Sunday, September 28, 2014
Osborne's deficit plan gets lost in the statistical fog
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.

Maybe Ed Miliband should have talked about the budget deficit, and not just for the obvious reasons.

Had the Labour leader done so he could have provided George Osborne and David Cameron with a bit of discomfort ahead of their conference this week. As far as we can tell, the budget deficit so far this year is up rather than down, and the chancellor is in danger of missing his deficit reduction targets. The “long-term economic plan” will look more than a little tarnished if the deficit starts going up again.

I shall return to that in a moment. I say “as far as we can tell” because the figures for Britain’s public finances have just been put through the statistical mill. The Office for National Statistics (ONS) has redone the numbers to comply with the new European System of Accounts (ESA10) requirements, which apply to all EU member states, and it has introduced a new measure of the budget deficit.

These changes have had even the experts scratching their heads. The independent Office for Budget Responsibility said the new figures make it “more difficult to draw inferences from the latest data for performance against our latest forecast".

The Institute for Fiscal Studies was a little more willing to look through the “significant methodological changes” – which include increasing the level of public sector net debt by £130bn to £1,432bn – but conceded that there were uncertainties about what will happen in the rest of the current fiscal year.

This process of methodological upheaval for the statistics will get even more attention this week, when the ONS updates its GDP (gross domestic product) figures to meet the new ESA10 standard.

Though the ONS has warned against extrapolating the GDP re-estimates it has done so far – to 2012 – on the face of it, this week’s figures will show that the economy surpassed its pre-crisis peak last year rather than this, and is currently some 3% above it.

They may also show that this is no longer the slowest recovery since the dawn of time. Though they will still show that it took longer to get back to where we were before, a big reason for this is the scale of the 2008-9 downturn. When it comes to how fast the economy has recovered from its low point, there is a good chance that this week’s figures will show that the current recovery is slightly better than the 1970s.

Though these revisions are necessary – ONS officials will say they are required to implement these changes and that it would be wrong not to incorporate the latest thinking into their estimates – they are also infuriating.

Much of the debate about the recovery over the past 3-4 years will in time be seen to have been hot air, blown away by statistical revisions. Those initial underestimates of growth did affect business confidence and could easily have resulted in self-fulfilling gloom. The lesson, set out here on many occasions, is to take early unrevised data with a pinch of salt.

When it comes to the budget deficit and government debt, it so happens that the data changes are less welcome than the GDP revisions, in the sense that the headline numbers are higher than before. But, by making comparisons more difficult, they also make it harder to scrutinise the government’s progress against its fiscal targets. The goalposts have moved.

What do the figures for the public finances tell us through the fog? In most respects the story is a familiar one. Borrowing on the new definition (the public sector excluding banks) in the first five months of the current fiscal year, the April-August period, was £45.4bn, compared with£42.8bn in the corresponding period of last year.

That increase in borrowing is, as I say, embarrassing for a government engaged in deficit reduction, though both the OBR and IFS cite factors that will help the public finances as the year progresses.

These temporary timing factors, most notably depressed income tax receipts compared with a year ago – when bonuses and some regular pay were shifted from 2012-13 to 2013-14 to take advantage of the top rate cut from 50% to 45% - will gradually unwind. It remains more likely than not that the 2014-15 budget deficit will turn out to be lower than 2013-14.

Something else is happening in the public finance numbers, however, which suggests that when it comes to deficit reduction the government has inadvertently shot itself in the foot.

If you listen to the chancellor’s critics on the Tory right, you might think that the slow pace of deficit reduction is entirely due to the fact that the government has not been tougher on public spending. What Osborne should have done, they say, is slash spending harder, and use the leeway both to cut taxes and reduce borrowing faster.

In fact, public spending is coming in around £10bn a year lower than the chancellor intended in his June 2010 emergency budget, partly as a result of additional measures to cut spending and partly because departments have underspent. Spending is down in real terms, and some departments and much of local government have faced very big cuts. Public sector employment has fallen by more than 7%, excluding classification changes.

The problem, instead, is on the tax side, and it may lie with one particular tax change. More than 30 years ago in 1981, Geoffrey Howe introduced his austerity budget, as I describe in our special Fifty Years of Business supplement today. The centrepiece was a freeze in the personal income tax allowance, at a time of high inflation. The effect was to increase income tax for the majority of people, hastening the process of deficit reduction.

The coalition, as a result of the deal between the Conservatives and Liberal Democrats, has done the opposite. Instead of an austerity freeze on the personal allowance, we have had a big income tax cut, as it has been raised in large steps to its current £10,000.

It is laudable to take people out of tax and increase the incentives for those at the bottom end of the income scale. But it is also expensive and, it appears, has made it harder to reduce the budget deficit.

The interaction of subdued wage rises and the relative shift from high to lower paid jobs means that the £10,000 allowance costs much more. In an unchanging labour market and something like normal pay rises relative to inflation – which not so long ago official forecasters expected – a smaller share of people’s earnings would have been tax-free. As it is, the tax-free proportion – which higher earners do not benefit from – is one reason why tax receipts are depressed.

We should keep an eye on this. It is, as I say, more likely that we are still in a situation of gradual deficit reduction than not. But the chancellor has deprived himself of quite a lot of tax. The tax take is at least £12-13bn a year lower than it would otherwise have been. He should not be too surprised that it is taking longer to get the deficit down.