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8 myths about spending cuts

    1. Spending cuts will take us back to the 1930s

    In the immediate aftermath of the Autumn Statement, much of the criticism came from those decrying the fact that total public spending will be 35.2% of GDP by 2020. Mark Ferguson over on LabourList called it a “nightmare vision” which would take the country back to the 1930s and he was not alone. This is, of course, quite a ludicrous comparison which is intended to conjure images of starvation and slum cities. Quite where these images of disaster were in 2000 when total spending was 35.9% of GDP is unclear. Obviously, our economy is many times bigger so we are all much richer and public spending is much higher in real terms. In its latest Economic and Fiscal Outlook on page 148, the OBR states that day-to-day spending on public services in 2019/20 will be the same in real terms as it was in 2002/03. On a per-capita basis, real terms spending will be the same as it was in 2001/02. If the critics think life really will be so awful in 2020 under these plans, then they also have to explain why the first five years under Tony Blair’s government were so awful too.

     2. Spending cuts will destroy the NHS and schools

    Others have taken to claiming that the proposed public spending cuts mean that the NHS will be destroyed or that schools will be crippled. Sunny Hundal made this claim about education in a debate on Radio 5 Live. Whilst there should be discussion over the size of the NHS, education and international aid budgets, these are all three subject to degrees of protection. The OBR forecasts that under the protections, real spending on health will be £7.1 billion higher in 2019/20 than in 2009/10, international aid spending will be £3.3 billion higher and education will be a very manageable £1.8 billion lower. Inevitably, this means that other departments will face a greater proportion of the required spending reductions. It also means that anyone suggesting that the spending plans threaten public health or children’s education is fibbing or confused.

     3. Spending cuts will destroy other public services

    Opponents of the spending cuts have always argued that deficit reduction would lead to hideous damage to services and they have taken to using the term “public service cuts” instead of “public spending cuts”. Unfortunately for them, their overblown forecasts have been conclusively refuted by the people who use the services. For example, polling by ICM showed that six in ten people in the general population thought services had improved or stayed the same. Moreover, the polling shows that the people who actually use particular services have an even more favourable opinion than the general population. This applies to services as varied as schools and libraries.

    One of the best examples of public services surviving under spending cuts is the Home Office budget which fell from £13.4 billion in 2010/11 to an expected £10.9 billion in 2014/15. Yet despite the many dire warnings, crime has fallen over the same period; both in terms of the reported figures and in terms of what the public experiences. The Crime Survey for England and Wales showed that there were 7.1 million recorded crimes against households and individuals in the year to June 2014. This is a 16% fall on the year and the lowest number since the records began in 1981. What matters is not how much we spend but what we get out from public services. Spending cuts when combined with effective reform can still deliver high quality services.

     4. Spending cuts are unnecessary because we could just increase borrowing

    Those arguing for more borrowing based on the current relatively sanguine conditions in the markets for government debt are being terribly complacent. Who can really say if next year or in five years, government bond markets will have the same appetite for our national debt? The Eurozone crisis has shattered any illusions we may once have had about the sanctity of government bonds; financial markets are fickle and confidence can evaporate overnight. A borrowing splurge now, whilst deceptively cheap, would leave the deficit at an elevated rate, damage confidence in our willingness and ability to cut borrowing over a reasonable time period and make us more vulnerable to future bond market volatility. The impact of winding down Quantitative Easing is another unknown variable.

    Furthermore, more borrowing implies a rise in the dead-weight loss of debt interest payments. Central government debt interest is forecast to be £48.1 billion this year and even under the current plans, it will rise to £64.8 billion. In the supplementary fiscal tables provided by the OBR, they forecast that just a 1% increase in the rate paid on gilts would lead to a cumulative £13.1 billion increase in debt interest payments over the next five years. Despite big downward forecasts on debt interest payments, in 2020, 8.3% of total government spending will be used to pay for past profligacy, more than will be spent on education. This is bad enough and will be exacerbated by spending and borrowing more now.

     5. Spending cuts are unnecessary because we could just increase taxes

    Many have argued that spending cuts are unnecessary because higher taxes could cut the deficit anyway. Ever higher taxes on income and capital might make us feel better by bashing the rich but they will never get close to raising the revenue sufficient to eliminate the deficit. We made this point in our recent report, “The Cost of Labour”. Others, such as some of the unions have declared that clamping down on tax avoidance would eliminate the need to make any spending cuts at all. This is simply a fantasy. HMRC’s estimate of the tax gap, the difference between the amount it expected to receive and the amount it actually received is £34 billion. Even if somehow it was possible to eliminate the entire tax gap, there would still need to be spending cuts to restore a fiscal balance.

    Big increases in personal taxation would not be justifiable given that the middle 20% of non-retired households already pay 40% of their original income in taxes. Raising enough revenue could only come at the cost of severely reduced disposable income and a huge contraction of the private sector and inevitable job losses. It is therefore not surprising that no British government, at least over the last half century, has ever been able to generate more than 38% of GDP in revenue from individual taxes. There is definitely scope for tax reform and a further simplification of the system which would have the net effect of raising revenue but spending cuts will be inevitable. Every extra pound the state spends is a pound taken from the pocket of the taxpayer.     

    6. Spending cuts are an ideological crusade

    Since 2010, many have criticised the spending cuts as part of an ideological drive to shrink the state. A smaller state would indeed lead to a bigger economy and freer people. However, apart from the fact that supporting a small state per se is no more or less ideological than supporting a big state, it is the fiscal imperative to make spending cuts which trumps any other considerations. The uncomfortable reality is that a large part of the deficit is structural. Even if the economy grows strongly every year and the output gap reaches zero, the structural deficit will remain. Unless we are prepared to let it fester and grow, spending cuts are necessary to eliminate it.

    On page 199 of the Economic and Fiscal Outlook, the forecasts are set out for the cyclically adjusted current budget deficit ie the structural deficit. The OBR makes clear that it is larger than it previously anticipated; this year and next year will see structural components of the deficit rise to 2.7% and 2.2%. This cannot simply be wished away. Spending restraint is essential to root out inefficiencies and keep the cost of government as low as possible. There is nothing virtuous about delivering services at a higher cost to taxpayers than necessary.

     7. There are no spending cuts

    Others have argued that in reality there will be no real spending cuts over the next five years because Total Managed Expenditure (TME) ie total government spending will rise. It is true that TME is forecast to rise by £43 billion from £737 billion this year to £780 billion in 2020. However, a correction to the Economic and Fiscal Outlook shows that there has been an average real terms cut of 0.8% in total government spending every year of this Parliament. Over the entire period from 2010 to 2020, there will have been a real terms cut of 5.5% in total government spending. It is also important to remember that different components of the budget are facing different pressures.

    The big increases in spending over the next five years are coming from a £25 billion rise in welfare spending, a £7.5 billion rise in capital expenditure and higher debt interest payments. However, the cuts which will have to occur will be in departmental spending. The most relevant figure is called Resource Departmental Expenditure Limits. This is the figure which shows the amount spent on day to day public services not including capital spending. Not including health, education and aid, this figure has been cut in real terms from £188 billion in 2009/10 to £147 billion this year and will need to fall to £85.6 billion in 2019/20. This means that another £60 billion of cuts in the non-protected departments could be made over the next Parliament.

     8. Spending cuts are impossible anyway

    This myth is apparently believed even by a number of serious economists. It is worthwhile examining what has happened so far to departmental spending. Government departments have not only achieved the reductions in spending with which they were tasked but also spent less than the limits they were set by the Treasury. Moreover, local authorities are on average building up their financial reserves instead of running them down (see page 149 of the EFO). Total Managed Expenditure has fallen from 45.3% of GDP in 2009/10 to an expected 40.5% of GDP this year. It should then fall to 35.2% by 2019/20. This means that 48% of the total cut in spending relative to GDP has been carried out with 52% required in the next Parliament. This may be difficult but given the progress so far, it is by no means impossible.

    In addition, the expected cut in non-protected departmental spending of £60 billion is probably higher than will be necessary. It is highly likely that further cuts in the welfare budget will offset some of the cuts in departmental spending and there are still some easier savings which can be made on, for example, Government IT contracts as James Forsyth reports. Furthermore, if productivity grows faster, then the boost to real wages would lead to higher than expected tax revenues. If productivity grows strongly, the OBR forecasts that the structural deficit will be eliminated by 2016/2017 and the national debt will be 56.7% in 2020 compared to 72.8% under its central forecast and 86.6% under its weak productivity scenario. Supply-side reforms to boost productivity will be key.

    Some of the reactions to the OBR’s forecasts have been hysterical and there have been a number of particularly misleading myths. The reality is that spending cuts are a necessary, although not sufficient, condition to restore fiscal balance.

    Adam joined the Centre for Policy Studies as Head of Economic Research in January 2014. 

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