Sunday, November 25, 2012
Tackle welfare, or you'll never tackle the deficit
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.

What should be George Osborne's priority for the public finances in his autumn statement on December 5? And how big is the risk to Britain's AAA sovereign debt rating?

Most monthly economic numbers do not deserve the headlines they generate, particularly those for government borrowing. October’s public borrowing, £8.6bn versus £5.9bn a year ago, was undoubtedly disappointing.

Some of it, however, was the impact of North Sea shutdowns on corporation tax revenues - down nearly 10% on a year ago - and the numbers are prone to revision.

In August, for example, official statisticians told us we had a rare July budget deficit (the figures are usually boosted by corporate taxes that month) and borrowing in April-July was running well above last year’s levels. Now, the red ink in that period has been revised down by over £5bn, and July is recorded as a surplus.

The big picture at present, which because of revisions can change dramatically, is that Britain is heading for a budget deficit of about £130bn this year, compared with an Office for Budget Responsibility forecast of just under £120bn.

That is disappointing. Though the latest official projections - in March - were for only a modest borrowing reduction this year, the latest estimate for 2011-12 being £121.4bn, a deficit reduction programme is meant to be just that. A deficit increase halfway hardly sends out the best signal.

It is not, in narrow terms, disastrous. The Treasury will see a small rise in the deficit as evidence the automatic stabilisers beloved of economists are being allowed to operate. When growth is slow, tax revenues suffer and cyclical elements of public spending rise.

Will the ratings agencies see it that way? Moody’s, which has Britain on negative outlook, downgraded France last week, to which the reaction ranged from “quelle horreur” to complete indifference.

The French think the Anglo-Saxons are ganging up on them, and that their public finances are healthier than Britain’s. But at least we do not have a government which has responded to the fiscal crisis by lowering the state retirement age and introducing a suicidal 75% top tax rate.

Moody’s says it will reassess Britain’s AAA rating early next year, when it has had time to assess fallout from the December 5 autumn statement. Though there is a case for a downgrade, at this stage it is hard to predict which way it will go.

There would be no case for a downgrade if the government had stuck to its deficit-reduction plans. By this I do not mean the ones set out in March - which will be revisited next month - but the original June 2010 plan, just after the coalition took office.

The first two years under that plan were not too bad, as I wrote a few weeks ago. This is the year, however, when it has started to go wrong. Public borrowing under that plan was supposed to be £89bn this year, 2012-13. If it is £130bn or more, that is getting on for a 50% overshoot.

Those June 2010 projections had borrowing down to £20bn in 2015-16. It is a long way off but it is now a pipedream.

What’s gone wrong? Labour pins all the blame on coalition tax rises and spending cuts, though the difference between what it would have done and what has actually happened under the coalition is small. The fact that few advanced economies have escaped post-crisis torpor strongly suggests there is more to it than that.

We know what the problems are, apart from fiscal consolidation: a damaged banking system unable or unwilling to extend credit; the eurozone crisis; risk-averse big businesses lacking the animal spirits to invest cash piles and the high-inflation squeeze on household real incomes.

There is, however, something else happening, and it goes to the heart of the government’s fiscal struggles. Seventy years on from the Beveridge report, we spend an enormous amount on welfare. In 2011-12 the combined figure for benefits (£175bn) and tax credits (£27bn) was £202bn, according to the OBR.

A few days ago, two things were neatly juxtaposed. One was a column in The Guardian by Polly Toynbee, under the headline ‘No amount of moralising will alleviate the hardship caused by Tory austerity’. The other came with the official figures for the public finances, showing spending last month on welfare, so-called net social benefits, up by 7.7% on a year earlier.

This Tory-led coalition is being so brutal, in other words, that benefit spending is up by nearly 8% in a year, or a shade under 15% over three years. October was no aberration, the 15% figure applies when the comparison is for the July-September quarter.

Why so much? It is not explained by unemployment, which at just under 2.5m is close to where it was three years ago. A lot has to do with the government deciding to maintain the real incomes of benefit claimants by uprating them in line with inflation, even as most people in work suffered from a huge real-income squeeze. Fraud certainly plays a part.

The tax credit system set up by Labour - with taxpayers topping up incomes of lower-paid workers - is a factor. Overall it is, however, a huge policy failure, a failure to grasp the nettle. Welfare spending has risen at almost double the rate envisaged when the coalition took office.

The government is getting blamed for welfare cuts it is not making. Under pressure from the Liberal Democrats the Tories have held back, letting things drift until Iain Duncan Smith’s welfare Big Bang, the universal credit, which will not be introduced until the autumn and winter of next year. Or there have been cackhanded reforms like removing child benefit from some higher tax-rate households.

It may be that things start to improve from next April, when the Department for Work and Pensions is targeting a real reduction in spending. It may be that talk of reining back inflation-linked benefit increases comes to something.

But at a time when the chancellor is said to be contemplating cutting pension tax relief, and after a period in which capital spending - infrastructure investment - by government has been slashed, with a devasting effect on the construction industry, it is clear where his priorities should lie. Unless you tackle welfare, you will never deal with the deficit. This government has failed to tackle welfare spending.