Sunday, December 09, 2012
Osborne's austerity: not as tough as it looks
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

We rarely compare Britain's budgets with those of other countries. Three years ago I had an opportunity to do so, being in Dublin on the evening Alistair Darling had unveiled his final pre-budget report and the Irish government had announced one of a series of austerity budgets.

Britain’s pre-budget report was a tinkering exercise, Darling’s achievement being to head off pressure from Gordon Brown in 10 Downing Street for a pre-election giveaway. Ireland, in contrast, announced a full-blooded austerity budget.

On Wednesday, history repeated itself. Despite the deterioration in the public finances, George Osborne’s autumn statement was broadly neutral in its impact over the next four years.

Ireland, in contrast, had another bloodcurdler, intended to take 2% out of the economy next year, through higher social insurance charges, fuel duty hikes, motor taxes, child benefit cuts, the taxation of maternity pay, a new local property tax.

The two economies are different. Ireland is constrained by euro membership and has had a ratings downgrade and a bailout. Britain is hanging on to her AAA status, for now, and has not had a bailout for 36 years.

I am not a headbanger on this. If you can avoid swingeing spending cuts or big tax increases it is generally better to do so. We have seen the effects of too rapid a cut in capital spending over the past two years.

The Irish comparison shows, however, that perception can differ from reality when it comes to austerity. Theirs is harsh, ours quite mild. A look at the numbers also shows how Osborne has been quietly doing what his critics have been demanding.

Some will recall Margaret Thatcher’s austerity budget of 1981, when the public finances needed fixing. Introduced by Sir Geoffrey (now Lord) Howe at a time of recession, its main measure was to freeze the personal tax allowance at a time of high inflation; it should have gone up by 14.8%.

Contrast that with what will happen in April. The personal allowance - the exempt amount before people start paying tax - will go up from £8,105 to £9,440, a combination of Liberal Democrat pressure and the Tories saying they wanted to do it anyway.

If the allowance were indexed, as was the norm, it would rise to £8,285. The bigger rise represents considerable largesse, and it costs. Had Osborne indexed it, he would have saved himself £4.9bn.

Had he “done a Thatcher” and frozen it, he would have saved £5.7bn. Raising the personal allowance means a £5-6bn tax cut that could have been used for deficit reduction. You could almost call it Keynesian.

A similar attitude prevails elsewhere. Take welfare. I have pointed out the relative generosity of welfare increases compared with wage rises and the statement highlighted it. In five years, out-of-work benefits have risen 20%, earnings 10%.

That is unsustainable but the response is quite mild. While Ireland has slashed welfare in its budgets, Osborne is limiting working-age benefits to 1% annual rises for three years. Tough but far from draconian.

As for the rest, it did not suggest a government under intense fiscal pressure. Cancelling next month’s fuel duty increase costs £890m this year, £1.64bn in 2013-14.

The very useful measures for business do not come without a price-tag either. The unexpected cut in the main rate of corporation tax 21% from 2014 has an eventual full-year cost of £875m, the two-year increase in the investment allowance to £250,000 a peak annual cost of £910m.

What does all this mean? I am not suggesting there is no austerity, but that it is more gradual and nuanced than you would think. Under the new plans, total government spending will rise from £674bn this year to £765bn in 2017-18. It will be higher as a percentage of GDP than this year for the next two years, and not drop below the magic 40% of GDP for five years.

The coalition is also, apart from tax gifts it can scarcely afford, adopting a textbook response to slow growth: allowing the automatic stabilisers to operate. Slower growth weakens tax revenues and pushes up government spending. Osborne, sensibly, has not tried to offset this now with tax hikes and additional cuts.

How bad a shape is the economy in? The surprise in the Office for Budget Responsibility’s (OBR) assessment was that the public finances were not worse, particularly this year.

Much excitement has been generated by the expected £3.5bn windfall from the auction of the 4G mobile phone spectrum in January. Though it is true to say without it borrowing would have been slightly higher than last year (partly because 2011-12 came in below the OBR’s March estimates), there is nothing unusual about governments counting asset sales in advance. The proceeds of this sale, of course, have to be set against future tax revenues from the mobile phone firms.

The more interesting story was that, stripping out all the distortions, the OBR is £5-10bn more optimistic than the independent consensus. Robert Chote, its chairman, thinks it has a better handle on what is happening to public spending than outside economists.

That is why, while most economists and a badly wrongfooted Ed Balls expected the deficit reduction strategy to turn into a deficit-increasing strategy this year, the OBR was able to come up with a tiny cut. If that call turns out to be wrong, Osborne and the OBR will feel the heat come March.

The bigger picture is that, despite disappointing growth, borrowing is still on its way down, if only gently. In that respect, I hope the OBR is right. Osborne was forced to abandon his target for reducing debt as a percentage of gross domestic product by the end of the parliament, shifting it into the next parliament. But he was spared the humiliation of a deficit increase.

What about the economy? As disappointing years go - the OBR estimates a 0.1% drop in GDP - this could have been worse. I have written a lot about the rise in employment but it is also the case, according to the OBR, that real household disposable incomes have risen by 2.1% this year, after falling on an annual basis since the second quarter of 2010.

What about next year and beyond? If the economy can grown by 1.2% in 2013 when the eurozone, according to the European Central Bank, shrinks 0.3%, that would not be a bad outcome, though industrial production figures on Friday showed that the fourth quarter started badly. But we will not see growth top 2.5% this side of the election, according to the new official forecast.

We know why. It grieves me to hear reputable economists blaming it all on austerity, which is a political not an economic verdict. Slow growth is the product of a range of factors, including the eurozone and a slower global economy, a damaged banking system which is not advancing enough credit and a corporate sector with cash to spend but caution holding it back.

Only when all this comes right can we expect good growth to return. In the meantime, we should not lazily lay all the blame on austerity. The lesson of the past week is that it is milder than you think.