A friend asked me, earlier this week, “If you’re saying David Cameron and George Osborne are not dedicated state shrinkers, and they’re not stupid either, why would they commit themselves to such a big reduction in public service spending?”
Because, when the Conservatives first promised to eliminate the deficit, they had no idea how big a task it was going to be.
To be fair, they weren’t alone. In 2010, most people assumed that the economy would eventually grow again in its usual post-recession pattern, starting with a big jump to counteract the big slump, then settling into steady growth. That would have boosted employment, increased wages, raised the tax take and lowered welfare costs.
In the event, that didn’t happen. The government’s growth forecasts in the early years of the Coalition turned out to be way too optimistic. Even after the ONS’s revised GDP estimates (black line on the graph), growth fell well short of expectations. As the OBR points out, the government projections were not that much different from those of most outside forecasters. In 2010, no-one expected the economy to perform so badly.
Source: OBR Forecast evaluation report, October 2014.
The result of the poor growth was poor tax revenues and stubbornly high welfare costs. At each budget and autumn statement, the forecasts had to be revised, in the wrong direction.
The tax take was disappointing:
Source: EY Item Club
While the welfare bill stayed high:
Source: OBR Welfare trends, October 2014
If tax revenues are poor and welfare costs rise, more of the burden of deficit reduction has to fall on public services. As time went on, therefore, the level of public service cuts needed for the elimination of the deficit increased.
Giles Wilkes produced this chart a couple of weeks ago based on public service spending forecasts over the past five years. Each time, public services get squeezed that bit more to compensate for lower than expected taxes and higher than expected social security costs. By the end of 2014, the cuts needed to eliminate the deficit were about £80 billion more than George Osborne envisaged in 2010. Even to achieve Labour’s current (as in day-to-day) spending surplus will require Ed Miliband to spend less on public services than George Osborne originally thought he’d be spending.
The problem, then, is very straightforward. To get rid of the deficit, if the economy doesn’t grow by as much as you thought, the amount that has to be cut from public services must increase by more than you thought.
David Cameron and George Osborne had no intention of slashing public services by as much as the OBR projections now suggest. Eliminating the deficit looked difficult but do-able in 2010. The problem now is that the weak economy has left them with much more to do than most people predicted five years ago. It implies more public service cuts in the next three years than we saw in the whole of the last parliament.
It may come right, of course. Perhaps the OBR growth forecasts are now too pessimistic and we will see a boost in productivity and GDP. In which case, the deficit may disappear without the need for even bigger public service cuts. At the moment, though, the recovery is looking anaemic and a sudden pick up in growth seems unlikely. Unless a lot more of us start getting paid a lot more, welfare costs will stay high and tax revenues will stay low. The IMF believes the UK will still have a deficit at the end of the decade. Whatever happens today, the deficit will be as big a headache for the next government as it was for the last one.