Tories' tax cut black hole

The new year has begun with a political battle about spending. Labour focused on the deteriorating state of the NHS under this government, highlighting its pledge to inject extra funding to recruit more frontline staff. It was no surprise that the Conservatives focused on the economy and fiscal policy, claiming Labour had made a series of unfunded spending commitments. Some of these claims were based on Treasury analysis, in response to political assumptions made by Conservative ministers and advisers and were swiftly rebutted by Labour. This battle on spending is one that Labour must not let the Conservatives win.

To understand what is happening in this debate about spending we need to start with the autumn statement and the accompanying Outlook from the Office for Budget Responsibility. The OBR is independent of political parties and provides an assessment of the likely future state of government finances. But its analysis is based on what the Treasury – for which read George Osborne and Danny Alexander – tells it about future spending plans. The result is that very harsh spending cuts are projected throughout the next parliament. Yet the Institute for Fiscal Studies, in a very useful report comparing parties’ fiscal plans, notes that ‘Perhaps oddly, current government policy … implies a substantially tighter fiscal stance than is strictly required either by the government’s own new fiscal aims or by any of the targets outlined by the three main UK parties.’ Why would the coalition government do this? Almost certainly for political reasons.

On the current OBR forecasts, there will be an overall budget surplus of one per cent of national income by the end of the next parliament (2019-20) and a surplus on the current budget, which excludes investment spending, equivalent to 2.3 per cent of national income. The IFS notes that the new fiscal mandate requires the government to balance the cyclically adjusted current budget by 2017-18. The implication is that the target could still be met if fiscal policy was loosened by £43bn (in 2015-16 terms). Roughly speaking, this is what Labour and the Liberal Democrats could do under their current policies. The Conservatives have stated they would run a stricter fiscal policy if they won power in May, achieving an overall budget surplus by the end of the next parliament. That still leaves them room to loosen fiscal policy by £20bn in 2019-20 (ie one per cent of national income).

There is a problem. Detailed spending plans only exist to 2015-16. In subsequent years, the current coalition government (if it still existed) would have to cut departmental spending by a further 14.1 per cent or £51bn by 2019-20, above the £38bn cuts already experienced, the IFS notes. If Labour and the Liberal Democrats kept their current fiscal policies, further cuts would be limited to £7bn and the Conservatives’ policy implies ‘only’ £30bn of further cuts. There is little information about these spending plans but it is clear the Conservatives should be under the most pressure to say where they would make at least £30bn of spending cuts.

Political parties may wish to do other things of course, such as cut taxes or make more changes to benefits. That would imply more cuts to spending. It is in this context that we should view the Conservative pledge to cut £7bn from income taxes. While this amount could in theory be found from the overall headroom projected by the OBR, we have no idea how it would be funded. What service or benefit would be reduced? Nevertheless, probably at or after the budget in March we should expect the Conservatives to ‘spend’ more of the difference between their own declared plan and the policy they advocate as the lead member of the coalition (an example of the mixed world in which this debate is taking place) on further tax cuts, probably to income tax in some way as their response to cost of living concerns. Labour will need to respond in two ways: first, by being clear what we think about tax cuts in general and, second, by challenging the Conservatives robustly to spell out exactly how they would pay for them.

The OBR projections allow the government to claim, just, that government debt will be falling by the end of the next parliament. The frame for the debate will be one about who can be trusted with government finances. Yet Conservative claims rest on highly uncertain forecasts and the assumption they will cut billions more from spending without saying how they will do this. This is the unreal world in which the economic debate is taking place. Moreover, the OBR shows it relies on households increasing debt to beyond pre-crisis levels: families will be paying for David Cameron and George Osborne’s politics. Despite their confidence, it is not clear the Conservatives can sustain this line for four months without providing more details. The opening salvos of this debate this year demonstrate the importance of Labour’s zero-based spending review and a hard line on spending pledges by Ed Miliband and Ed Balls. We need to be robust on spending while pushing the debate towards a discussion about what kind of economy this country wants to have in future – one in which everyone participates, or more of the same.

This article was first published by Progress on 6 January 2015.