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Let's reverse some of the private sector austerity

    The Coalition government aims to eliminate the structural component of the current deficit (i.e. the bit excluding public investment) within five years, and for debt as a proportion of GDP to be falling by the end of the Parliament. As I explained in my City AM column this morning, on current policies neither of these targets look likely to be met. What to do?

    The uncomfortable truth for those who slam austerity as being the cause of all our ills is that the vast majority of the consolidation of the current budget so far has come through tax hikes (i.e. private sector austerity) rather than current spending cuts (i.e. public sector austerity). Tax revenues are up £31 billion in real terms between 2009/10 and 2011/12 compared to a real increase of £8 billion in current government spending. VAT, CGT, fuel duty, stamp duty and other taxes have been hiked.  But in this period, real GDP increased by just £40 billion, meaning government took over ¾ of the gains.

    There is academic literature to suggest tax-based consolidations harm output growth much more than spending-based consolidations. Though overall the government’s programme is supposed to be a spending-based consolidation, the tax hikes were heavily front-loaded and current spending cuts back loaded. It’s unclear whether people have confidence the government will actually follow through on the current spending cuts – some of them have been shoved into this next Parliament, and there’s constant rumours of the Lib Dems and the Treasury thinking of new innovative ways to tax people instead. The Chancellor has already rolled over his current budget target, meaning he’s sticking to his spending plans whatever the weather – some are right to suggest this means it’s not strictly a deficit reduction plan anymore.

    With the Autumn Statement coming up, actually cutting current expenditure while cutting taxes should be seriously considered.  Much of what the state does is merely transfer money around. As such it has little impact on growth, but can harm growth through the incentive effects that a higher than otherwise tax burden can bring. Our economy was warped by cheap credit and government spending towards credit-based industries, retail and the public sector (which between them made up 60% of the economy in 2009) – now the party is over we have no right to automatically grow. Diverting as many resources as possible to the private sector through tax cuts while maintaining decent levels of public services should be what the Coalition tries to achieve.

    But, what, I hear you ask, about investment? Well, the Coalition has followed through on slashing the net investment budget largely in tune with the plans they inherited from Labour. It’s therefore ironic that the Labour party and its acolytes are quickest to criticise the policy. That aside, if there are projects that will provide good returns (which should be the basis of deciding whether to go ahead) on things which can’t be delivered by the private sector then of course the Government should seriously consider doing them. However, these are unlikely to be shovel-ready (as Barack Obama found in his so-called ‘stimulus) and if these projects consist of white elephants and political gimmicks such as high-speed rail and inefficient renewable energy resources, then the long term health of the economy and the public finances would probably be better served if they weren’t done. Again, Barack Obama showed how this can go badly wrong.

    No doubt there will be those who react to calls for more (read: some) overall current spending cuts with horror. Yet, this has to be put in some sort of context. Real current spending increased by £100 billion in the five years prior to the global financial crisis, and has increased by a further £54 billion since. Given we need private sector growth, spending this much through what is largely government transfers, administration etc and raising taxes in order to pay for this high level of spending makes no sense at all.

    Ryan joined the Centre for Policy Studies in January 2011, having previously worked for a year at the economic consultancy firm Frontier Economics.

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    Comments

    Adrian Fisher - About 2501 days ago

    The much quoted achievement by Canada to reduce its deficit deserves much more respect and admiration for its achievement. It was remarkable.

    Clearly similar success today for the UK, USA and the West is much more likely if there is a strong political mandate for change. We don't have this strong enough in the UK, and now not in the USA. Yet numbers have a habit of rapidly spiralling out of control, if not dealt with.

    The need and urgency could not be greater.

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