The worst of the spending cuts may be yet to come, warns IFS

4th February 2015

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The Institute for Fiscal Studies (IFS) has warned that the deepest spending cuts are yet to come.

Its Green Budget, which reviews potential issues ahead of next month’s Budget, said that the Government would need to make departmental spending cuts of £51.4bn, or 14.1%, over the next parliament in order to meet plans set out in the Autumn Statement.

Cuts during the current parliament are expected to reach £38.3bn, or 9.5%.

Public spending stands to fall to its lowest share of national income since 1948, with fewer public sector workers than at any point since 1971.

Debt is set to peak at over 80% of national income. The deficit is still more than 5% of national income. The fact that they remain so high largely reflects poor economic performance at the start of this parliament, the IFS revealed.

But real spending cuts have been substantially less than originally planned, no net additional tax rises have been implemented, and tax revenues have proved less responsive to the economic growth we have had than was expected. Difficult choices lie ahead.

Some countries have implemented much bigger austerity packages than the UK since 2008. But analysis of IMF forecasts suggests that the UK is currently planning the largest fiscal consolidation out of 32 advanced economies over the period from 2015 to 2019.

Real terms cuts in spending on public services over this parliament have been smaller than planned, as inflation has come in below expectations but cash spending plans have not been adjusted down to offset this fully.

Original plans implied real cuts of 10.6% to departmental spending by the end of this financial year. Current plans suggest cuts of only 9.5% by the end of next year. Capital spending by departments has been cut in real terms only about half as much as originally planned by the current government.

The last five years have demonstrated how hard it is to reduce the level of social security spending, the IFS continued. Despite cuts in the generosity of working-age benefits there has been no real reduction in spending on social security as the number of pensioners and the generosity of the state pension has risen, while rising rents and falling pay have increased pressure on the working-age budget.

The three main UK parties could each cut spending by less than is implied by Autumn Statement plans and still meet their fiscal targets.

If they implement the tax cuts and £12bn cut to social security that they have suggested, to meet their target of budget balance the Conservatives would need to reduce departmental spending after 2015/16 by 6.7% (£24.9 billion).

Labour and the Liberal Democrats would need to impose departmental spending cuts of 1.4% (£5.2 billion) and 2.1% (£7.9 billion) respectively to be consistent with their fiscal targets and stated intentions on tax and benefit policy.

Labour’s fiscal target, of balance on the current budget, could be achieved with substantially smaller spending cuts than could the Conservative target of overall budget balance. But continuing with Labour’s target over the 2020s would result in debt falling by 9 percentage points of GDP, compared to a 19 percentage point fall in debt under the Conservatives’ proposed overall budget balance.

None of the parties is talking about significant tax rises, but history suggests that general elections tend to be followed by tax rises. The first year after each of the last five elections has seen the announcement of net tax rises of more than £5 billion per year in today’s terms. On current plans tax receipts will be 1% of GDP lower in 2019-20 than they were in 2007-08.

Oxford Economics, which collaborated with the IFS on the report, forecast that the slump in oil prices will propel UK growth to 3% in 2015. It expects this growth to be driven by consumer spending and business investment, with only a modest contribution from net trade. Further out, it expects the economy to continue to grow at a solid pace, though faster growth would be possible were it not for the drag from fiscal consolidation. While its growth forecasts are similar to those of the OBR, it is significantly more optimistic about the scope for the UK economy to grow before inflationary pressures return. If they are right, less fiscal consolidation would ultimately be needed than is currently planned.

In terms of risks to the UK economy, Oxford Economics sees the most significant upside risk being stronger-than-expected recoveries in the US and Eurozone leading to a boost in UK export growth. Conversely a broad-based retreat from risk by investors, resulting in a global sell-off of equities and other assets, could drag the UK back towards recession.

Paul Johnson, director of the IFS, said: “Mr Osborne has perhaps not been quite such an austere Chancellor as either his own rhetoric or that of his critics might suggest. He deliberately allowed the forecast deficit to rise as growth undershot in the early years of the parliament. He has not cut spending in real terms as much as planned, as inflation has undershot. And he has cut departmental investment spending by only half as much as he originally planned. One result is that he or his successor will still have a lot of fiscal work to do over the course of the next parliament. The public finances have a long way to go before they finally recover from the effects of the financial crisis.”

Andrew Goodwin, senior economist at Oxford Economic, said:  “For UK households the collapse in the price of oil is the equivalent of a large VAT cut, a pre-election giveaway financed largely by the oil producers. This will provide a significant boost to households’ spending power and should mean that 2015 sees zero inflation and 3% GDP growth, a powerful combination. With very low inflation, even such strong growth is unlikely to force the Bank of England to raise interest rates before 2016 at the earliest.

“What’s more if, as we believe, there is plenty of spare capacity in the economy, the UK will be able to continue to enjoy strong growth through the medium-term. Indeed, were it not for the drag from fiscal austerity, we believe that the UK could achieve faster growth rates than those shown in our forecast. If it does turn out that there is still a sizeable amount of spare capacity that may allow the next government to reduce the pace of fiscal consolidation further down the line.”

The IFS Green Budget 2015, was published in association with ICAEW and funded by the Nuffield Foundation with analysis from Oxford Economics.

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