Outlook grim, forecast worse

The impact of the Tory-LibDem Coalition's first Budget

The cult of austerity is embraced by the Government as it plans misery for millions. The Tory-Liberal Democrat coalition’s first Budget represents a significant challenge for Labour in opposition, despite the pain as spending cuts kick in.

The background to the Budget had been set by the new Office for Budget Responsibility. After the general election, Conservatives and Lib Dems insisted there were nasty surprises in the nation’s finances which Labour had hidden. In fact, before the Budget, the OBR revised down the estimate for the deficit this year and in the future. New data also showed the deficit in 2009/10 was £23 billion lower than Alistair Darling had predicted last December. A combination of growth, higher tax receipts and lower welfare spending (due to lower than expected unemployment) had brought the figure down by more than half the extra tightening now planned by George Osborne.

It was also claimed that national finances were worse than Darling’s projections in March because the new OBR estimate of the structural deficit, which remains throughout the economic cycle, was higher. However, the OBR estimate was not far out from Darling’s December projection.

Established as a body independent of the Treasury, the OBR seems to be run by people with the same economic outlook as the Chancellor, which fits well with his aim to shrink the public sector. This is the old “Treasury View’” – a term Keynes employed to describe the inter-war consensus that insisted on balanced budgets even when economies were depressed. The theory is that as government reduces its deficit, so the private sector steps in with an increase in investment. That did not happen in the 1930s, when the private sector was depressed. Fiscal tightening after the Wall Street Crash and the subsequent banking crisis led to a new recession in 1937. Now, as then, governments and central banks have become focused on meeting short-term market demands for fiscal tightening, at the risk of future growth. The banks which got us into this mess retain their power.

Despite the pressure from financial markets and the Government’s rhetoric, the extra cut in the deficit this year is only £8 billion. New measures apply to future years and compared to the total spending cuts add little more detail than Labour’s last Budget. However, since one of Osborne’s aims was to convince markets that he means business on cutting the deficit, he has gone further than Labour had planned – whether or not that is wise or feasible. The OBR believes these measures will reduce the structural deficit to 0.8 per cent of gross domestic product in 2014/15 from 8.7 per cent this year. Labour aimed to reduce it to 2.5 per cent.

Osborne intends to reduce the deficit by £40 billion more than Labour planned, even though Labour was pencilling in big cuts. On the tax side, VAT will rise to 20 per cent and there will be a new (but small) bank levy. Although the Chancellor claims the VAT increase is unavoidable, the Institute for Fiscal Studies suggests it could alternatively be blamed on his desire to cut other taxes, such as corporation tax or the rise in the personal allowance.

The spending outlook is grim. Spending will be cut by an extra £32 billion by 2014/15, of which £11 billion will be in welfare cuts. Child benefit will be frozen, there will be rule changes for the unemployed and benefits will be linked to the Consumer Price Index rather than the Retail Price Index, which is currently 1.7 per cent higher. This last measure means that benefits are unlikely to increase as much, saving £5.8 billion by 2014/15, according to the Treasury. With development aid and health spending protected, other departments could face cuts of between 20-33 per cent. The Government is looking for more ways to cut welfare. Osborne has produced spending forecasts for the next five years – a programme the IFS calls “the longest, deepest sustained period of cuts to public services spending at least since the Second World War”.

The Treasury’s own assessment fails to take account of the cuts in public services, which will hit the poorest hardest. The claim for a progressive Budget relies on policies inherited from Labour, not new measures.

The problem for Labour is that we do need to cut public spending over the next few years. Labour’s plans were already stringent. The Labour message has been that we should not threaten the recovery by cutting too fast, too soon. It is a difficult message to get across. Despite Tory hype, there is a limited amount of deficit reduction this year. Consumption – and therefore growth – might even rise ahead of the VAT hike in January. The problems lie later on. OBR growth forecasts have been revised down since the Budget.

A Labour approach should focus on spreading the burden more fairly and less aggressively. Labour should be arguing for government spending to be radically redirected to maintain levels of investment. We must realise that arguing for a growth strategy is not the same as arguing against practically every spending cut that is proposed. It is amazing that Labour’s leadership campaign has yet to get to grips with this.

This article was first published in Tribune on 2 July 2010.