Sunday, July 27, 2014
The black hole's still huge - but Osborne's slowly filling it
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.

The latest figures for Britain’s public finance a few days ago produced an interesting reaction. Either Britain’s budget deficit is soaring, and George Osborne’s strategy for reducing it is in tatters, or it has stopped falling, which is hardly any better.

Neither of those verdicts is correct, as we will see in the coming months. But they are part of a wider problem when it comes to assessing Britain’s fiscal policy. Those on the right of the chancellor – there are some – say he should have cut spending harder in the face of disappointing deficit reduction, claiming that he has left all the hard work, two-thirds of it some say, until the next parliament.

Those on the left, meanwhile, accuse Osborne of inflicting untold misery on large sections of the population with his unremitting austerity, while some economists – mainly on the left – say the only reason Britain’s economy is recovering is because he abandoned that austerity.

Let me guide you through this minefield, starting with the latest figures. They showed that the budget deficit, public sector net borrowing, was £11.4bn last month, up £3.8bn on June 2013. The figures a year ago were, however, artificially helped by a £3.9bn payment from the Bank of England to the Treasury of interest it receives on its holdings of gilt-edged securities under the quantitative easing (QE) programme. Adjusting for that, borrowing last month was marginally (£111m) down on a year earlier.

That does not sound like much of a deficit reduction programme and borrowing in the April-June period, the first three months of this fiscal year, was £36.1bn, £2.5bn up on a year earlier.

Again, however, there were special factors at work. In the spring of 2013, as noted here before, both wages and salaries and income tax receipts benefited from income being shifted into the 2013-14 tax year to benefit from the cut in the top rate of tax from 50% to 45%. The silver lining for this year, as the Office for Budget Responsibility (OBR) pointed out, will be that self-assessment receipts due in January will be similarly boosted.

This “end-loading” to tax receipts, coupled with the strong revenue growth in June – Vat up 5.5% on a year earlier, corporation tax 17.6%, stamp duty 43.1%, National Insurance contributions 3.3% - should mean that the borrowing overshoot of the first three months turns into an undershoot. Borrowing this year in line with the official forecast of £95bn, after £105.8bn in 2013-14, remains in prospect. This is better, incidentally, than the OBR expected in March 2013, when it thought borrowing would be becalmed at £120bn for three years and only slip to £108bn this year.

But £95bn is still a big number, and is a lot bigger than the OBR expected when it published its first forecast alongside Osborne’s first budget, back in June 2010, when it predicted a deficit of only £37bn for this year. Doesn’t this tell us that the critics are right, and that the chancellor has soft-pedalled on austerity, kicking the can down the road?

No. If we take public spending, which is where the chancellor gets it in the next from his right-wing critics, the striking thing is not that that spending has been relaxed but that it has been tightened – cut – relative to the 2010 plans.

According to those plans, the government intended to spend £722bn in the 2013-14 fiscal year, that one that ended this spring. In fact it spent £714bn.

Spending has been lower each year than set out then. Public sector current spending was originally intended to be £679bn in 2013-14. In fact it was £668bn. Unusually, for any government, spending has come in comfortably within budget. There has been no slippage.

Where there has been slippage is in tax receipts, which have been weaker than expected. A small amount of that was due to deliberate policy choices – not raising fuel duty and increasing the personal income tax allowance to £10,000 more quickly – but most of it was not.

The weakness of the recovery until 2013, due in part to deficit reduction but mainly weak credit, the squeeze on real wages and the eurozone crisis – hit tax receipts. As long as growth persists, and the International Monetary Fund last week revised its forecast for Britain up to 3.2% this year and 2.7% next, and with figures on Friday showing GDP back above pre-crisis levels, tax receipts will continue their comeback, reducing the deficit more quickly.

Did Osborne abandon his austerity? No, of course not. The always excellent Institute for Fiscal Studies, in an analysis by Gemma Tetlow, one of its economists, sets out the numbers clearly on its website. Starting in 2010-11, there was a discretionary fiscal tightening of 1.6% of gross domestic product, followed by 2.4%, 1.4%, 1% and a planned 0.6% this year. The pace of tightening has slowed, but that “front-loading” was always intended. Over the course of the parliament the coalition will have tightened by 7% of GDP, slightly less than the 7.9% originally planned because of the tax changes described above, but only slightly.

Why is there still so much to do? By the end of this year, says Tetlow, 55% of the planned tightening will have occurred, leaving 45% to the next parliament. It is important to be aware, however, that the goalposts have been moved.

They were moved in November 2011 when the OBR changed its view on the economy’s productive potential, so more of the deficit was deemed to be structural – and thus requiring tax hikes or spending cuts – and less of it cyclical, in other words disappearing with the recovery.

The second goalpost shift was by Osborne himself, when he set himself the goal of achieving a sustained budget surplus, rather than merely getting the deficit down to zero. Between them, these moves increased the amount of work to be done, so there is more to do. But a lot will have been achieved. By 2018-19, according to the IFS, a deficit reduction programme equivalent to 11.5% of GDP will have been achieved. Apart from in the special conditions of moving from war to peace, I do not think that has ever been done before.

It is disappointing more than four years after Britain’s budget deficit hit a record £157bn, that it is still closer to £100bn than it is to zero. But progress is being made. It has to continue.