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.
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.
- 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 [↩]
- conversely, of course, it is much easier if the economy out-performs the forecast! [↩]
- 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 [↩]