Fiscal Fallout: £48bn extra cuts by 2018

The RSA and Social Market Foundation report Fiscal Fallout got very little coverage this week. There were reports in the Guardian, the Telegraph and Public Finance but, if it made the TV or radio news, I must have blinked and missed it.

This is a pity because, as Matthew Taylor said, it is far more important than most of the hullaballoo that’s been making headlines this week:

Given the importance of the research’s conclusions, I predict with total confidence that its contents are more important to you than the question of George Entwistle’s payoff.

What’s the big news? The RSA and SMF have crunched OBR figures together with growth projections and concluded that, to meet its deficit reduction targets, the government will have to cut a further £48bn from public spending by 2017-18. That’s on top of the cuts already announced!

The reasons are that the economy hasn’t grown as much as the government assumed it would when it wrote the 2010 spending review. Therefore, tax revenues have not recovered and benefit payments have remained high.

What is supposed to happen during a recovery is that companies recover, unemployment falls, tax revenues rise and benefit payments fall. This reduces the government’s need to borrow. Increases in GDP give the added benefit of making the public deficit and debt look smaller.

Alas, this hasn’t happened. A couple of years ago, there were fears of a jobless recovery. Instead, what we seem to have had is a recovery-free job increase. Unemployment has fallen but growth has remained flat (at best) for the past two years. The tax revenues have barely moved from where they were a year ago and, if anything, in recent months they may even have fallen. The cost of welfare is rising as low wages force many of those in-work to claim benefits.

It’s not hard to see what’s going on here. The rising army of part-timers and self-employed odd-jobbers might be keeping the unemployment figures low but they are not earning enough to pay much tax. In some cases, they are not even earning enough to keep themselves off benefits.

Not only does a recovery-free job increase not do much for the public finances, it also, say the authors of Fiscal Fallout, has worrying implications for the country’s ability to bounce back:

There has been a fall in average hours worked as the proportion of part-time workers in the labour force has increased. This partly explains the fall in productivity per worker, but doesn’t account for the entire drop. While output per worker is 3.7% lower than immediately prior to the 2008 recession, output per hour is only 2.5% lower.a However, even output on a per hour basis has been falling recently, suggesting that there are other factors limiting productivity of the UK economy.

A recent ONS analysis of the issue has suggested a number of potential factors that may have reduced productivity.b These include:

  •  The 2008–09 recession adversely affected high-productivity sectors of the economy, such as manufacturing;
  •  Lags in the response by firms to lower demand, as some businesses decide to ‘hoard’ skilled staff in anticipation of the economy picking up;
  •  The impact of the downturn in lending on firms. This may in turn be reducing firms’ investment in capital and innovation, damaging productivity;
  •  Over-exuberance in the financial sector pre-recession resulting in capital being diverted to areas with less potential for returns;
  •  The loss of human capital, as those who have been unemployed for a long period of time lose skills.

a. Office for National Statistics, The Productivity Conundrum, Explanations and Preliminary Analysis, October 2012 (http:// http://www.ons.gov.uk/ons/dcp171766_283259.pdf)

b. Ibid.

Some of these, like the hoarding of labour, might be temporary, but others, like the reduction in investment and innovation and the degradation of skills, suggest that the economy may have run out of oomph.

The report continues:

This is profoundly important for two reasons. First, the economy has less far to bounce back, so we may be permanently poorer than we thought we were. Second, together with higher borrowing, it means that even more public spending cuts or tax rises than those announced to date will be required to return the public finances to structural balance within five years.

Anaemic growth will, as I’ve said before, have serious implications for public finances.

Fiscal Fallout concludes that, if the government persists with its strategy of reducing deficit by spending cuts, it will need a further £48bn worth of cuts in the next spending round, on top on the £81bn proposed in the current one.

Assuming the government sticks to its plan for reducing the benefits bill by £10.5bn (which also assumes a certain amount of cost reduction due to growth but let’s not over-complicate things) that leaves £37bn in cuts to public services. Fiscal Fallout calculates that this will be a real terms cut of 11 percent over the three years 2014–15 to 2017–18.

But that 11 percent is unlikely to be spread evenly across the board. Fiscal Fallout concludes that, if the government continues with its policy of protecting health, international aid and, to an extent, education, the cuts required from other departments would average 23 percent. Because health and education are so large a proportion of public spending, protecting them transfers a massive burden to everywhere else.

If these cuts are combined with those in the current spending round, the implications for the other public services are huge. Some departments would end up with budgets nearly half the size they were in 2010.

The reports gives some examples of what this might mean:

Ministry of Justice

  • Halving spending on the National Offender Management Service – i.e. prisons and probations budget; or
  • Cutting over 80% of the Legal Services Commission – i.e. the legal aid budget.

Department of Work and Pensions

  • More than halving combined spending on Jobcentre Plus and employment programmes; or
  • Cutting departmental operating costs and housing benefit and council tax administration costs by around 90%.

Home Office

  • Cutting over a third of crime and policing spend; or
  • Cutting spend on the UK Border Agency and the Office for Security and Counter-Terrorism by around 90%.

The report doesn’t get into specifics about the impact on local government, but remarks:

At a local level, the fiscal impact of rising demand is daunting. The Local Government Association have estimated that the cost of meeting rising demand for statutory services such as adult care and waste could leave local government with a funding gap of £16.5 billion by 2019–20. Assuming that social care and waste costs are met in full, this means that other services would have to be cut by 66 per cent.3 None of this takes account of the further cuts identified as necessary by the SMF after 2014–15. Birmingham City Council has given a stark illustration of the impact of these cuts on the UK’s second largest city, warning that some £600 million of cuts could result in ‘the end of local government as we know it’.

On top of all this, there is the near-certain increase in social costs as a result of demographic change:

Responding to growing and changing demand: the impact of demographic change will be profound and is well known to policymakers. The OBR, for example, estimates that health spending alone will rise by 2.4 percentage points of GDP between 2015-16 and 2016-61.1 Research commissioned for the 2020 Public Services Commission from Professor Howard Glennerster of the London School of Economics predicted that an additional 6 per cent of GDP would need to be spent on public services by 2030 to meet the social costs of an ageing society and to maintain existing cross-party social policy commitments.

According to PwC, that amounts to another £20bn in tax rises or spending cuts, plus an increase in the retirement age, sometime in the next decade.

Anyone who thinks that efficiency savings or the salami-slicing of budgets is going to solve this is living in cloud cuckoo land. As is anyone who thinks public services will get back to normal when the recession is over.

Here’s Matthew Taylor again:

Reading the RSA/SMF report has enabled me to put my finger on the ambivalence I feel about a whole range of government polices – such as free schools and police commissioners – which I don’t actively oppose but which also feel somehow misguided. The answer is that the scope and credible impact of these policies is utterly out of proportion to the strategic challenge government now faces. The leader of any organisation facing Whitehall’s scale of crisis would deal ruthlessly with ideas which did not seem powerfully relevant to core strategic needs. But instead it seems that Number Ten seems positively to encourage these irrelevancies, perhaps in the hope they will distract people.

He could also have mentioned the utterly pointless and counterproductive re-organisation of the NHS.

Tinkering with the state isn’t good enough any more and neither is a laissez-faire just-cut-spending-and-see-what-happens approach. Even if a Labour government is elected in 2015, the problem won’t go away. OK, some of the targets might shift but the underlying debt problem will remain. Whoever is running the country at the end of this decade will have very little room to manoeuvre.

As some politicians are at last starting to recognise, a fiscal gap of this size means that a complete re-design of services and entitlements will be needed. And soon. As I keep saying, the task of this decade is to design a state which can cope with the next one. If we fail to do that, we will be living with the consequences long after everyone has forgotten who George Entwhistle was.

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20 Responses to Fiscal Fallout: £48bn extra cuts by 2018

  1. Pingback: Fiscal Fallout: £48bn extra cuts by 2018 - Rick - Member Blogs - HR Blogs - HR Space from Personnel Today and Xpert HR

  2. Dipper says:

    Yes. The numbers are awful. The government is borrowing roughly £2,000 per person this year. And the next. This isn’t going to end well.

  3. Metatone says:

    Given the history of UK Debt from WWII on, there’s remarkably little evidence for your assertion that the debt is actually a problem, if we were to get the economy growing again. Of course, thanks to the doom and gloom spread by Matthew Taylor and others, it seems we’ve become much more interested in enabling George Osbourne’s vicious spiral into collapse than looking at the real, existing solutions we could adopt.

    • Duncan Brown says:

      We dealt with WW2 debt through a combination of sustained decline defence expenditures from high levels, Baby Boom demographics and the low-hanging fruit of the post-war boom (unexploited technologies, reconstruction investment, rapidly growing world trade). Oh, and financial repression mixed with high inflation, which was possible without major consequence under the international financial system of the time.

      None of these conditions hold now. Even when they did, we dealt with that debt by twenty years of large primary budget surpluses, at levels only seen recently in the early 2000s (when spending had been restrained and tax revenues were buoyant). And further, the consequences of some of the ways we dealt with the debt (i.e. inflation, financial repression) contributed to our poor comparative growth record through the postwar decades.

      • Actually, UK defence expenditure continued at a relatively high level (though reduced in absolute terms, for obvious reasons) after WW2. Thus we had the cost of National Service, the Korean War, the various “emergencies” such as Malaya and Kenya, and the expensive codpiece of the independent nuclear deterrent. Defence expenditure didn’t really start to yield up a plougshares dividend until the 60s, largely as a result of Suez and decolonialisation forcing the UK’s hand. This was a significant factor in the relative under-investment in British industry during the 1950s.

        The Baby Boom did not contribute positively to the economy, and therefore the erosion of debt, until the 60s/70s. Prior to that, the bulge in nippers simply added to social costs (NHS maternity, schools and fewer women in the workforce).

        The key to reducing high levels of debt after the war was high levels of taxation. The problem post-Thatcher was that in times when the economy was bouyant, the pressure was on for further tax cuts, hence the failure to build up surpluses prior to the financial crash. We should also bear in mind that rates of private saving were very high in the immediate postwar years, which meant that high levels of debt could be funded quite easily. That doesn’t apply now – the level of private debt is far worse than public debt.

        • Duncan Brown says:

          Defence: true, the larger decline was later (I didn’t say otherwise), although it still declined as the 1950s progressed, after the initial Korean War expansion. The average 1951-55 was 10.2% GDP; 1956-60 was 7.5%; 1961-65 was 6.9%; 1966-70 was 6.1%; 5.5% was 1971-1975.

          The Baby Boom: again, I didn’t stipulate when the demographic effects occurred happened, and indeed, the first of the new generation didn’t add to the labour force until 1960. But the expectation of a growing market contributed to confident investment before then; it’s the upside of a Baby Boom. (Incidentally, relative to GDP, education spending was only a little few tenths of a point higher in the 1950s – post-Butler – than in the 1930s.)

          Taxation: but – although the rich were soaked – overall postwar tax levels were lower than under Thatcher or since. In the mid-1960s, taxes were less than a third of GDP, a level only seen briefly in the aftermath of the early 1990s recession. As I said above, the public finances did generate some large primary surpluses; but these were possible because of lower social spending rather than higher taxes.

          As for “post-Thatcher… when the economy was buoyant, the pressure was on for further tax cuts” – this is clearly incorrect; in the post-Thatcher era, there were a couple of tax-cutting Lamont budgets amidst recession, and from then until 2008, taxes increased relative to GDP except for a brief and small reduction in 2001 and 2002. If there was “a failure to build up surpluses”, this was primarily because public spending was increased markedly (by a third in real terms over a decade).

          • The history of tax post-WW2 is of a shift from direct taxation to indirect, with the Thatcher era marking the watershed. You are correct that the overall burden of tax (as a percentage of GDP) increased, but this was largely due to the introduction of VAT, the extension of fuel duty (as more people bought cars), increases in excise duties (tobacco & alcohol), and increases in NICs. In contrast, income tax declined. Between 1976 and 2007 the basic rate of income tax was cut from 35% to 20%. The top rate of tax went from 83% down to 40% before the financial crisis, and despite an emergency increase to 50% will be down to 45% come next April.

            On top of that we should also consider the reductions in the effective rate of tax paid on dividends and capital gains, and the policy of raising the inheritance tax threshold as property values have risen, which collectively means that we are taxing wealth less than in the past. Corporation tax has been more volatile over the years, but the overall trend has been downward, from 40% in 1965 (when first introduced) to 24% today.

            While you are absolutely right to say that surpluses in earlier decades coincided with lower levels of public expenditure, a surplus or deficit is simply a product of spending versus income, as you concede in respect of the 00s. The point then is that taxation was high relative to the needs of public spending in the 50s/60s. My original point (which I concede should have made more explicit) is that this was largely due to high rates of tax on income and unearned wealth, and that the failure to build surpluses in the 90s/00s was (as much as anything) down to a failure to expand these revenue streams.

    • Dipper says:

      “there’s remarkably little evidence for your assertion that the debt is actually a problem”

      well if debt isn’t a problem, what’s the point in any of us working? What’s the point in any of us acquiring skills to increase our earning potential as we can simply borrow endlessly to fund consumption without ever paying back? And who is going to produce the goods and services we consume with this borrowed money? Why aren’t they just borrowing money too?

    • Rick says:

      Metatone – That was then and this is now.

      Sure, if we have 25 years of 3% growth like we did after 1948 we can get our debt-to-GDP ratio down and cover the additional costs of demographic change. But no-one is forecasting growth anywhere near that anywhere in the western world. Under most projections, we struggle to get even one year above 3%, let alone a 25-year average.

      Even with a government investing heavily (which would, at least initially, require more borrowing) it is extremely unlikely that a mature economy with an ageing population would grow at the same rate as a young one enjoying a peace dividend.

  4. The reasons why “Fiscal Fallout” got little coverage in the media are threefold:

    1) There is already a crowded market for doom-mongering. David Cameron tells us we are in “a race” (the zero-sum fallacy), Martin “Nostrodamus” Kettle tells us that we face 50 years of austerity, while the usual suspects assure us that we can’t afford to pay workers a living wage.

    2) The report comes in two parts: first, a reasonable assessment of current thinking on the great productivity mystery, and a slightly less robust analysis of the output gap and its impact on the public finances; and second, a commercial pitch by the RSA for government business, specifically the facilitation of a “social productivity spending review”.

    3) It is riddled with fashionable nonsense: “flexicurity” and “open-source decision-making”, to name but two.

  5. @PerryTimms says:

    Geez I wish I’d studied economics when in education. Actually, I wish I’d studied psychology, and a whole raft of other things. I entered the workforce after 6th form, university educations didn’t happen in my family and still don’t. I’m very much working class, but with a heart full of belief in the positive and a mind full of curiosity and an insatiable desire to learn. So I don’t feel totally let down by my education but there seems to be very little rudimentary awareness I was taught about macro economics works etc and the impact of debt on the UK (and in most of the people I’ve ever worked with actually).

    So my post here doesn’t come from a particularly informed point of view but more from the low confidence I feel in this Government’s round of policies in getting the UK back on its feet. I agree there is some baffling tinkering and policies which I agree with Rick that needs culling. It hardly moves us around in the quagmire let alone pull us out of it.

    Surely, at times of HUGE adversity like this, everything is focused on the core strategic principle? In WWII it was defending our free status and purging the world of evil in Western Europe. Now, it appears to be recreating a market system that has fundamentally failed all of us. We’re facing a position where being/feeling/doing better is not a natural evolution anymore. Children could be worse off than their parents in terms of quality of life – that is simply abhorrent.

    So why don’t I see everyone in Government, markets and industry and great brains in academia coming together and really sharing what this is all about and how to deal with things? I see us lumbering on with cuts thinking we’ll come out stabilised at some point in the future. That’s like needlessly cutting out whole ranges of foods, yes – to lose weight but risking undernourishment. That’s what this fiscal policy feels like – malnourished consumption.

    I agree we need to totally rewire things in order for 2020 beyond to be reasonable for those of us entering whatever stages in our lives. A 12 year deep recession is enough of a diet for anyone. More focus on getting out of this to not “get back to where it was” but create a new macro economical model and a new way of delivering services appropriate for a 21st century.

    Through blogs like this i get a greater sense of perspective on things so thank you.

    I am though even more concerned that those in positions of democratically elected responsibility are too quiet, too busy faffing around with seemingly inconsequential policies and leaving many beleaguered friends I have in public services facing even more harsh times earning a living and keeping the UKs people protected, cared for and enabled.

    Please, someone, give me some faith with a long-term plan that I can see will create that new way.

    • Cynic says:

      No answers here I’m afraid – but my own view is that over the past couple of decades politics has tended to select for vanity, cowardice, and the ability to bullsh*t. As a result of this, and the narrow recruitment pool (too many have studied politics, worked for an MP, and done little else), imagination seems to be in short supply on both front benches, although there are some great backbenchers on both sides. The other problem in relation to economic policy is that Ed Balls, whatever his talents, is in a politically very weak position, in part for having been at the Treasury so long and not got a proper handle on what the banks were doing (to be fair, the banks and ratings agencies didn’t either…). Clarity comes more easily with proper debate, and I don’t feel, myself, that the Labour Party is doing its opposition job properly at the moment.

      If you haven’t read them already I’d recommend Peter Oborne’s ‘The Triumph of the Political Class’ and Ferdinand Mount’s ‘The New Few’ as giving good insights, as well as Nouriel Roubini’s ‘Crisis Economics’ as an analysis of the fallout from the 2007-8 crisis (this last is very US oriented but I’ve found it helpful and interesting). NB I got all of these from a public library, so if expense is an issue that should help…

  6. Duncan Brown says:

    On the report itself, I generally have some sympathy with From Arse to Elbow above; the SMF half is a reasonable contribution to the debate on our fiscal state (but doesn’t tell us a lot that’s new), while the RSA half is fairly obviously a pitch for their own work, and is heavy on management guff. (“Social Citizen Driven” public services?)

    I’d agree that the problem can’t be addressed through salami-slicing; probably we have to have a more candid conversation about what our expectations of government are. We also have to think about whether public programmes are stimulating demands for more public provision, or tackling problems and so reducing them (this is a major problem at present). We also have to decide as a society how much we prefer holding on to our ideological baggage to getting better services at affordable costs (especially in health and education).

    I think Matthew Taylor is quite wrong to be so dismissive about PCCs and free schools; and your (Rick’s) additive point about the NHS reforms demonstrate exactly the reason why he’s wrong. Our public sector employs nearly 6m people in a system of central bureaucracy, with accountability through official channels only. It ignores local knowledge, stifles innovation and makes for a perverse, trust-destroying, risk-confusing culture. It has an instinctive bias for the Big Bang policy change, even though that’s often fraught with unanticipated and unintended consequences. Creating more local sources of power, balanced by direct accountability (ballot box for PCCs, school funding following pupils for free schools), we can lower our reliance on the Great Man bureaucrats we assume we can find but struggle to actually find. (The NHS reforms were a pale imitation of this, more than outweighed by lots of new central bureaucracy.)

  7. “Birmingham City Council has given a stark illustration of the impact of these cuts on the UK’s second largest city, warning that some £600 million of cuts could result in ‘the end of local government as we know it’.” – I’m slightly suspicious that the mentioned £600 million cuts factor in the recent successful equal pay claims against BCC. If so, it does make me doubt the credibility of the rest of the report (with the hasty caveat that I haven’t read the report yet)

  8. roGER says:

    I’d like to ask the experts here if it wouldn’t be possible to inflate some of the debt away, but hopefully in a rather more controlled manner than 1970s run-away inflation?

    • Dipper says:

      I’m not an expert, but as I understand it, that’s the plan. Hence QE. The market latched on to this in 2008 – that the UK’s debts were so big that he only way we can get out of it is to print money, so making the pound worth less internationally. If you look at the charts on the BBC news site you can see the pound drops by about a quarter at this point, and inflation starts to kick in.

      The problem, as with all economic policy, is what this does to incentives. It is a tax on the prudent to bail out the profilgate, and a slap in the face of those who bought UK government debt. It may get us out of one problem, but at the risk of creating lots of others.

      You can see this as a battle of the generations. Each generation borrows off the next to fund its lifestlye, so the next generation has to rob the previous one to get their money back, and inflation does that quite well.

      What can individuals do about this? Buy assets. And that is what is happening – buy to let is a main.driver of the property market, and auctions of art and collectibles are going to record levels, as the current generation looks to protect itself from the impending inflation.

  9. rogerh says:

    A good dose of inflation and a zonking tax on pensions. Pensions (not the OAP) have been seen as an ‘infinite money machine’ and many payouts are far too generous. Claw a slab of it back.

  10. Pingback: Opinion: The trouble with George – you can’t argue on economics with such a political Chancellor

  11. Pingback: Can the UK's 'recovery free job increase' continue much longer? - XpertHR's Employment Intelligence blog - XpertHR Blogs - HR Blogs - HR Space from Personnel Today and Xpert HR

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