IFS GREEN BUDGET More fiscal tightening ahead
Paul Johnson, Director of the Institute for Fiscal Studies (IFS), explains the findings of the recent IFS Green Budget and the outlook for public finances, the key issues relating to the public spending cuts and possible decisions on taxation
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HE CHANCELLOR, GEORGE Osborne, is facing exactly the situation he was hoping to avoid. When he set out his fiscal policies in 2010 he was aiming to sort out the budget deficit within the lifetime of the current parliament. But weaker than expected growth, and a severe downgrading by the independent Office for Budget Responsibility of their views about the potential future output of the economy, have left him needing to pencil in two more years of public spending cuts after a probable 2015 general election. In our annual Green Budget we set out the scale of this planned fiscal tightening. Our latest estimates, based on official forecasts, suggest that the financial crisis and associated recession created a permanent hole in the public finances of 7.5 per cent of national income – that is £114 billion in today’s terms. This broadly reflects a large reduction in the amount that the economy is expected to be able to produce sustainably going forwards, with this expected to be a full 13 per cent lower in 2016-17 than the Treasury forecast in March 2008. The chancellor is aiming to slightly more than fill the hole that has opened up in the public finances through a combination of tax rises
and spending cuts that are expected to total 8.1 per cent of national income, or £123 billion, by 2016-17. These are huge numbers. We have not
experienced a fiscal tightening on anything like this scale in the last 60 years. That’s because we have not experienced either such a large loss of output or such a large deficit at any point over this period. That a substantial tightening is required is not in doubt. Had this government and its predecessor announced no policy action then
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Seven consecutive years of spending cuts is wholly unprecedented
We have not experienced a
fiscal tightening on anything like this scale in the last 60 years
national debt would have spiralled out of control passing through 100, then 150 and 200 per cent of national income. Two key choices have been made. One is over the speed of the tightening. The other is over its composition. In terms of speed Mr Osborne has set himself a ‘fiscal mandate’ which requires him to put in place policies to be able to expect to have sufficient receipts to cover non-investment spending, after adjusting for the estimated impact of temporary ups and downs of the economic cycle, by the end of the five-year forecast horizon. His current policy statements mean that he meets that mandate, but only because he has planned two years of unspecified but substantial spending cuts in 2015-16 and 2016-17.
As it has turned out he is aiming at a level
of borrowing in 2016-17 almost identical to that implied by Alistair Darling’s last budget. But that is because the outlook for the economy has deteriorated in the intervening period. Had Mr Darling remained chancellor and not adjusted his tax and spending plans in response to the economic news – an entirely hypothetical situation since of course we cannot know for sure what he would have done – then he would have been on course for more borrowing than is currently planned. The speed of the tightening carries risks.
Higher taxes and lower spending has the direct impact of reducing economic activity in the short run. On the other hand it can increase certainty and credibility, thereby potentially reducing
22 SOCIETY NOW SPRING 2012 ”
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