Sunday, March 20, 2016
Why two Osbornes and one Duncan Smith don't mix
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.

My initial reaction to Wednesday's budget was that, apart from being the fiddliest I could recall, it would not stay long in the memory. That was before it exploded on Friday evening with Iain Duncan Smith's resignation.

We are four days on from a budget that included 77 separately costed measures – more in a single budget than anybody can remember – as well as some of most obvious and ungainly fiscal gymnastics.

So, I was fully geared up to hold forth on a chancellor more addicted to unnecessary tax tinkering and more prone to using smoke and mirrors to meet his fiscal rules than that legendary exponent of the art, Gordon Brown.

And I was all ready to weigh in an assault on George Osborne for failing so soon in this parliament on two of his fiscal targets; the so-called welfare cap (breached in November and still breached now) and reducing debt as a percentage of gross domestic product every year, which is breached now according to the Office for Budget Responsibility. If this, his eighth budget, were also to be his last because of a Leave vote in the EU referendum, it would not have been a great swan song. It wasn’t even the safety-first budget the referendum had apparently required.

Then, two things happened. One was that plenty of other people immediately weighed in with a similar critique of the chancellor, so there was no point in repeating what is already out there. The other was the surprise resignation of Duncan Smith as work and pensions secretary on Friday evening, ostensibly about cuts to disability benefits. In leaving, he attacked Osborne’s entire approach.

Before coming on to that, I do not want to add to the unjustified gloom that surrounded much of the budget coverage. True, there is a significant referendum risk to growth, described here last week. Otherwise, however, Britain does not look like an economy in all that much trouble.

On the morning of the budget official figures showed a rise of nearly half a million in the numbers of people in work over the latest 12 months. A record percentage of people are in employment and growth in wages has ticked higher.

The biggest surprise in the OBR’s projections was a downward revision of its prediction for government borrowing this year, 2015-16. Instead of the £73.5bn of borrowing it projected in November, and a near-unanimous view among outside economists that there will be a sizeable overshoot, the OBR expects the number to come in at £72.2bn.

It is quite likely too that Osborne’s debt rule, having been broken in 2015-16 on this occasion, will be subsequently found to have been met. The rule was broken, not because of higher debt – it is a little lower than expected in November - but because of lower nominal, or cash, GDP. As the official statisticians get round to revising the GDP figures, most likely upwards, so this apparent failure could revised away.

Similarly, the almost universally downbeat view on growth and productivity – the biggest single economic change underlying the budget – should be taken with an appropriate quantity of salt The OBR responds to the latest data at its disposal. The productivity numbers in the final quarter of last year were thoroughly gloomy, so the OBR gave up the ghost on its previous productivity expectations.

But these are murky waters. Sir Charlie Bean’s independent review of official statistics, the recommendations of which were fully accepted by Osborne, pointed out the challenges of measuring both output (GDP) and labour input (hours worked) in a changing economy and labour market. Productivity growth has undoubtedly slowed since the crisis but the extent of that slowdown is complicated by measurement challenges.

Why is productivity so important for the public finances? As the OBR says: “Lower productivity growth means lower forecasts for labour income and company profits, and thus also for consumer spending and business investment. In aggregate this reduces tax receipts significantly.” If the OBR is right and, as I wrote a couple of weeks ago we should learn to live with weak productivity, we may also have to learn to live with weaker tax receipts than we would like.

This brings me on to my big point. When Osborne misses his fiscal targets, and has to perform contortions with the timing of corporation tax changes and infrastructure spending to keep his target of a budget surplus alive, some of that is due to factors outside his control, including the performance of the global economy. If Britain’s productivity performance has deteriorated then anything that has been done since 2010 to try to fix it – and there is a legitimate debate about whether it should have been more – will not show through until long after this chancellor has moved to pastures new. Supply-side reforms take time.

Some of the missed targets are, however, entirely deliberate. There are two Osbornes; the Jekyll and Hyde of the Treasury. There is Osborne the deficit cutter, harsh and unbending in his determination to slow and eventually eliminate the rising tide of debt. Osborne the deficit cutter wanted to get rid of most (not all) of the deficit by the end of the parliament.

Then there is Osborne the politician who, like all politicians, wants to be loved. He is not, as we have seen in recent days, necessarily all that good at it. This Osborne developed his economic philosophy in the years of plenty. “Sharing the proceeds of growth” between tax cuts and spending was the Osborne and David Cameron call when Labour was in office. It has survived into the era of austerity and big deficits.

A good example is fuel duty. Wednesday marked the sixth successive year in which fuel duty has been frozen. The chancellor is proud of the fact that pump prices are 18p a litre lower than they would have been if the pre-2010 duty escalator had been maintained, and that the average motorist spending £450 a year less on fuel than five years ago (not just because of duties). The cost of this admittedly popular freeze compared with the alternative is at least £6bn this year and cumulatively several times that, according to the OBR. Assuming the freeze continues, that cost will continue to rise. Deficit-cutting Osborne would have had no truck with this; for politician Osborne it was second nature.

Or look at the details of last week’s budget. Faced with a £56bn underlying deterioration in the public finances, the deficit-cutter would have bent over backwards to squeeze more revenue and cuts out of the system, eschewing any giveaways.

Politician Osborne, in contrast, found room for reducing business rates, corporation tax and capital gains tax, and for generous increases in the personal tax allowance to £11,500 next year and in the higher rate threshold to £45,000. Every tax-raiser, such as the sugar levy, was immediately spent. As I sometimes remind people, in his austerity budget of 1981 Lord (Geoffrey Howe) froze allowances and thresholds at a time of high inflation. Osborne prefers to increase them at a time of no inflation.

Politician Osborne may be right. Most voters do not follow the finer details of the public finances. Many do not know the difference between debt and the deficit. They do know when the cost of filling up the car goes up. Holding out the ambition of a surplus is an important signal, drawing the distinction between the Tories and Labour. Achieving that surplus may be less important.

But the Duncan Smith resignation has also exposed the weakness of the “two Osbornes” approach. Had the chancellor stuck to deficit-cutting, eschewing giveaways, the former work and pensions secretary would not have had much of an argument, leaving aside the obvious differences over Europe. Welfare cuts and deficit cuts need to go hand in hand. Because Osborne did not, preferring to splash some of the welfare savings around, he left himself open. It remains to be seen how quickly he can recover.