today.

Unfortunately, their suggested policies for stimulus represent exactly the short-term, Ed Balls-ist style Keynesianism that we should be moving away from. According to the IFS, the tax cuts or spending increases should be ‘timely, temporary and targeted’ – meaning they have chosen temporary cuts to VAT, temporary cuts to employers’ NICs and more investment spending as their weapons of choice. All three of these policies seem to be straight out of the ‘spend now, pay later’ school of thought with little positive long-term effect for the economy, and potentially little short-term effect either.

Households have plenty of deleveraging to be getting on with having spent the past decade racking up the debts; and the Government’s NICs holiday policy failure has shown that firms engage in long-term planning when deciding to hire workers. If George Osborne is set to undertake extra borrowing, it would be much better to undertake something that will be more beneficial in the medium to long-term, such as slashing the rate of Corporation Tax to attract foreign direct investment or lowering employer NICs permanently.

Corporate income taxes have been found by the likes of the OECD to be the taxes most harmful to growth, and through history the rate which generates higher revenues has been consistently falling. By lowering the main rate of Corporation Tax to 20%, with further planned reductions, George Osborne would be clearly signalling that the UK is open to business and the tax cut would likely result in both increased FDI and a wealth effect through equity prices. The very short-run revenue cost would be around £4.2 billion, which could be easily closed – if desired – by other simplifications to the tax system, such as scrapping higher rate pension tax relief. This would meet much more closely with the desire for the new British economy to be built on ‘saving and investment’ rather than ‘consumption and debt’.

 

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Comments

Toby Fenwick - About 937 days ago

Ryan,

Thoughtful as ever. However, can I respectfully disagree on the investment spending? At a time when HMG can borrow at very low rates, and when the construction sector remains in the doldrums (implying that HMG could spend on construction without setting off inflationary pressures) and that construction workers are largely low-paid (and that therefore their propensity to spend the marginal pound is high), surely now is exactly the time to buy infrastructure that we will need in the future?

All the best,

Toby

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Ryan Bourne Bourne - About 935 days ago

Toby,

Few economists would argues that capital spending would be more beneficial to growth than current spending at the current time - because, as you imply, the multipliers are likely to be much higher. The main point of this article is exactly that: even within this strategy of spending restraint, the government should have made cuts to current spending first ahead of the cuts to investment and tax rises.

Your point raises the question of whether they should be borrowing more for investment spending now ON TOP OF existing borrowing. I'd still disagree here. Many economic studies show that debt to GDP ratios greater than around 85% prove pretty difficult to escape from. We're sailing dangerously close to this. I don't think investment spending on the scale the IFS suggested would do much to improve long-run infrastructure - and if we engaged in much more ambitious projects, I do think we'd be gambling with market reaction.

Ryan

Anonymous - About 917 days ago

Hard to see enmeelts of this as anything but ideology.I fear for the poor kids of the future. It seems my generation will be one of the few who had a chance to break through that glass ceiling via a higher education.

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