Why final stage of Tory plan is a taxing problem

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David Cameron and George Osborne had a plan when they arrived in office in 2010.

They would castigate Labour for leaving the economy in a mess; announce remedial action for the public finances; and ensure that the economy was growing strongly by the time of the next election. Finally, they would promise voters that their reward for stomaching the pain made necessary by Labour mismanagement would be tax cuts.

Parts of the plan have worked. Labour is blamed for causing the recession. A plan was announced to bring down Britain’s record peacetime budget deficit. The economy is growing at 3% a year and creating lots of new jobs.

But as the election approaches, the final piece of the plan – the offer of tax cuts – is proving difficult to achieve. The economy had two years of virtual stagnation in 2011 and 2012, and only really started to get up a head of steam in early 2013. Gross domestic product is smaller than it was expected to be in 2010. What’s more, as far as the public finances are concerned, the economy has been enjoying the wrong sort of growth. The upswing has created 750,000 net new jobs in the past year, but many of them are poorly paid, which means those employed in them don’t pay income tax.

Back in 2010, Osborne thought the government’s annual budget deficit – the gap between its spending and its income – would be below £40bn this year. As things stand, it will be close to £100bn. Hence the need for continued austerity. The ease with which some multinational companies have used loopholes and tax havens to minimise their tax bills has not helped either.

As a result, the deficit-reduction plan is well off course. When he became chancellor, Osborne said he expected net borrowing to be £37.5bn this year. In its March forecast, the independent Office for Budget Responsibility said borrowing was actually likely to be £95.5bn this year – and after six months of the current financial year that already looks like an optimistic forecast.

Cameron and Osborne have responded by modifying their strategy. The deficit-reduction programme has been extended until deep into the next parliament, with the chancellor now pencilling in 2018-19 for the year when the budget will be balanced. But the Conservatives have stuck to their original strategy of promising tax cuts in the run-up to the election. These were proffered at the party’s conference in Birmingham in September.

Convincing voters that tax cuts are for real is no easy task when the budget deficit is on course to be in the region of £100bn this year. One tactic used by the prime minister has been to play down how much austerity there will need to be in the next parliament, something for which he has been upbraided by the Institute for Fiscal Studies. Cameron said that after £100bn of spending cuts, there was only a further £25bn hole to fill after the next election.

Not so, said the IFS. The thinktank said the prime minister could come up with his numbers only by counting spending cuts in 2015-16 as if they had taken place in the current parliament, by ignoring what might happen in 2018-19, and by using two measures of spending that were not comparable. The projected £25bn of savings that the prime minister has pencilled in for the next parliament is a measure of all government spending bar interest payments. The £100bn figure cited by the prime minister is a measure of discretionary spending cuts made between 2010 and 2015-16. Far from being a mopping up exercise, the IFS calculates that spending cuts in the next parliament will be at least as big as those in the current one.

The other way the prime minister and chancellor have gone about convincing the electorate that the pledged £7.5bn of tax cuts are for real is by getting even tougher with spending. Osborne announced a fresh squeeze on the welfare budget in his conference speech and the Treasury is now putting pressure on Whitehall departments to come up with plans for significant new savings.

But this is no easy matter. The decision to ringfence big slabs of government spending – the NHS, schools and international development are exempt from cuts – has meant non-protected departments have seen their budgets slashed. All the low-hanging fruit has been picked already, and Osborne will meet strong resistance from his cabinet colleagues – Conservative as well as Liberal Democrat – if he comes looking for big new savings.

The IFS calculates that if the Conservatives commit to continuing to ringfence the NHS, schools and aid in the next parliament, non-protected departments will see their budgets fall in real (inflation-adjusted) terms by almost a third in the eight years from 2010-11 to 2018-19. Hence the reports that the next parliament could see spending cuts of close to £50bn. Cuts of this size on departments that include responsibility for the police, the courts and the army will be mightily difficult to achieve.

These numbers are not, of course, set in stone. The economy might do better. Tax receipts might start rolling in. A new government might make different choices about the pace of deficit reduction. But both the IFS and the International Monetary Fund have mused on the possibility that the chancellor after the 2015 election will need to rely less on spending cuts for deficit reduction.

Governments don’t like raising taxes but if forced to do so tend to announce them as soon as possible after an election. Faced with a deficit of £100bn, it’s a reasonable bet that whatever the prime minister says now and whoever occupies Downing Street after next May, taxes will go up before they come down.

Powered by Guardian.co.ukThis article was written by Larry Elliott, economics editor, for The Guardian on Monday 10th November 2014 19.57 Europe/London

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