Chancellor gets away with it but pain is postponed

This fiscal tightening will roll back the frontiers of the state, but does it in the end go far enough? Sean O'Grady reports

This was indeed the toughest Budget since the Second World War. The Chancellor announced a total fiscal tightening – including the cuts and tax hikes announced by his Labour predecessors – of £120bn by 2015, according to some estimates. Even that number shrinks in comparison to the £425bn by which the Chancellor claimed Labour had missed its old fiscal rules. Instead, Mr Osborne announced a new "fiscal mandate" – "that the structural current deficit should be in balance in the final year of the five-year forecast period" (which is 2015-16 in this Budget) – and he set out how he would meet it.

That structural deficit – the part that will not disappear as a result of a return to growth – is being put by the Office for Budget Responsibility and Treasury at 8.7 per cent of GDP, contributing to the largest proportionate annual government borrowing of any EU nation expect Ireland. Mr Osborne's ambitious plans will turn that structural deficit into a small surplus on current spending – wages and so on rather than investment in, say, roads – of 0.3 per cent and 0.8 per cent in 2015 and 2016 (there will still be borrowing when capital spending is accounted for). The majority of the squeeze, as the Conservatives promised in the election, will consist in cutting spending rather than increasing taxes: 77 per cent will come from spending cuts, 23 per cent from tax changes.

In headline terms, public borrowing is projected to fall from £149bn (10.1 per cent of GDP) to £20bn (1.1 per cent) in 2015/16.

Although 2016 is a long way away, Mr Osborne signalled his earnestness by the rise in VAT announced for 4 January next year. Unlike any planned cuts to public expenditure, which the markets might discount, a rise in VAT yields immediate returns, in this case of about £13bn a year. Coupled with Labour's other tax rises, such as the new 50p rate, and some of Mr Osborne's own, such as the rise in capital gains tax, the tax burden will rise to 38.8 per cent of GDP by 2014.

The £11bn reduction in the welfare bill through capping housing benefit and freezing child benefit was one of the few clues to Mr Osborne's plans for individual departmental spending. The full truth about the cuts will be revealed in the spending review in the autumn, but the welfare changes suggest that the Government is unafraid of unpopular decisions.

Total public sector net debt, colloquially termed the national debt, will now peak at 70.3 per cent of GDP in 2013/14, rather than at just below 75 per cent under Labour' s plans. In cash terms it will hit £1,316bn at its highest point. In historical terms though, that is some way below the 262 per cent of GDP that the UK's national debt peaked at, in 1946, as well as the near 200 per cent debt pile in Japan.

Although Mr Osborne didn't publish detailed departmental plans, he confirmed independent estimates from the Institute for Fiscal Studies that spending cuts in departments that have not been protected by specific pledges will amount to 25 per cent, rather than the 20 per cent that was implied in Labour's policies.

Overall, the Government is planning real-term cuts to departmental expenditures over the next five years adding up to a total of 10 per cent. Protecting areas such as overseas development and NHS spending and restoring the earnings link to pensions mean that the squeeze in other, unprotected areas will be that much heavier. Transport, housing and schools are usually mentioned as the areas most vulnerable to the axe.

The sharp reduction in Labour's plans for capital spending will be retained, but not extended. Thus the stress is now on the "current" side of spending, and that will mean continuing restraint on the wages bill and benefit payments, both given plenty of attention by Mr Osborne yesterday. Rightly or wrongly, Mr Osborne is certainly set on a course that will roll back the frontiers of the state, to borrow an older Tory slogan. The share of total public expenditure to national income is planned to fall from around 47 per cent currently (and over 50 per cent on some international definitions), to less than 41 per cent by 2014/15.

Dr John Philpott, chief economic adviser at the Chartered Institute of Personnel and Development, commented: "Economic growth will slow by far more than today's Budget suggests and, rather than peaking at 8 per cent this year, unemployment will continue to rise toward 3 million (10 per cent) by the time Mr Osborne's measures take full effect. This will add to public borrowing and debt, not reduce it."

Yet while many liberal economists were dismayed by the Budget, some argued that the ageing population and diminishing flow of younger immigrants into the UK mean that the Government ought to have done more rather than less to repair the finances and prepare the nation for any future financial shocks.

The National Institute of Economic and Social Research commented: "Today's plans are a credible attempt to eliminate the structural budget deficit. They also begin to address longer-term public finance issues. Nevertheless in the longer term the budget needs to be tightened further if the economy is to be suitably prepared for another economic crisis like that of the last two years and is also to make adequate provision for an ageing population."

The Economy: Osborne crosses fingers that his destiny is in his own hands

The Chancellor may be correct in stating that the independent Office for Budget Responsibility agrees he is "on track" to bring the public finances back into balance by 2016. But the OBR is also clear that George Osborne's programme will mean lower growth, higher unemployment and lower living standards than would have been the case under Alistair Darling's plans.

The changes are not dramatic from the last time the OBR reviewed the economy. The growth forecast has been trimmed to 1.2 per cent from 1.3 per cent, while the 2011 projection has been cut to 2.3 per cent from 2.6 per cent. The 2012 figure is unchanged at 2.8 per cent while the 2013 and 2014 projections are edged up to 2.9 per cent (from 2.8 per cent) and 2.7 per cent (from 2.6 per cent). What will this mean in real, human terms?

Unemployment will be about 30,000 higher this year as a result of cuts to public spending, as some forecasters predicted. The OBR says it will peak at 8.1 per cent, but fall to 6.5 per cent by 2014 – around 100,000 more jobless than might have been expected under Labour's policies, though the coalition claims continued higher borrowing would have triggered a Greek-style crisis.

Yet some economists warn that unemployment could go much higher. James Knightley of ING commented: "Unemployment is likely to remain high. The Chartered Institute of Personal Development is warning of up to 725,000 public sector job losses resulting from fiscal austerity.

"During the last period of significant fiscal austerity in the 1990s more jobs were lost, but these were absorbed by a vibrant private sector. This time the prospect of three million unemployed is still a risk, which has the potential to feed back and further depress activity."

Most miserably of all for a nation grown used to substantial increases in its living standards, the OBR say that household consumption will rise by a minimal 0.2 per cent this year and 1.3 per cent next: then again, raising a tax on consumption, such as VAT, is supposed to be part of the "rebalancing" of the economy towards exports and investment, both of which are set to bounce back. Much depends now on inflationary expectations and pay rises. The latest surveys from the Bank of England suggest that inflationary expectations are starting to become "de-anchored" from the official two per cent target, which will worry the Bank, especially with a rise in Vat pending. In his Mansion House speech, Governor Mervyn King said: "If prospects for growth were to weaken, the outlook for inflation would probably be lower and monetary policy could then respond."

Mr Osborne will be hoping Mr King keeps his word and that events in the eurozone and the banking world don't upset their plans.

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