Business | Markets

Hamish McRae: Pain now will help us to avoid a lot worse later

 
George Osborne's Autumn Statement forms the basis for the next budget in the spring (Photo: AP)
Hamish McRae
3 November 2014

A parliament of pain? That is the clever title of a conference later this month organised by the Resolution Foundation.

It will be just ahead of the Autumn Statement, the presentation on the country’s fiscal position by the Chancellor that forms the basis for the next budget in the spring.

That budget will inevitably become the pitch by the Government for re-election, though quite how two parties of the coalition will be able to agree any sort of budget, given their own different political objectives, is hard to see.

It is clever because it neatly captures the great challenge for whoever forms the next government, which will be to do the other half of fiscal consolidation that the coalition has failed to achieve.

Growth is now re-established, but even above-trend growth of around 3% does not seem to be cutting the deficit. In any case, the easy cuts in spending and increases in taxation have been done, raising the clear possibility that the second half of the job might be harder than the first. Pain indeed.

Is it really only half done? Well, yes. Last week the Institute for Fiscal Studies was provoked into making an observation on the Prime Minister’s statement: “In this parliament we will have made £100 billion of savings while cutting income tax by £10.5 billion. In the next parliament we plan to make £25 billion of savings while making £7.2 billion of income tax cuts”.

The IFS noted that this suggested that most of the planned cuts in public spending had been made and that the tax cuts in the next parliament would be quite modest compared with those of this one. But this is not true. For a start the £100 billion figure includes some cuts to be next year — ie, in the next parliament, not this one. Nor is the £25 billion figure right, for those are the projected cuts for years two and three of the next parliament and there will be another two years to go.

With other adjustments and depending on how you do the figures, the IFS concludes that either a little less than half the consolidation, or a little more, has been done. To say half seems an acceptable approximation.

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That presents politicians with a huge problem. They have to prepare voters for some pain, the issues being how that pain might be shared and what might come along to make the outlook better — or worse.

The sharing issue will dominate the election, but the depressing thing so far is the extent to which the numbers are not being discussed honestly. Let’s accept that there is a £75 billion gap. If for David Cameron to give the impression that much of the job had been done is plain wrong, the suggestion by Ed Balls that a mansion tax would be a significant revenue earner is deeply misleading.

Even if it raised the supposed £1.2 billion, that is nothing in the context of either the £75 billion gap, or total tax revenues of nearly £600 billion. The next government may or may not want to bring in a mansion tax but it is plain silly to pretend it would make any material difference to total tax revenues. Increase tax revenues by any significant amount means increasing the big taxes, such as income tax, national insurance and VAT, not by fiddling around at the fringe.

In a way, though, the more interesting issue is whether things will turn out better or worse than they appear at present. The uncertainties are huge. A few weeks ago, a paper from the Office for Budget Responsibility looked at the difference between the fiscal plans set out in 2008 and what actually happened. I shall give you just two figures: in the 2008 budget, the projection for income tax revenue in the year that ended last April was supposed to be £209 billion.

Actually it raised only £152 billion. If over the past five years things have been much worse than expected, might the reverse now turn to be true?

In terms of overall growth I think it is reasonable to expect pretty good numbers. There is still slack in the economy and although some of the ground lost has been lost forever there ought, on past experience, to be some years of above-trend growth. The problem is that this may not translate into correspondingly higher tax revenues.

One of the many puzzles at the moment is why growth of more than 3% is not cutting the deficit. Tax revenues are much weaker than they should be. Maybe it is lower-than-expected inflation, maybe greater push-back by taxpayers, maybe the structural changes in the labour market — we just don’t know.

What we do know, though, is that the only safe assumption for the next government is that it should be aiming for a budget surplus, so that it is better-prepared for the next recession, as and when it comes, than we were in 2008. That will indeed involve pain, but in the long-run, much less pain than happened last time if we are prepared for the next cyclical downturn.