Sunday, February 14, 2016
Osborne's budget surplus starts to look like a distant dream
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.

Every recording artist is familiar with the idea of the difficult second album – the tricky follow-up to a successful debut – as is every author of a bestselling first novel. Now George Osborne is experiencing the equivalent, in what so far is proving to be a difficult second term.

To be fair, not all of the chancellor’s first term ran smoothly. The low point was 2012 and the “omnishambles” budget, and there were others. But, as he prepares for next month’s budget, his fourth big set-piece event in 12 months (three budgets and an autumn statement/spending review), even his best friends would admit that things are not going that well. What might have been his golden age – a Tory chancellor in a Tory-only government – is proving a bit of a headache.

Osborne’s U-turn on cuts to tax credits in his autumn statement may have been politically necessary, but it was embarrassing. Another U-turn may be looming over planned reductions in the amount of public money, so-called Short money, opposition parties receive.

Tumbling stock markets, which have taken on a slightly more sinister turn with the sell-off in banking shares, have forced the postponement of the sale of the government’s remaining stake in Lloyds Banking Group, a sale once intended to recapture some of the privatization spirit of the 1980s.

Growth forecasts are being revised down. Both the CBI (down from 2.6% to 2.3% for this year) and the Bank of England (down from 2.5% to 2.2%) predict continued recovery, but at a slower pace. A 1.1% drop in industrial production in December, announced last week, owed much to the effect of exceptionally mild weather on electricity and gas demand but added to the softer growth tone. The chancellor’s “dangerous cocktail” of risks he referred to last month is having an impact. There is also a tricky EU referendum to negotiate.


The biggest question, perhaps, arises over what is central to Osborne’s chancellorship, his aim of eliminating the budget deficit and leaving a legacy of permanent surpluses. Having planned to eliminate most of the deficit in the last parliament and not succeeded, he moved on to the more demanding target of achieving a budget surplus by the end of this one, and keeping it there.

Recent days have seen one of the biggest events in the fiscal calendar that does not involve the chancellor, the Institute for Fiscal Studies’ annual green budget. The IFS, which is always fair, warned that Osborne is “boxed in by his own rule” (that of achieving a surplus) and “has to pull off a precarious balancing act”.

The all-party House of Commons Treasury committee, which will shortly publish its assessment of the autumn statement and spending review, is also set to criticise Osborne’s fiscal rule, while pointing out that the tax burden in rising as a result of measures such as the apprenticeship levy and the tax attack on buy-to-let landlords. Ahead of the election the chancellor had promised to finish the job of deficit reduction by restraining spending, not raising taxes.

The IFS is right to say that budget surpluses are rare – there have only been eight in Britain over the past 60 years – but wrong to point to a £7bn “black hole” in forecasts for the public finances over the next five years, caused by weaker project growth in earnings and the recent stock market fall.

Its economists know as well as I do, that £7bn in the context of the public finances at the end of the decade is the equivalent of loose change. The path of the budget deficit over the next few years will not be determined by what has happened to the stock market over the past few weeks.

Where the IFS is right is to point to the difficulties of achieving a budget surplus while simultaneously reducing some significant taxes. Osborne aims to increase the personal income tax allowance to £12,500 (from £10,600 now), while also increasing the higher rate threshold. These pledges are so far unfunded. The sums on which the official public finance projections are based assume fuel duties will rise in line with the retail prices index – not the more gently rising consumer prices index – something that the chancellor last did five years ago. Our business-friendly chancellor is bent on cutting the main rate of corporation tax to 18%, the lowest in the G20, even though the main challenge with this tax is getting companies to actually pay it.

This, perhaps, is the nub of the problem. There is nothing wrong with setting a target of achieving a budget surplus in normal times, rare while that might have been in the past. It does not mean starving the country of necessary infrastructure spending: that depends on how much you raise in tax and how you divide up public spending. It does mean you reduce the public sector debt burden more quickly, which after the huge budget deficits of recent years is no bad thing.

Where there is a problem, particularly if you have a chancellor with a populist eye on succeeding David Cameron as prime minister, is trying to combine expensive and supposedly popular pledges, including raising the inheritance tax threshold on family homes to £1m, with the hard job of eliminating the budget deficit. The two may be incompatible.

A few days ago we had a rare speech from Sir Nick Macpherson, the outgoing Treasury permanent secretary, its top official. Normally those in his position adopt a Sir Humphrey-like vow of silence.

He was responding to criticism that the Treasury should have been more Keynesian in its approach in recent years, and less obsessed with getting the deficit down. I agreed with most of his speech, particularly what he described as the “asymmetry” of policy by governments, which find it much easier to relax fiscal policy than tighten it, and to run budget deficits rather than surpluses. I also agree that most economists underestimated what a tightrope Britain was running with the very large budget deficits of a few years ago, and how close the country was to a full-blown fiscal crisis. Sir Nick was weaker on the absence of “shovel ready” infrastructure projects which the government could have spent money on. A government determined to spend more on infrastructure should by now have overcome planning and bureaucratic delays.

In 2009 and 2010, some of Sir Nick’s Treasury colleagues were worried that Gordon Brown, if re-elected, would not have the stomach or the desire to push through the necessary measures to get the deficit down.

Now, they are entitled to wonder whether the same is true of Osborne, or whether populism will win out over eliminating the deficit. A test will come next month. With oil prices hitting new lows, there has never been a better time to start increasing excise duties on petrol again, albeit in the knowledge that it would certainly generate negative headlines for him. Osborne should forget popularity, which may in any case be a lost cause, and do the right thing.