How could the Chancellor fill a £22bn gap?

The OBR will deliver bad news for George Osborne tomorrow. But how bad? Ben Chu looks at the numbers

Pity the poor Office for Budget Responsibility. George Osborne's fiscal watchdog-cum-forecaster has been a model of openness since it was set up in May 2010. Visit the OBR's website and one can see its forecasts broken down into granular detail. It even publishes the equations that Robert Chote and his small team of economists use to calculate the size of the UK's structural deficit. Compared with the Bank of England's interest-rate setting Monetary Policy Committee, which keeps its calculations and equations jealously hidden from the unwashed public, the OBR lets it all hang out.

The trouble is that openness has a price. It allows other economic researchers to replicate the OBR's methods and predict what Mr Chote and co are going to conclude even before they have done their sums. So when the OBR publishes its forecasts tomorrow and rules whether or not Mr Osborne is on course to hit his Fiscal Mandate, its verdict is unlikely to come as a total surprise.

So what is the size of the fiscal hole that the Chancellor will confront? What size mountain will Mr Osborne have to commit to climb in order to eradicate the current structural deficit in five years' time, as his self-imposed mandate compels him to do? The Institute for Fiscal Studies has run the numbers and come up with what it calls a "pessimistic" scenario, whereby the Chancellor would need to fill a £23bn gap by 2017-18. Ian Mulheirn and Nida Broughton of the Social Market Foundation have performed a similar exercise and produced a figure of £22bn.

So how did they get there? Weak growth is the main story. The economy has double dipped into recession since the OBR last laid out its forecasts. At the time of the March Budget it expected GDP to grow by 0.9 per cent over the first three quarters of the year. But in fact the economy has expanded by just 0.3 per cent. This has depressed tax receipts, which are up 0.4 per cent this year as against the OBR's forecast of 3.7 per cent growth. Government spending is running slightly lower than the OBR's expectations but not enough to offset the tax shortfall. This combination looks likely to result in £10bn to £15bn extra government borrowing for the 2012/13 financial year.

Other economic forecasters have downgraded their UK growth outlooks for future years too. In the past the OBR's output forecasts have tended to follow the consensus. This implies that the UK government's public borrowing will also be higher over the rest of the OBR's five-year forecast period. The question is how much of this deterioration in the public finances the OBR will find to be structural, rather than cyclical? When growth disappointed in 2011 the OBR argued that much of the extra borrowing was permanent and would not disappear with an economic recovery.

And the SMF expects it to do so again, based on what information the watchdog has published on how it works out the output gap (the amount of slack in the economy). Using the OBR's equations the SMF (see chart, right) estimates that the output gap has fallen since the end of last year, and hence that the structural deficit is 1.1 per cent bigger.

It's true that some private forecasters have revised up their estimate of the size of the output gap this year. So it's possible that the OBR will do the same. But this would leave the forecaster open to the charge that it has ignored its own model out of a desire to make life easier for the Chancellor.

So assuming the IFS's pessimistic scenario and the SMF's central view are correct, how could this £22bn-£23bn gap — roughly equivalent to the entire transport budget — be filled? By way of illustration the IFS says the Chancellor could fill the gap at a stroke by hiking VAT from 20 per cent to 25 per cent. The SMF estimates that if the Government spread the cuts (on top of the savings Mr Osborne has already pencilled in for the next parliament) evenly over all government departments spending would drop by 11 per cent in real terms between 2015-16 and 2017-18. But if the health, education and international development departments were held steady in real terms, other departments' budgets would have to come down by 23 per cent over the three years. As the SMF points out, that would imply cutting police and crime expenditure by a third. It would mean halving all employment programme outlays. And, of course, that would be on top of the unprecedentedly prolonged round of cuts already due over the remainder of this Parliament.

More likely Mr Osborne will promise to make the post-2015 cuts but fail to spell them out. That's what he did in November 2011 when the OBR last revised up its estimate of the size of the structural deficit. Another Spending Review, which sets departments' multi-year budgets, is not due until next autumn. It remains to be seen whether the Conservatives and Liberal Democrats will be able to agree to further cuts which will fall during the next Parliament, when the Coalition could well be history. That would effectively commit the two parties to fight the next election on a common fiscal platform, something their respective MPs would baulk at.

Yet, before confronting that hurdle, there's a more immediate challenge for the Chancellor tomorrow. His fiscal mandate has a supplementary target, which is to put the national debt on a downward trajectory by 2015-16. There is now not a forecaster in the land who expects that the OBR will find the Chancellor to be on course to hit that target under present plans. So the burning question is whether the Chancellor will announce new spending cuts and tax rises to put himself back on course to hit it — something even deficit hawks accept would damage the economy — or whether he will abandon the target and inflict potentially huge political damage on his reputation.

Thanks to the OBR's openness, we can be confident that Mr Osborne's fiscal cage will shrink. Now we wait to see whether he will produce the key to that cage that he always swore he would not use.

Suggested Topics
Start your day with The Independent, sign up for daily news emails
Arts and Entertainment
Joe Cocker performing on the Stravinski hall stage during the Montreux Jazz Festival, in Montreux, Switzerland in 2002
musicHe 'turned my song into an anthem', says former Beatle
News
Clarke Carlisle
sport
Sport
footballStoke City vs Chelsea match report
Arts and Entertainment
theatreThe US stars who've taken to UK panto, from Hasselhoff to Hall
PROMOTED VIDEO
ebooks
ebooksA year of political gossip, levity and intrigue from the sharpest pen in Westminster
Life and Style
Approaching sale shopping in a smart way means that you’ll get the most out of your money
life + styleSales shopping tips and tricks from the experts
News
newsIt was due to be auctioned off for charity
News
Coca-Cola has become one of the largest companies in the world to push staff towards switching off their voicemails, in a move intended to streamline operations and boost productivity
peopleCoca-Cola staff urged to switch it off to boost productivity
Environment
Sir David Attenborough
environment... as well as a plant and a spider
Voices
'That's the legal bit done. Now on to the ceremony!'
voicesThe fight for marriage equality isn't over yet, says Siobhan Fenton
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

The Jenrick Group: Night Shift Operations Manager

£43500 per annum + pension + holidays: The Jenrick Group: Night Shift Operatio...

SThree: Trainee Recruitment Consultant - LONDON

£20000 - £25000 per annum + OTE £40,000 + Car + Pension: SThree: SThree are a ...

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + OTE £35K: SThree: We consistently strive to be the...

SThree: Graduate Recruitment Consultant

£20000 - £25000 per annum + OTE £35000: SThree: SThree are a global FTSE 250 b...

Day In a Page

Surrounded by high-rise flats is a little house filled with Lebanon’s history - clocks, rifles, frogmen’s uniforms and colonial helmets

Clocks, rifles, swords, frogmen’s uniforms

Surrounded by high-rise flats is a little house filled with Lebanon’s history
Return to Gaza: Four months on, the wounds left by Israel's bombardment have not yet healed

Four months after the bombardment, Gaza’s wounds are yet to heal

Kim Sengupta is reunited with a man whose plight mirrors the suffering of the Palestinian people
Gastric surgery: Is it really the answer to the UK's obesity epidemic?

Is gastric surgery really the answer to the UK's obesity epidemic?

Critics argue that it’s crazy to operate on healthy people just to stop them eating
Homeless Veterans appeal: Christmas charity auction Part 2 - now LIVE

Homeless Veterans appeal: Christmas charity auction

Bid on original art, or trips of a lifetime to Africa or the 'Corrie' set, and help Homeless Veterans
Pantomime rings the changes to welcome autistic theatre-goers

Autism-friendly theatre

Pantomime leads the pack in quest to welcome all
The week Hollywood got scared and had to grow up a bit

The week Hollywood got scared and had to grow up a bit

Sony suffered a chorus of disapproval after it withdrew 'The Interview', but it's not too late for it to take a stand, says Joan Smith
From Widow Twankey to Mother Goose, how do the men who play panto dames get themselves ready for the performance of a lifetime?

Panto dames: before and after

From Widow Twankey to Mother Goose, how do the men who play panto dames get themselves ready for the performance of a lifetime?
Thirties murder mystery novel is surprise runaway Christmas hit

Thirties murder mystery novel is surprise runaway Christmas hit

Booksellers say readers are turning away from dark modern thrillers and back to the golden age of crime writing
Anne-Marie Huby: 'Charities deserve the best,' says founder of JustGiving

Anne-Marie Huby: 'Charities deserve the best'

Ten million of us have used the JustGiving website to donate to good causes. Its co-founder says that being dynamic is as important as being kind
The botanist who hunts for giant trees at Kew Gardens

The man who hunts giants

A Kew Gardens botanist has found 25 new large tree species - and he's sure there are more out there
The 12 ways of Christmas: Spare a thought for those who will be working to keep others safe during the festive season

The 12 ways of Christmas

We speak to a dozen people who will be working to keep others safe, happy and healthy over the holidays
Birdwatching men have a lot in common with their feathered friends, new study shows

The male exhibits strange behaviour

A new study shows that birdwatching men have a lot in common with their feathered friends...
Diaries of Evelyn Waugh, Virginia Woolf and Noël Coward reveal how they coped with the December blues

Famous diaries: Christmas week in history

Noël Coward parties into the night, Alan Clark bemoans the cost of servants, Evelyn Waugh ponders his drinking…
From noble to narky, the fall of the open letter

From noble to narky, the fall of the open letter

The great tradition of St Paul and Zola reached its nadir with a hungry worker's rant to Russell Brand, says DJ Taylor
A Christmas ghost story by Alison Moore: A prodigal daughter has a breakthrough

A Christmas ghost story by Alison Moore

The story was published earlier this month in 'Poor Souls' Light: Seven Curious Tales'