Sunday, August 26, 2012
The wrong kind of cuts leave Osborne struggling
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

A year ago, amid the fall-out from the riots, turmoil in the eurozone and the stunning loss of America’s AAA debt rating, George Osborne looked to be in fiscal trouble.

Net borrowing in July 2011, initially reported at £20m, added to a picture of a deficit stubbornly refusing to come down . The deficit reduction programme, it seemed, was stuck.

Things changed. July’s small deficit was eventually revised to a surplus of £2.8 billion. Borrowing did come down significantly over the course of 2011-12, to £125 billion, from £148 billion in the previous year, 2010-11. The strategy survived.

Whether history is repeating itself remains to be seen. Public borrowing in the first four months of the current fiscal year is not just failing to come down, it is up.

Adjusting for two distortions - the transfer of the Royal Mail pension plan to the public finances and a payment to the government at the end of the Bank of England’s Special Liquidity Scheme - April-July borrowing was £47.2 billion, £11.6 billion higher than a year earlier.

Though the fiscal task this year is less onerous - on an underlying basis borrowing only has to drop by £5 billion to £120 billion - things are heading the wrong way.

There will be data revisions for all the usual reasons, and the fact the Treasury is running in a new computer system for monitoring spending. A North Sea shutdown artifically depressed tax receipts.

Nor was a July deficit quite as rare as it was painted when the figures were released. The government was £557m in the red in a month in which corporation tax payments are concentrated but this was better than two years ago, when the deficit was £3.4 billion, or three years ago, when it was £6 billion. Every year from 1993 to 1996, July was a deficit month.

Not only that but a glance at the details shows how complex working out what the government’s fiscal position is. It is a minefield, making the accounts of the messiest individual or business look like child’s play.

Perhaps because of this, both the Office for Budget Responsibility and the Institute for Fiscal Studies say it is too early to say this year’s fiscal target will be missed. There is time to make up lost ground.

Does this mean the chancellor’s garden is rosy? Not a bit of it. In fact, the more you look at it, the more of a mess it is.

Some readers will be too young to remember the Margaret Thatcher year. In her first term as prime minister, 1979-83, almost the entire nation believed Britain was reeling under the impact of “the cuts”.

Labour, the unions, most economists and the majority of voters believed it, and ministers did nothing to disabuse them of it. The reality was rather different.

Whie capital spending, on infrastructure, was indeed cut sharply, by more than half, the lion’s share, current spending, rose strongly, increasing by 13% in real terms over four years.

Some of this was the effect of recession, pushing up the bill for unemployment and other benefits. Much of it was public sector pay, after the government agreed to honour the recommendations of the Clegg commission (no relation).

Only in its second term did the government start to get to grips with spending.
It is happening again. Current spending is rising under the coalition, and is intended to carry on doing so until beyond the end of the parliament.

Capital spending, as then, is being slashed, from £48.5 billion in 2009-10 to £26.1 billion in 2011-12, Osborne having taken the plans he inherited from Alistair Darling and run with them. These are the “cuts”. As under Thatcher three decades ago, the coalition has failed to put a brake on the recurring items of spending.

So last month, current spending was up 5.1% on a year earlier. Welfare payments, (officially net social benefits), were up 6.2% year-on-year last month, and an even more worrying 7% in the April-July period.

This is not a temporary phenomenon. Cash cuts in current spending are not planned this year, next year nor the year after. By 2016-17, the government expects current spending to be £709 billion, £80 billion or 13% above the cash total for 2010-11.

In later years the hope is this spending bill will rise more slowly than inflation. The evidence so far is discouraging.

Why is it happening? Though some payouts such as child benefit and the working tax credit are being frozen, a government that has a reputation for slashing spending is being rather generous.

Most benefits rose by 5.2% in April, in line with last September’s inflation rate. It was a kick in the teeth for workers, who these days are lucky to get a 2% pay rise. It was not the action of a government determined to bear down hard on spending.

We may have to await Iain Duncan Smith’s reforms for better control of welfare spending, though they will not be fully effective until 2017. Osborne’s efforts, such as the cackhanded initial attempt to limit child benefit to basic rate taxpayers, have been unimpressive and ineffective.

In opposition, Tories talked about following Canada, which cut public spending by 20% over three years in the 1990s. In truth the gulf between British and Canadian policy is as wide as the Atlantic.

So far deficit reduction has come from two things: those deep cuts in capital spending and the hike in Vat to 20%. It is obvious why the Treasury wanted the Vat hike: it did not trust the politicians to cut spending. But higher taxes and cuts in infrastructure spending are bad for growth, short term and long-term.

Failing to tackle the current spending bill, by the same token, is bad for the economy: leaving us with a size of state that reflects the overblown Blair-Brown years rather than the current reality.

Some of the weakness in corporation tax revenues - down 19% in July compared with a year earlier - is temporary. But the OBR thinks some will persist. The days when the City was a giant cash cow for the Exchequer are over. The days when booming profits allowed ministers to play Lady Bountiful are gone for some time.

So, even though the latest numbers for the public finances are not quite the disaster portrayed last week, Osborne is in a deep bind. Strongly rising current spending and weak corporation tax leaves him little room for fiscal manoeuvre.

The boost to infrastructure spending business wants cannot realistically be achieved without cuts elsewhere. Getting such cuts past his coalition colleagues is likely to be impossible. He has made his choice. Like the early Thatcher, he has a reputation as a cutter that is undeserved. That may be where the comparison ends.