Want to stop the spending cuts? That’ll be £25 billion!

The Institute for Fiscal Studies was scathing about the government’s spending review. Even though George Osborne was working into the night with a takeaway burger, it seems that he and his team still couldn’t put out a proper explanation of their plans.

Even so, after having moaned about the crapness of the government’s documentation, the IFS folk still produced some good briefing notes. This, of course, is because they pretty much knew what was coming and had written most of it beforehand.

Looking at the big picture, it is interesting to compare these two charts. One shows spending in real terms, the other, spending as a percentage of GDP.

The level of public spending is set to stay roughly the same in real terms but, as the economy starts to grow again, spending falls as a percentage of GDP, back towards the non recession norm of just below 40 percent.

The trouble is, Annually Managed Expenditure (AME), the bit that is made up of social security, debt interest and other less predictable expenses, continues to grow in real terms and as a percentage of GDP it stays roughly the same. Our weak economic growth, then, is forecast to do no more than keep pace with our increases in benefits spending and debt interest payments.

As a result, for the government to cut public spending as a proportion of GDP, the axe has to fall on Departmental Expenditure (DEL), which is Treasury-speak for public services. When conservative commentators complain that the state isn’t shrinking they are right, in a sense. Real terms spending hasn’t reduced by much and is not set to do so significantly over the next few years. That doesn’t mean, though, that public services are not facing massive cuts.

By the time AME has eaten up its ever-increasing chunk of spending and much of what’s left has been ring-fenced for schools, overseas aid and the NHS, everyone else takes a huge hit.

And on top of this, there’s more to come. If the government is to meet its deficit reduction targets, by 2018, a further 8 percent cut would be needed or, if the NHS, schools and overseas aid are still protected, a further 15 percent shared between everyone else.

Cuts of 15 percent, or even 8 percent, over two years would be difficult enough on their own. Coming on top of the budget squeeze from previous years they are almost impossible without a collapse in some services.

IFS Director Paul Johnson gave this stark warning:

At almost any other moment in the past 60 years announcements of spending cuts of this scale would have created a storm. As would an announcement that 144,000 public sector jobs would go in one year as part of a programme that could see one million jobs lost by 2017-18. Not now. We seem almost to have got used to this level of austerity. We might need to get used to it. Cuts of a similar magnitude are pencilled in for the two years from April 2016 as well. No doubt Treasury and government have been encouraged by the apparently relative ease with which cuts have been implemented so far. But, of course, past performance may not be a guide to future performance.

I’d go further than that. It probably won’t be. Most of the savings that are easy to identify and implement have already been made. As anyone who has been through a cost reduction exercise knows, cutting the first few percent is relatively easy. But when you have to do it again the following year and then again the year after that, it gets extremely hard. You can only close your under-utilised resources, fire your contractors and scrap your training budget once. A bit of innovation some clever thinking and a lot of luck might get you through the next stage. After that, you just have to sack people and stop doing stuff. That is clearly what many local authority bosses think they will be during the second half of this decade.

The IFS reckons it will take an extra £25 billion in tax just to stop any more cuts during the next parliament. (The Resolution Foundation is even more pessimistic, putting the figure at £26.1 billion.) Just to be clear, that’s not £25 billion to put things back how they were before the Coalition’s spending cuts but £25 billion simply to prevent the further 15 percent in cuts after the next election.

All of this presents the next government with a dilemma. If it wants to stop any further spending cuts it will need to raise taxes. This is quite a difficult sell. In the past, tax increases have usually been sold to the electorate with promise of better public services. But “Pay an extra 2-3 percent in income tax or things will get worse” doesn’t sound like a great election message. Even Alastair Campbell would struggle to put a positive spin on that one.

As the fiscal situation worsens, though, fewer and fewer people believe that the government can meet its deficit reduction targets just by cutting spending. Here’s Paul Johnson again:

At some point we are going to have to have a serious debate about whether all of the rest of the fiscal consolidation is really going to happen through spending cuts alone.

The cuts announced were part of the biggest fiscal consolidation since the war. At any other time they would have been considered extraordinary. And there is much more to come.

We need to start the discussion now about the scale and composition of those cuts to come, whether protected spending areas will continue to be protected, and whether we will really avoid further tax increases.

That’s about as far as the boss of a think-tank which tries to avoid party politics can go towards saying that the government’s plan to reduce the deficit through spending cuts is totally unrealistic.

Given that more radical options like ‘helicopter money’ (effectively financing public spending or tax cuts with Bank of England created money, or even just giving it to people) seem to be politically unacceptable, it is likely that whoever wins the 2015 election will impose more spending cuts but temper them with tax increases. The choice between the parties will probably come down to the relative balance between the two, with Labour advocating slightly lower cuts and slightly higher tax increases than the Conservatives.

As Benjamin Franklin might have said, nothing can be said to be certain, except death and tax rises after 2015. Apparently, both Labour and the Tories think they are going to lose the next election. Perhaps that’s just wishful thinking.