The Coalition's cuts and compromises

Unfortunately, the new Government's economic policies are entirely what they seem

George Osborne, the new Chancellor of the Exchequer, and his new Liberal Democrat Chief Secretary, Danny Alexander, are promising a string of spending cuts totalling £6.2 billion. One of the clear dividing lines in the general election campaign was between Labour’s belief that the recovery should be protected and Conservative plans to cut spending faster and further and tax less. Yet all is not as it seems in the world of fiscal policy.

The coalition Government is producing a compromise economic policy, although one which tends more to the Conservatives’ original plans. The Conservatives had planned to cut £6 billion of spending in the current tax year, whereas the Liberal Democrats had plans to raise spending by more than £3 billion. The Budget later this month will need to find up to £9 billion more, according to some calculations, on the basis of the coalition agreement. This does not include the cost of all the political reforms, which have not been announced but must be significant.

The £6.2 billion spending cut amounts to a net cut in spending this year of just over £5 billion. This is because £500 million will be recycled into spending on education, apprenticeships and social housing, and £704 million represents cuts the devolved administrations will have to make next year. The net effect over more than a year will be muted because the new Government intends to partially reverse Labour’s National Insurance rise and begin implementing the rise in the personal allowance.

The highest profile casualty is the Child Trust Fund. It is being phased out on the grounds that it does not make sense to increase debt to put money in children’s saving accounts, since they would pay for it via increased taxation later. Yet it encouraged parents to provide children with capital they could later invest in improving their own skills, boosting national productivity. It was always a policy vulnerable to short-term cuts. Reversing it is a sign of Tory and Lib Dem priorities.

Over the past year, the Conservatives called for aggressive and instant spending cuts. By the time of the election, these cuts only amounted to £6 billion in 2010-11, which would be offset by reversing Labour’s National Insurance rise the following year. Yet the annual deficit had already come in £15 billion less than the £178 billion estimated in December – by more than twice the Tory cuts. Budget projections are not usually accurate. Higher growth can bring in more tax and lower unemployment means a lower welfare bill.

Labour planned to reverse last year’s fiscal stimulus, which meant that while tightening would not begin in 2010-11, this would be after the stimulus, worth £23 billion, was removed. In other words, there would be tax rises and spending cuts. Labour argues that further action this year would threaten the recovery.

The experience of Greece and the eurozone sovereign debt crisis this month has raised fears that investors will focus on other governments they believe are not taking radical enough action on debt. Once the markets begin to move – by selling government bonds, for example – a government usually has to take harsh measures to convince investor opinion it means business about tackling public debt.

Conservative propaganda at the height of the financial crisis helped to create doubt that Britain might be less than firm. This was despite a deficit reduction plan that was perfectly credible. Alistair Darling’s budgets were finely balanced between investor desires for lower deficits and promoting recovery. However, whether or not the “bond vigilantes” are right, they often need convincing. They need to see some pain. The cost of funding public debt can rise a great deal if they are ignored when they turn against a country.

The British answer is not necessarily harsher cuts than Labour planned, simply more detail about where the cuts will be. If Labour had won the election, it would have had to bring forward details about specific cuts, since it could not afford to wait until an autumn spending review. While Osborne is giving the impression he is taking firmer action than Labour, in reality, as the Institute for Fiscal Studies has shown, all three parties’ plans would have had the same impact on the deficit by April 2017. However, if markets are convinced Britain means business, they may focus elsewhere.

So far, discussion about the public finances is still working on the basis of Labour’s 2009 Budget projections, revised in the December Pre-Budget Report and in the March Budget. By the time of Osborne’s Budget, there will be new estimates for economic growth and public finances prepared by the new Office for Budget Responsibility. These may paint a more pessimistic outlook for growth and debt. We will need to look behind the rhetoric to see if there really is much that is different to Labour’s plans.

Labour needs to adjust to being in opposition and that includes reviewing its economic policy. All three parties at the election aimed to find £71 billion worth of tax rises and spending cuts over the next few years, according to the IFS. That means some difficult decisions and, under this compromise Government, some spending cuts that we will particularly dislike. We may find that Labour has bequeathed an economy much stronger than many now believe, which will benefit the new Government. We need to be strategic in our opposition to cuts, but we also need a fresh narrative about the kind of economy we want. It is time to shake off statist world views and think about how to encourage a more dynamic economy based on opportunities for all. Otherwise, while we may win points for opposing specific Tory-Lib Dem measures, we will never undermine the foundations of their economic policy.

This article was published in Tribune on 4 June 2010.