Politics

What the Budget didn't tell you

Taxes will have to go up if the deficit and the growth in public debt is to be brought back under control

March 18, 2015
Cameron and Osborne will be happy with today's performance, but some nasty surprises await in the next parliament. © PA/PA Wire/Press Association Images
Cameron and Osborne will be happy with today's performance, but some nasty surprises await in the next parliament. © PA/PA Wire/Press Association Images

The promise of no gimmicks or give-aways in George Osborne’s last Budget before the election was greeted with widespread disbelief. But there were no pre-election rabbits to be plucked out of the hat. On the contrary. The Chancellor seemed to find virtue in a "steady-as-she-goes-and-you-will-benefit" strategy, which is how his party aims to fight the election—casting Labour as the party which will take incalculable risks and torch the last few years of hard work. The coalition parties will boast that the economy has turned the corner and returned to growth, which the Office for Budget Responsibility (OBR) has revised up a little, and that the UK now has record levels of employment and rising real incomes. So, why risk the reputation for competence?

Probe a little, however, and you can see that the Chancellor’s Budget strategy is only slightly less flawed than that of his opponents. The idea that the economy, which needs the clampdown on public investment to be reversed, can get through the next Parliament only with spending cuts as the Chancellor proposes, or with much fewer spending cuts as Labour insists is a fantasy. There is going to be a rise in the tax burden, which no one wants to admit.

No big surprises

There were some surprises in the Budget, such as the Help-to-Buy ISA, aimed at boosting the savings of would be first time buyers. Other things had been well-flagged, such as the ability of pensioners to cash in their annuities, the restriction to £1m of lifetime allowances for pensions savings, and the rise in personal tax free allowances, specifically to £10,800 this year, and £11,000 next. Small reductions in the duty on beer, cider and wine were announced, along with a significant reduction in the supplementary charge levied on oil producers in the North Sea, a rise in the bank levy which will raise £900m, as well as other measures that come under the heading of noise in a big picture sense.

But the Office for Budget Responsibility (OBR) said that the Budget measures would not have a material impact on the economy. And we have no reason to doubt it.

Debt, defined as the net debt of the public sector, is predicted to drop from just over 80 per cent of GDP this financial year to 79.1 per cent in 2016/17 and 71.6 per cent in 2020. But since the annual budget deficits are not expected to be eliminated by 2020, the reduction of debt has to occur as a result of something else. That something is asset sales, not least the proposed sale of roughly £9bn of Lloyds Bank shares. The Chancellor also said a new Conservative government would consider the sale of some £13bn of Northern Rock and Bradford and Bingley mortgage assets to lower net debt.




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The real message

The real messages in the Budget strategy were hidden in documents that only journalists and analysts examine. Politically, one of the most important was to puncture the PR bubble that the opposition parties had been exploiting since the Autumn Statement, namely that the level of public spending was predicted to drop by 2019-20 to the lowest level since the 1930s. The implied comparison with social and living conditions of the time was rather meaningless since the level of GDP is so much higher, but the mud stuck. In any event, last year’s plan for a budget surplus of £23bn in 2019-20 has morphed into just over £7bn. This is still the lowest since 1957-58 (or since 1999-2000, the year Osborne quoted in his speech today) but the particularly emotional comparison with the Great Depression has been killed off.

By implication, the squeeze on public spending in the next Parliament will now be less draconian by the end of the period. That said, there’s a less comfortable hidden message as well.

The OBR numbers show that resource departmental expenditure limits (RDEL)—department spending excluding capital spending—is predicted to decline substantially more aggressively in 2016/17, and in 2017/18 than at any time in the last five years. Declines are about twice as big as in the worst of those five years, and then hey presto, department spending surges by four per cent before the next scheduled election in 2020. These cuts amount to about £13bn, on top of which there are expected to be some £12bn in welfare savings. Leaving aside discussion as to whether the £5bn of savings planned from anti-tax avoidance measures is realisable, spending cuts on this scale, given what has already happened and the public mood, also seem to fall under the heading of fantasy. Over the life of the next Parliament, the Budget envisages the budget deficit will go into a small surplus largely as a result of savings of 3.6 per cent of GDP from day-to-day spending on administration and public services, 1.3 per cent of GDP from welfare, and 0.5 per cent of GDP from a rise in receipts.

Why taxes will rise

. A majority government, were we to be so fortunate, would find it hard enough to do so without recourse to a rise in the tax burden. A minority government or coalition would find it impossible. Here’s why.

First, productivity. We have pretty much exhausted the growth contribution from adding jobs. There may be some more scope to lower the unemployment rate a bit, but the lion’s share of the fall is over. The OBR assumes that productivity growth will resume at some stage, but if it doesn’t or if any revival is weak, then growth will be weaker, which means tax revenues will be lower, and the next government will surely be unable to balance the books without recourse to a significant change in receipts, ie taxes would have to rise.

Second, the government’s deficit, year by year, has to be financed by the savings generated by some combination of the three other sectors operating in the economy: households (via pensions, insurance, financial products), companies, and the rest of the world. At the current time, both households and companies are small net borrowers, and the government’s deficit of five per cent of GDP is being financed in effect by foreigners, which are running a surplus of equivalent magnitude. This surplus is the equivalent of the UK balance of payments deficit, now standing at a near record as a share of GDP.

For the government deficit to close by 2020, either households or companies will have to save less, ie borrow more—and the OBR assumes household borrowing is set to rise from 145 per cent to 170 per cent of GDP—or we have to eliminate our balance of payments deficit. More personal borrowing seems rather unlikely or highly dangerous. Ditto more company borrowing in a low inflation, low revenue growth world. And eliminating the balance of payments deficit is either structurally difficult or needs an unlikely export boom.

So this is the end of the road for deficit reduction as we have known it. If we are to do more of it, the tax burden is going to have to rise. The only questions are whose and by how much?