50p, deficit reduction and hiding from the long ugly.

Sometimes politics is a total mystery to me. Oh, don’t snigger like that. I’m quite aware of what a remarkable feat it is to have spent as much time as I have working in British politics and to have achieved such a pathetic array of titles and status. I am above all that now. Or below it.

I am reminded of my poor political judgement because of the way Ed Balls’ announcement on Labour’s commitment to run a current budget surplus by 2020 and reintroduce a 50p Tax rate was covered in the media.

One of these policies will effectively decide the course of the next Labour government. The other got all the news coverage.

I was baffled by this, as I thought the 50p tax rate rather small beer in the grand scheme of things, and certainly not an objectionable policy when we face a huge deficit for an extended period. So long, that is, that the rate brings in extra revenue, which it seems very likely to.

Being the political naïf I am, I thought the deficit commitment was far more politically meaningful than the 50p rate, and although no news editor in Britain agrees with me, I still think I am right.

What would hitting Labour’s new deficit targets mean? First, we need to examine what they are.

Ed Balls said the following:

“I am today announcing a binding fiscal commitment. The next Labour government will balance the books and deliver a surplus on the current budget and falling national debt in the next Parliament.”

In fiscal policy the naming of parts is quite important. I’m assuming that by ‘a surplus on the current budget‘ we mean the headline ‘current budget surplus’, rather than say “the cyclically-adjusted current  budget”

I’m also assuming that by ‘falling national debt’ we mean Public Sector Net Debt as a percentage of GDP1.

So, by the end of 2020, a Labour government would achieve both a surplus on the current budget and falling national debt.

Now, this doesn’t rule out ‘borrowing to invest’ as a supplementary policy, but it surely suggests that such a policy will be unlikely to be deliverable at a major level if such borrowing is included in the National Debt figures.

Balls’ pledge also means that  while Labour is committed to repealing the rolling five-year fiscal mandate (and quite right too), he is replacing it with a fixed five-year fiscal mandate, and one not based on the estimates of ‘structural’ deficit. Meanwhile, Osborne’s Supplementary target – that net debt will be reduced as share of GDP by 2015/16 –  is effectively moved back to 2020, with Labour’s pledging the national debt will be falling by 2020.

So what does all this mean for the next Labour government?

The latest OBR projections are:

“The current budget balance, which excludes borrowing to finance net investment spending,  is forecast to show a deficit of £74.2 billion this year (£86.3 billion on an underlying basis),  down from a peak of £109.5 billion in 2009-10. The current balance moves into surplus in 2017-18 and records a surplus of £28.0 billion in 2018-19″

For public sector net debt, the report indicates:

“We forecast public sector net debt (PSND) to rise as a share of GDP in each year up to and including 2015-16, peaking at 80.0 per cent of GDP. It falls by a statistically and fiscally insignificant margin in 2016-17, and more rapidly thereafter, reaching 75.9 per cent of GDP in 2018-19.”

In other words, one way of reading Labour’s pledge is that it gives a Labour chancellor two years extra time on the deficit ‘glide path’, while also creating some space for extra investment, (as long as this means Public Sector Net Debt/GDP  is falling by 2020).

However, if the economy should underperform, there is very little wriggle room on these targets. Labour’s pledge is looser in general, but will bite far harder if the economy is weaker than forecast2.

Assuming the central forecast is correct, does this change in the ‘glide path’ create room for substantial ‘extra’ spending under Labour?

I doubt it. Here, the Fabian Society’s spending review is helpful. Under their ‘scenario two’, a Labour government would be spending some £20bn more than the current government projects by 2017/18. This is more or less what you’d expect if you were looking for £28 billion extra fiscal space around the end of the next parliament.

This does not make life easy for the next government: Here’s the Fabian breakdown of what it would mean:

‘Social security: spending £5bn less than currently forecast….

„„‘Future-oriented’ spending: a £5bn increase in capital investment and ‘flat’ real spending for three key economic budgets: education; business, innovation and skills; and work and pensions.

„„ Health and social care: ‘flat’ real spending for the NHS and for the proportion of local government grants paying for social care. This would still be very challenging for health and care providers.„„

Other department spending: a cut of around 3.5 percent per year.’

So that’s a £5 bn extra cut to social security – over and above what the Coalition is proposing in this parliament- , 3.5% cuts in departments like transport, defence and local government (ex Social care), and flat real spending in the NHS, social care, education, DWP and BIS. That creates £5 billion space for extra capital investment, which frankly isn’t very much.  On top of this would have to come funding for childcare, social care changes, and so on.

These extra cuts are required because in order to meet anything close to the Coalition’s baseline after the election, the post 2015 pending cuts would have to be utterly savage. The IFS have set out how scary some of this is in various presentations.

ScreenshotScreenshot-3

Me, I’ve called this the ‘long ugly’.

The ‘Long Ugly’ means that even ameliorating the deficit reduction targets by two years will still require a very tight budget framework with significant further cuts to be made somewhere.

The Fabian spending commission made the choice to protect current departmental spending, which left little room for further capital spending, but the reverse is just as likely to apply.

Would it be straightforward to simply increase capital spend significantly, and not count this against the current budget? It’s a possibility, but it looks to me as if the pledge to have the national debt falling by the end of the parliament means the room for manoeuvre here is limited.

Of course, capital investment can be done outside PSND, but it would have to be structured extremely carefully. (See for example the role of the Green investment bank and PSND.) If it’s done within PSND, you’d probably be looking at a level of overall budget flexibility not much different to the amount I’ve already discussed before you risk breaking your ‘falling National Debt as share of GDP target’3.

In other words, the next Labour government would, under our fiscal rules, be making significant further cuts on top of those this coalition has decided on in this parliament.

This would allow us to  increase capital investment, though if not done off-balance sheet, not by a great deal. Any further significant increase in capital spending would be dependent on either social security cuts, departmental cuts or tax increases.

This is a tough, important strategy for a Labour government to follow, and I fully support it.

I’m surprised though, that all the attention is going on the announcement about the top rate, which is more or less a rounding error when compared to the above.

In other words, the Long Ugly is still coming to get us all.

  1. It’s possible to imagine a different definition for either target , but these seem the most likely, given the language in the speech For example, we could mean the straightforward PSND number must fall. Though that would mean finding an extra 20 billion in savings/taxation than the current coalition forecast, which seems unlikely []
  2. conversely, of course, it is much easier if the economy out-performs the forecast! []
  3. I haven’t done the calculations, because I’m a bit thick, so I welcome any correction to this – I’m basically just looking at table 4.38 in the latest OBR report and trying to work out how much flex a revised PSND target would give []

10 Responses to “50p, deficit reduction and hiding from the long ugly.”

  1. Tom Miller

    One small suggestion – remove public housing investment from debt and deficit calculation as in other European countries.

    Reply
  2. Dan Filson

    It’s difficult to see ohw Ed Balls can sqare all the circles. IF we are to meet the commitment to reduce the National Debt whether defined as a ratio to GDP or in absolute terms, that will require a balanced budget That will take some doing given where we will be by 2015 or 2016. There’s a real risk we will go into 2016 wilh a commitment that is – or is interpeted as – deflationary to the extent of holding back growth and marring the possibliity of getting down unemployment (which I am increasingly seeing as the key to all else we seek).

    IF we get unemployment rapidly down to below 1,250,000 or lower still, we reduce massivley the benefits bill, increase tax yields and close the revenue deficit, all done without further austerity or significant rises in tax rates (the 50% is a fleabite save for those on it, in terms of extra revenues raised or macro-economic effect, whatever its critics say; it’s all to do with the message conveyed of ‘all in it togehter’, and very little to do with creating a more equal society or closing the revenue deficit).

    When some time back I asked Ed Balls at LSE whether, in his view, the rhetoric and recurring mantra of inherited mess that the Tories put out in the period May to December 2010 was a bigger contributor to the collapse in growth that happened than the impact of the actual austerity measures themselves, most of which did not bite until later, he didn’t agree. However I’m convinced the public reined in their horns on the basis of ‘there’s may be trouble ahead’ well in of the actual austerity measures impacting.

    The same could recur in 2015, with the markets taking fright not only at a Labour government coming into power, as they – like maiden aunts so easily do – lift their skirts and jump onto chairs at the sight of a mouse, but also at the prospect of Labour continuing austerity one way or another in full measure to fulfil an unecessary commitment to create an actual budget surplus during 2015-2020. This is a target less important in my view than full employment, higher incomes to the lower income groups and restoring public services.

    Reply
    • Pacificweatherman

      Whether or not I pay my fair share of tax is even more of a flea bite to the economy but that does not mean I should not do it. Those who will be paying the 50% tax are keeping the salaries of their staff below inflation whilst taking pay rises much larger than inflation. Most importantly, by holding down wages they are damaging the economy and slowing the recovery. The government has acknowledged this by agreeing to raise the minimum wage. Some pain for those earning over £150,000 is not only morally just but may lead them to think again about what they pay their employees are paid. Ten billion will also pay for many NHS operations.

      In all other respects your analysis is sound.

      Reply
  3. Paul

    “Would it be straightforward to simply increase capital spend significantly, and not count this against the current budget? It’s a possibility, but it looks to me as if the pledge to have the national debt falling by the end of the parliament means the room for manoeuvre here is limited.”

    It’s good that you have acknowledged this as a key area for a manoeuvre within the self-imposed (and therefore eminently changeable) rules, but you dismiss it too lightly – I suspect because it doesn’t fit with your overall #intheblacklabour ram-home-the victory narrative-so-that-it-actually-does-become-a-victory strategy.

    It’s still all to play for.

    I’ll be doing the same from my side, and though your institutional forces look and sound stronger for now – largely because some on my side are wailing rather than working – things may turn out differently as we get closer to 2015, what look like ‘tough choices’ on paper become undeliverable, and as actual, realistically spend-to-save programmes do emerge (that’s what I mean by my side working).

    Reply
  4. botzarelli

    Do you think Balls wants the press to focus on “the Long Ugly”? Or let the public see that Labour isn’t offering to reverse what it has described as appalling cuts driving the weakest in society into the ground but rather to go further with them?

    Look away from the nasty spending cuts and ooh, see the fluffy kitten of bashing evil rich folk.

    Reply
  5. crossland

    Substance wise i agree with Paul. The coalition promised to eliminate the deficit and have largely only started to make progress since Osborne announced he was dropping the austerity last April.
    Most people are not aware of how the coaltion changed its position and started using capital spend to stimulate the economy again ,likewise all the heavy lifing done by monetary policy and accounting changes to how the QE created debt shows up.
    Austerity has been 3 wasted years but the crucial political point is that the voters dont see that, dont seem to care about deficit targets being missed and nor do they see how Osborne has used wiggle room to get out of recession.

    Reply
  6. Wintergreen

    By how much is social security spending affected by economic growth and unemployment? That is, if the UK economy continues to grow along the current trend, by how much will spending fall by “naturally”?

    Reply
    • Dan Filson

      Wintergreen, that’s it exactly!

      IF we could just get the unemployment down to say half a million, the reduction in benefit spending and increased tax receipts (both those directly from the newly-employed but also those indirectly from the businesses benefitng from the increased spending) would – at a stroke – close the revenue deficit and render unnecessary much of the austerity we are currently enduring.

      How much so would need an economic forecaster and a good computer model (such as the Treasury has) but it is a considerable way of achieving a closiing of the revenue deficit.

      The big question is how to trigger the unemployment reduction. The government is immensely proud, and never stops trumpeting about, the growth in the number of jobs that are around (even if some are part-time etc), but they refuse to look at reducing unemployment. being more obsessed with reducing the benefit count even if by dubious means like ATOS.

      Capital spending is preferable to revenue spending because at least the former adds to the national balance sheet on both sides : Yyes, the National Debt may increase, but on the other side so does the totality of national assets (an often neglected part of looking at the size of the National Debt). So I think we should aim to reduce revenue spending only if there is a corresponding increase in capital spend on real projects (rather than the book-keeping legerdemain of reclassifying what is patently revenue spend as capital).

      Whether we match one pound off revenue spend with one pound onto capital spend or a slightly skewed exchange is perhaps one for the macroeconomists, but I think the principle is sound – reduce government revenue spend both absolutely and as a % of GDP, and upgrade the national infratrsutuctre asset register.

      Reply

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