Can the Chancellor really wield the axe?

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The Independent Online
The iron law of Budgets is that the first-day response in the media tends to be favourable, as commentators are impressed with the 'clever' Treasury ideas invariably unveiled in the speech. Typically, however, this reaction does not last very long, and in the ensuing few days or weeks the atmosphere tends to sour. Economists start to pick holes in the Treasury's arithmetic. More importantly, an adverse political climate develops as pressure groups seize on the less pleasant aspects of the package.

So far, this second leg has been noticeably absent from the picture this year. Kenneth Clarke had only one target - to raise as much revenue as possible without triggering a hostile political response - and it has become increasingly clear that he did indeed exhibit considerable political skill in compiling his package. On the micro side, no one has yet been able to identify any concealed landmines lurking in the fine print. And on the macro side, the surprise unveiling of 'cuts' in public spending has anaesthetised the potential rebels on the Tory Right, who might otherwise have opposed some elements.

As the public spending 'cuts' were so vital to the political success of the package, it is worth re- examining them in some detail. How large were these cuts relative to the tax increases announced in 1993, and can they really be implemented?

If we simply take the effect of the Lamont and Clarke Budgets combined, it is unarguable that tax increases have outweighed spending cuts by a very heavy margin. By 1996/97, the Lamont tax increases will raise the annual tax burden by about pounds 11bn, and the Clarke Budget will add a further pounds 6bn, making pounds 17bn in all. Meanwhile, the genuine spending cuts announced by Mr Clarke amount to only pounds 3bn in 1996/97. (A further pounds 3bn has been cut from spending as a result of 'estimating' changes relating to unemployment, debt interest and the like. But since these changes follow automatically from the behaviour of the economy, they can scarcely be scored as discretionary spending cuts.)

On the face of it, therefore, the measures of 1993 have seen tax increases outweigh spending cuts by a margin of over five to one. But the Treasury regards this calculation as misleading, because it omits the change in public spending announced in the November 1992 Autumn Statement. It claims this should be seen as part of the overall package of fiscal tightening now due to be implemented. The problem with this claim is that there was no figure given for the cuts in public spending in the last Autumn Statement. Nevertheless, as it is Christmas week, let us be generous and try to give the Treasury its due.

We know that the 'discretionary' increase in taxation by 1996/97 will amount to pounds 17bn. What is the equivalent 'discretionary' cut in public spending, taking the latest plans at face value? According to the Treasury, the share of public spending (including privatisation) in GDP will fall by 1.9 percentage points between the current financial year and 1996/97.

Around 0.6 percentage points of this decline, however, stems from the automatic effects of GDP growing by more than trend. Therefore the 'discretionary' cut in public spending - as currently intended - must be 1.3 percentage points of GDP, equivalent to pounds 10bn in 1996/97. On this basis, tax increases therefore outweigh spending cuts by 1.7 to one.

But this calculation assumes that the figures pencilled in by the Chancellor for public spending will actually be achieved. There is nothing in the Treasury's past record which indicates that this is likely, especially in the two years before a General Election. Targets for public spending several years out have almost never been hit since the Tories came to office, despite the fact that the Government has always been politically committed to lower spending, with the Treasury continually improving its methods of enforcing spending control.

The truth is that in a modern democracy the forces that tend to increase spending as a share of GDP are inexorable, and it is a Herculean task simply to stabilise the ratio, let alone reduce it. So it is inevitable that the Clarke plans should have been greeted with much scepticism.

Some of this scepticism is unjustified. For example, there has been much derision aimed at the Treasury's promise to cut the public spending control total in real terms by 1.3 per cent next year, especially as the whole of this reduction has come from a drop in the contingency reserve, not from the spending departments themselves. But the key point here is that the reserve for 1994/95 is no lower than usual. The only difference this year is that the cut in the reserve has been allocated to a drop in the overall spending total, and not to an increase in departmental spending as usual. The Treasury seems justified in calling this a genuine spending cut.

Furthermore, there are two fortuitous forces helping the control of spending next year. First, the timing of UK contributions to the European budget has by chance reduced the level of spending next year by pounds 1.3bn. Second, the 1993 social security uprating - calculated by reference to the abnormally low retail price inflation rate in September - will be about 2 per cent less than the rate of inflation in the coming fiscal year. Taking account of these two factors, the drop in real public spending planned for next year does not look too ambitious.

In subsequent years, by contrast, it will be extremely difficult to limit the real growth in the spending control total to the planned 1 per cent per annum. To get some idea of how difficult this will be, consider the experience of the Tory Government in the mid-1980s, a period in which GDP growth was similar to that expected in the next few years.

The graph compares the planned growth in real public spending, excluding debt interest, in the mid- 1990s with what was actually achieved in the mid-1980s. It is similar to a graph recently published by the Institute for Fiscal Studies, but in my opinion their selection of years for comparison had the effect of somewhat exaggerating the results.

Nevertheless, the graph still makes a telling point: Mr Clarke has announced plans for real spending which are around 3-4 per cent tighter by 1996/97 than the performance that was achieved at the equivalent point in the 1980s.

Lady Thatcher and Lord Lawson, who were in control of the public purse-strings in the 1980s, were not noticeably wimpish when it came to cutting public services. Indeed, even their best friends may wonder whether Messrs Major and Clarke will display quite the same zeal when swinging the spending axe in the two years before they face the electorate.

But even if the control total follows the pattern of the 1980s - in itself quite a task - then public spending in 1996/97 will be about pounds 10bn higher than planned in that year. That would be precisely enough to eliminate the 'discretionary' cuts in public spending calculated above - and in that quite plausible case, the whole of the cut in government borrowing would come from tax increases, with nothing at all coming from the spending side.

(Graph omitted)