Will spending cuts and tax rises help balance the books or simply make maters worse?.
Today's Spending Review put more flesh on the bones on how the Government plans to cut spending over the next 4 years.
But the big picture remains largely unchanged from June's emergency Budget, so let's take a look at the figures for a quick reminder:
Government accounts
Forecasts for the Government's current budget:
| 2010/11 | 2011/12 | 2012/13 | 2013/14 | 2014/15 | 2015/16 | |
|---|---|---|---|---|---|---|
| Revenue | £548bn | £584bn | £622bn | £662bn | £700bn | £737bn |
| Spending | £637bn | £651bn | £665bn | £679bn | £693bn | £711bn |
| Depreciation | £21bn | £22bn | £22bn | £23bn | £24bn | £25bn |
| Annual Balance | £-110bn | £-88bn | £-65bn | £-40bn | £-17bn | £0bn |
| Total Deficit | -£932bn | -£1,059bn | -£1,162bn | -£1,235bn | -£1,284bn | -£1,316bn |
| Annual Debt Interest | £43bn | £46bn | £52bn | £58bn | £63bn | £66bn |
| Source: OBR Budget Forecast. (Depreciation is an accounting method that spreads the cost of assets over their lifetime). | ||||||
Yes, spending is still projected to increase, but at a slower rate than under the previous government. Tax revenues are projected to grow by more than a third over the next five years.
Even if these targets are met, the total deficit will still swell, from an estimated £932 billion this year to £1,316 billion by 2015/16. And so will debt interest payments, from an estimated £43.3 billion this year to £66.5 billion in 2015/16 – the annual interest equivalent to over £2,500 per household.
So the going will be very tough, but the saving grace is that if the plan works then we should start to see the overall deficit start to fall from 2016/17.
However, the plan is based on a number of assumptions about economic growth, including employment, inflation and how much we all spend.
The assumptions
The forecasts behind the Budget plans include (figures show annual change unless specified):
| 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | |
|---|---|---|---|---|---|---|
| UK GDP | 1.2% | 2.3% | 2.8% | 2.9% | 2.7% | 2.7% |
| Household Consumption | 0.2% | 1.3% | 1.7% | 2.1% | 2.2% | 2.2% |
| Government Consumption | 1.7% | -1.1% | -2.0% | -2.3% | -3.0% | -2.1% |
| Business Investment | 1.4% | 8.1% | 10.0% | 10.9% | 9.5% | 8.2% |
| Inflation (CPI) | 2.7% | 2.4% | 1.9% | 2.0% | 2.0% | 2.0% |
| Inflation (RPI) | 3.7% | 3.2% | 3.2% | 3.3% | 3.4% | 3.5% |
| Average Earnings | 2.1% | 1.9% | 2.3% | 3.8% | 4.4% | 4.4% |
| Real Household Disposable Income | 0.2% | 1.2% | 1.3% | 1.5% | 1.7% | 1.8% |
| Unemployment (rate) | 8.1% | 8.0% | 7.6% | 7.0% | 6.5% | 6.1% |
| House Prices | 5.9% | 1.6% | 3.9% | 4.5% | 4.5% | 4.5% |
| Source: OBR Budget Forecast | ||||||
I think it’s fair to say the assumptions are pretty optimistic. Gross Domestic Product (GDP), a measure of our economy’s health, is assumed to grow consistently, by over 2% a year from 2011 – by contrast European GDP is predicted to grow at less than 2% over the next 3 years.
If we slip back into recession (i.e. GDP falls rather than grows) then we can throw most of the assumptions out of the window, as they’re all interlinked with economic growth the lynchpin.
For example: economic growth means higher employment, which fuels wage rises, giving us more disposable income to spend, increasing household consumption which helps stop inflation from falling too low – with all of this boosting tax revenues via VAT, income tax, NI and corporation tax etc along the way. Take out economic growth and the house of cards might collapse.
So, can the economy grow?
Labour argues the Government's cuts are too swift, jeopardising the much needed economic growth. And there's a very real chance they could be right (although I'm not sure there are other sensible options open to the Government).
With the public sector expected to shed around 490,000 jobs over the next four years the Government is placing a massive bet on the private sector growing sufficiently to compensate for this. if it doesn't then our economy could end up between a rock and a hard place as revenues, especially those from taxes, will likely fall and make the deficit gap very difficult to close.
Conclusion
I think the Government is doing the right thing by trying to slash spending and curb the deficit. But it's an almost impossible task - there's a fair chance it will fail and leave our economy in recession with rising unemployment AND little change in the growth of the deficit.
But then there's really very little alternative. If the deficit isn't curbed the cost of the debt could continue to soar and place an even greater strain on Government finances. Yes, the Government could keeping issuing debt (i.e. gilts) to fund borrowing and low inflation (likely given rising unemployment) could help boost demand for gilts. But ultimately this all comes at a cost (interest) which cannot be ignored indefinitely.
Bottom line, there is no guaranteed fix and we face some potentially painful years ahead. I think the best we can hope for is just managing to avoid falling back into recession and the Government getting close to its targets. But I'm not holding my breath...
More Spending Review info to follow shortly.
Read this article at http://www.candidmoney.com/articles/article160.aspx
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