Sunday, July 26, 2015
Cuts: the big bad wolf's howl is worse than his bite
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.

Sometimes I think that when George Osborne looks in the mirror each morning, he thinks: “Now how can I put the wind up the Labour party today?” Then, while holding that thought, he goes on to: “And how can I put the fear of God into people working in the public sector?”

A few days ago, the Treasury produced a 24-page document called ‘A country that lives within its means: Spending Review 2015’. Signed by the chancellor and his Treasury chief secretary, Greg Hands, this was not the spending review itself; that will not be published until November 25.

No, it was the Treasury’s opening gambit in the coming negotiations between it and the spending departments. Unlike in 2010, when the coalition’s first and most important spending review was a bit of the back of the envelope affair, the chancellor does not want to be accused this time of not following proper procedure.

Actually procedure has become a lot more formal during the time I have been following these things. There was a time when to extract from the Treasury, or more likely from disgruntled Whitehall departments, what the mandarins were demanding was gold dust. Now it is set out in black and white in an official document.

Osborne and Hands have asked “unprotected” departments to model two scenarios, of 25% and 40%, for real-terms reductions in their so-called resource budgets. Even in an official document, that is big news. The BBC led on it all day.

Does it mean, as some have suggested, that the Treasury is setting a target for cuts that can never be achieved? Does it mean an ideologically driven plan to shrink the state beyond recognition, so people have no choice but to use the private sector?

I suspect it means neither of those things. There is an interesting question to be asked about what kind of spending review we might have had, if the budget deficit had come down as much as expected in the last parliament. It is falling, but at £88bn in 2014-15 was some £50bn more than Osborne intended in 2010.

Even if the deficit had come down by more, however, there would have been a case for a proper look at public spending, the Canadian-style review the Tories used to talk of fondly before the 2010 election. Time and manifesto commitments have, however, taken their toll.

The government is committed to raising NHS spending in England by £10bn in real terms by 2020-21, to protecting per-pupil funding for schools, and to increasing the Ministry of Defence budget by 0.5% a year in real terms. The overseas aid commitment of spending 0.7% of national income will be met.

Being inside the ringfence, as this spending is, does not preclude efficiency savings, indeed the NHS will be required to deliver significant ones. But it is the non-ringfenced departments – all the rest – which will be bearing the brunt. Will they be cutting by 25% or even 40%? No, the resource budget only encompasses some Whitehall spending, excluding for example capital spending, which is significant for some departments. The Institute for Fiscal Studies estimates that the actual real-terms cut for non-ringfenced departments will be 12.6%. Whitehall should not be as afraid of the big bad wolf as the headlines might have suggested.

This is even more the case if we look at the overall numbers for public spending. According to the Office for Budget Responsibility, it has come down from 45.7% of gross domestic product in 2009-10 to an estimated 39.6% this year. The task for the next five years is to get it down to 36.3%.

How much will overall government spending be cut over the next few years? Not at all. In real terms – 2013-14 prices – it will rise from £724bn this year to £746.5bn in 2020-21, an increase over and above inflation of 3%. Public sector current expenditure rises by more than 2.5% over the same period. We can argue over the composition of spending, and whether the ringfence is in the right place. Some bits of government will see their budgets reduced but in most cases this is a long way from savage cuts. I can understand why Osborne wants to play the big bad wolf but his howl is a lot worse than his bite.

There is another fiscal issue to be touched on here. After the budget I bemoaned the absence of serious tax reform, in particular the failure to mention merging income tax and National Insurance. Since then, though I would not claim cause and effect, it has emerged that the chancellor has commissioned a Treasury study into the integration of income tax and NI into a single “earnings tax”.

The name earnings tax, if it happens, is important. Merging tax and NI and applying it to all incomes would create a large swathe of losers among pensioners, who do not pay NI.

Michael Johnson of the Centre for Policy Studies, who wrote a report last year on NI, called The End Should be Nigh, argued for a single earnings tax with three rates, 32%, 42% and 47%. The lowest rate would kick in at the existing personal allowance, £10,600, which is well above the NI lower earnings limit (£5,824) and the more relevant primary threshold (£8,060). The change would thus help lower earners.

One reason why chancellors have been reluctant to merge income tax and NI is because the latter preserves a semblance of the Beveridge contributory principle, though the Mirrlees review commissioned by the Institute for Fiscal Studies declared in 2010 that NI “is not a true social insurance scheme; it is just another tax on earnings”. Another is that NI is a good stealth tax. Under the last Labour government the basic rate of income tax – which people are more aware of - went down but NI went up.

There is the bigger question of what to do about employers’ contributions, which are responsible for a substantial chunk of the £109bn NI brought in last year. Johnson suggests that these could be replaced by higher corporation tax, though that would go against the grain for a government bent on reducing the corporation tax rate to 18%. The easiest thing would be just to rename employers’ NICs as an employer earnings or payroll tax.

Osborne will not be the first chancellor to have considered merging income tax and NI. Let us see if he will be the one to do it.