Sunday, February 12, 2017
Spending down, taxes up - but we will keep on borrowing
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.

The Institute for Fiscal Studies has been producing its “green” budget for 35 years, through changing economic and political circumstances. The latest, the final one (for now) at this time of year because Philip Hammond is moving the budget timetable to the autumn, is a bit of a humdinger.

The IFS pulls few punches in laying out the scale of Britain’s fiscal challenge, leaving me a little punch-drunk. Seven years after the start of post-crisis deficit reduction, the budget deficit is 4th largest, relative to gross domestic product, of 28 advanced economies. Public sector debt, on the same basis, is 6th largest among the same group of advanced countries. It has not been higher relative to GDP since the mid-1960s, when the post-war unwinding of debt was still in full swing.

This is despite a fall in real-terms public spending of 10% since 2009-10, the longest and biggest on record, with more to come. By 2019-20, on present plans, real departmental spending will be 13% lower than in 2009-10.

For every Scylla, meanwhile, there is a Charybdis. With £17bn of tax rises planned for the rest of this parliament, the tax burden will rise to more than 37% of GDP by the end of the parliament, its highest since 1986-7, when the Thatcher government was in the process of aggressively reducing income and corporate taxes. Even then, we will still have a budget deficit.

I have always adopted a “something will turn up” approach to the public finances. In the past, time and economic growth proved to be great healers. In the 1980s, economic revival turned a budget deficit of 4.3% of GDP into a surplus within eight years. In the 1990s the timetable was even shorter. Britain went from a 6.7% of GDP deficit to a budget surplus in just five years.

This time the challenge was greater, with a deficit of 10.1% of GDP in 2009-10. Progress has been made. The latest full-year deficit, for 2015-16, was 4% of GDP. But that is still high, as is this year’s projected deficit of 3.5% of GDP. As the IFS points out, in the 60 years before 2008, Britain has run a bigger deficit in only 13 years, mainly when the economy was in recession.

If ever the economy needed a positive growth surprise, in other words a few years of above-trend economic growth, this is the time. Unfortunately, for reasons I do not need to spell out, that is highly unlikely, notwithstanding Friday’s good manufacturing and construction figures for December.

Oxford Economics, which provides the macroeconomic forecasts which underpin the green budget, is less gloomy on Brexit than most but it sees the next three years as ones of weak growth, with 1.6% this year, 1.3% in 2018 and 1.6% in 2019. At a time when a growth boost would have helped the public finances, the opposite is occurring. The idea that leaving the EU would mean healthier public finances has been exposed for the fantasy that it was.

There is more than just Brexit, of course, weighing on the economy. The loss of underlying oomph, which matters hugely for the public finances, has been with us for some time. Oxford Economics says potential growth over the 2017-21 period is a weak 1.5% a year, barely more than half the 2.7% of the 1996-2006 period, which now seems like another age.

Subdued growth is a problem, but so are the measures that will be required to tackle the underlying or “structural” budget deficit. As anybody who has been anywhere near a television screen or a radio in recent weeks will be aware, the National Health Service is in the middle of a winter crisis which is more severe than most. The pressure on the government to give the NHS and social care a sizeable cash injection, if not £350m a week, is intensifying.

The NHS, of course, benefited from its budget being ring-fenced. In other parts of government the spending squeeze in recent years has been intense. Even ring-fenced, however, the squeeze on NHS spending is considerable. As the IFS points out, the five years to 2015 saw the slowest growth in spending since the mid-1950s, shortly after the NHS came into being.

On present plans, NHS spending per head will be lower by 2020 than it is now, and even lower when adjusted for the fact of an ageing population. Big cuts in welfare are also built into the government’s plans. A four-year cash freeze on most working-age benefits and tax credits will bite hard at a time of rising inflation.

Within the spending numbers, the government is trying to increase the amount spent on capital, including infrastructure, relative to day-to-day spending. So, while in 2012-13 capital spending was 13% of current spending, the aim is to raise that to 21% by 2020-21. Such are the pressures on day-to-day spending, however, that may be unachievable.

Austerity fatigue has set in. When George Osborne aimed to complete most of the job of fixing the deficit by 2015, it was in the knowledge that there was a limit to how long a government could continue to bear down on spending. Hence the relief when some of his successor’s early pronouncements were interpreted, wrongly as it turned out, as an end to austerity.

All this is rather gloomy. The damage to the public finances from the financial crisis and the years of aggressive spending increases under Labour in the roaring 2000s has proved enduring.
It has been compounded by decisions made under both the coalition and the post-2015 Tory government. While the spending cuts have been genuine, the pill has been sweetened for households in other ways. Some taxes have gone up, but others have been cut, notably corporation tax, the prolonged freeze on petrol and diesel duty and the substantial raising of the personal income tax allowance, currently £11,000 and due to rise to £12,500 by the end of the parliament. In contrast, when the Thatcher government wanted to show it meant business on deficit reduction in 1981, it did so by freezing the personal allowance at a time of high inflation. This time, the 2011 VAT hike is the only surviving major tax hike.

So things are different. In the 2020s, remember, demographic pressure for higher government spending will kick in with a vengeance. Perhaps we will have to get used to a world in which borrowing of 2% of GDP or so is the norm, perhaps more, as are higher levels of government debt than we have been used to for most of the past half century.

That, as things stand, looks much more plausible than a future of budget surpluses, or even balanced budgets, and falling government debt. As long as the markets are prepared to lend what Britain needs to borrow, the debt and deficits will be manageable, though with a rising debt interest bill. If not, there will be a problem.