George Osborne thrown off course by pay squeeze and falling income tax take

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The squeeze on pay packets and falling income tax receipts mean George Osborne will miss his short-term budget targets, the government’s fiscal watchdog said, as it predicted public spending will drop to an 80-year low by the end of the decade.

The Office for Budget Responsibility said the budget deficit – the gap between government expenditure and income, which is covered by borrowing – was expected to fall by only £6.3bn this year to £91.3bn. That was bigger than the £87bn predicted at the budget in March and more than double the £40bn deficit that had been pencilled in for 2014-15 back when Osborne became chancellor in 2010.

It also warned that a “very tight further squeeze” on public spending lay ahead in order to eliminate the deficit, with expenditure falling to 35.2% of GDP in 2019-20, taking it below the previous postwar lows reached in 1957-58 and 1999-2000.

The OBR said although the UK economy had outperformed its March growth forecast, wage and productivity growth had been disappointing – resulting in lower income for the exchequer.

Explaining the impact on the public finances, the OBR said: “This year has seen a sharp fall in the amount of tax raised for every pound of measured economic activity.”

As a result, despite strong economic growth, the budget deficit was expected to fall by only half as much as the OBR expected in March.

“That would be the second smallest year-on-year reduction since its peak in 2009-10, despite this being the strongest year for GDP growth,” the OBR added.

The watchdog also revised up its deficit forecast for the next fiscal year, 2015-16, but it predicted a relatively rapid drop in the deficit after that, with a small surplus in 2018-19. That was predicated on a changing pattern for what the government has coming in and what is going out.

On the income side, earnings growth was forecast to recover and to boost income tax receipts. On the spending side, there was help to cut outgoings from lower interest payments on the government’s debts, thanks to the fall in market interest rates. But much would also come from further cuts to spending on public services, the OBR said as it predicted the lowest level of public spending in 80 years.

Presenting the watchdog’s latest outlook, the OBR’s chairman, Robert Chote, said: “This assumption now takes total public spending to its lowest share of GDP in 80 years. Given the prospective paths of welfare and debt interest costs, this would imply a very tight further squeeze on public services spending.”

The OBR’s outlook was based on current government policy and Chote was keen to stress that the picture could change significantly after the election in May.

“The fiscal outlook depends crucially on the assumptions that you make about the level and composition of public spending beyond 2015-16, the last year for which the government has firm and detailed plans. The government has provided us with a very detailed policy assumption, but both members of the coalition say that in practice they would like to do something different if they were left to their own devices.”

The OBR noted in its report that the Conservatives have said they would seek to cut welfare spending by more, so that they could cut public services by less. The Liberal Democrats had said that they would be willing to borrow more to finance capital spending that would increase growth, and also to increase taxes on the relatively well-off, the watchdog added.

Labour has said that in the next parliament it will “balance the books and deliver a surplus on the current budget”. However, it has been more vague on timings, stating that the pace and scale of cuts “will depend on the state of the economy and the public finances we inherit”.

The bad news on the deficit will have come as little surprise to Osborne, after the public finances have repeatedly come in worse than expected over recent months. The main culprit has been weak income tax receipts because wages have stagnated and much of the rise in employment has been in low-paid jobs and self-employment. The OBR says wages will rise as growth returns for productivity, a measure of output per worker or hour worked.

The thinktank Resolution Foundation said the latest forecasts for Britain to remain in the red for several more years underscored a “worrying decoupling of economic growth from tax revenues”.

Matthew Whittaker, senior economist at the Resolution Foundation, said: “All parties will be concerned that strong employment growth hasn’t fed through into healthier receipts. This raises further questions around the merits of the tax cuts promised by all parties in the next parliament.

“The recent shortfall in tax revenues has created a fiscal headache for the chancellor, but they have made the deficit reduction plans of every party harder. With the election approaching it becomes ever more important for the parties to open up to voters about just how much more fiscal pain there may be to come after the election.”

Rob Wood, chief UK economist at Berenberg Bank, said the prospect of total government spending falling to 35% of GDP amounted to “implausible cuts”.

“Osborne seems to be targeting a US-size government in a country with a public health service. He also took the odd decision today to add an extra year of spending restraint in 2020. That is unnecessary as he already plans to run an overall budget surplus of £4bn in 2018-19. Self-flagellation seems to be in vogue over in Downing Street. Perhaps it was a ploy to make life difficult for the opposition Labour party,” said Wood.

Powered by article was written by Katie Allen, for The Guardian on Wednesday 3rd December 2014 23.13 Europe/London © Guardian News and Media Limited 2010