Public sector spending cuts are already deeply unpopular, even before they really begin to bite. According to a recent Populus poll for The Times, only 22 per cen support the Government’s economic policy. Yet, according to the June Budget, only £8.9 billion of fiscal tightening is taking place this financial year. This surges to £41 billion next year and to £128 billion by 2015-16. The policy is unlikely to become any more popular.
One of the charges laid by the coalition is that these are cuts that Labour would have made anyway. So far as this year is concerned, that is not true. Only £800 million of net tax increases were planned by Alistair Darling in his March 2010 Budget. But cuts are no more likely to be popular if implemented by a Labour government. His Budget also outlined plans for a fiscal tightening of £25 billion next year – greater than that being wrought by the coalition this year, with bigger spending cuts, too. In fact, £14 billion in spending cuts was planned by Labour compared to the £8 billion in cuts currently being made. Altogether, Labour’s spending cuts over the next four years would have amounted to £130 billion, compared to coalition cuts over the same period of £216 billion.
We know, thanks to documents leaked to The Guardian, that the Treasury’s estimate of job losses arising from Osborne’s Budget is between 1.1 million and 1.3 million, with slightly more than half coming from the private sector. On a pro rata basis, the implied level of job losses arising from Labour’s March 2010 Budget is 660,000 to 780,000. This would be an indefensible record for a Labour government. Yet the argument against spending cuts is not mainly about their unpopularity or their immorality, although both of these have some force. The decisive argument is that they are economically damaging. It would be possible to illustrate this idea with reference to all the main economies in the 1930s, and to Britain’s experience under Margaret Thatcher (when the deficit widened despite spending cuts) or even to contemporary Europe, where Greece went back into recession after implementing cuts.
Instead, let us focus on a more recent British experience. In particular, let us contrast of the 2009 Budget with both the Budgets of 2010. The 2009 Budget attempted to combat the effects of the recession through letting welfare payments rise, modest increases in discretionary spending and bringing forward capital spending. The actual increase in spending by central and local government amounted to £37 billion. As a result, the official Treasury forecast was that the public sector deficit would rise in this financial year from £155 billion to £178 billion.
However, net borrowing in the first four months of this financial year is lower than in the same period last year and is on course to undershoot the Treasury estimate. The rolling 12 months’ borrowing total is currently £152 billion, having peaked in January this year, before the coalition cuts take effect. The reason for the decline in the deficit is primarily because tax revenues have risen – up £13 billion in the first four months of this financial year. Further, because many taxes are only collected after some time delay (self-assessed and corporation tax especially), the recent modest improvement in the economy virtually guarantees that this improvement will continue – or at least it will until cuts take effect.
This current total in government borrowing of £152 billion (and falling) is actually below last year’s total of £155 billion. According to the “there is no alternative” school of fiscal policy, this is impossible. Increases in government spending cannot lead to a lower deficit – for that, massive cuts in public spending are required. Yet this is what has happened. The logic of the 2009 Budget was correct (if somewhat modest) and the opposite logic of both 2010 Budgets is disastrously wrong. Increased government investment lowered the deficit. By the reversing the process, cuts will widen it.
The Treasury’s own, largely hidden, analysis supports this observable fact. (The two key documents are the National Audit Office’s account of the Treasury Public Model 2002 and the Treasury’s own Public Finances and the Cycle, Working Paper Number Five.) The key findings can be summarised as follows. For every £1 billion increase in government spending, total economic activity rises by
£1.4 billion as the private sector produces goods or services to meet that public spending. For every £1.4 billion increase in total activity, government finances will improve by £1.05 billion – £700 million in tax revenues and £350 million in lower welfare payments as people are brought back into work. So, a £1 billion increase in government spending produces £1.4 billion in economic growth and £1.05 billion improvement in government finances. In this way, there is a net improvement in government finances of £50 million.
As we have seen, the actual increase in government spending in 2009 was £37 billion. On the basis of this Treasury analysis, the improvement in government finances should be 5 per cent of the increase or £1.85 billion. The actual improvement in the deficit to date has been £2.5 billion. This will actually rise for two reasons. First, the Treasury’s estimate is based on long-run averages and the positive effects of government spending increases in times of recession. Second, there is a multi-year effect of increased government investment, at least thrice the size of initial outlay.
It is a myth perpetuated by the coalition and its supporters that the cause of the deficit is Labour’s over-spending. The analysis and the positive response to the 2009 Budget suggest that Labour should have spent more to offset the recession and lower the deficit.
This is the continuation of long-term under-spending. In both government spending and receipts, as a proportion of GDP, Labour spending at 40 per cent was on average consistently lower than the 43.5 per cent. of Margaret Thatcher and John Major But so, too ,were tax receipts much lower – at 37.6 per cent, compared to 44.8 per cent of GDP.
Experience and analysis show that increased government investment is required to revive the economy and to close the deficit. Part of rebalancing the economy is increased tax revenues to pay for that investment.
