Most economists have concluded there is no difference between the Labour and Tory fiscal objectives. But this is not necessarily true. Because the Conservative plans are so tight over the medium term, Labour might be able to loosen them a little while still having a credible fiscal framework.
Last year's Budget plans aimed to balance the Budget by 1998-99, and to tighten the underlying fiscal stance every year between now and then. Just because the Public Sector Borrowing Requirement has recently been exceeding the tough target set last year, the public debate (especially on the right of the Tory Party) is missing the fact the Government intends to squeeze public services in real terms by about 1 per cent next year - a phenomenally tight objective.While the Tories are focused exclusively on how to "afford" tax cuts, they may be heading straight for a massive electoral backlash centred on the state of the public services. The Oxfordshire middle class revolt on the state of the schools might be the first of many outbreaks.
If fully implemented - and admittedly that is a big "if" - these public spending objectives would tighten the fiscal stance much more than Labour's framework would require. Here is the arithmetic: Gordon Brown reiterated yesterday that Labour's budgetary plans would have two separate objectives. First, over the economic cycle, the government would borrow no more than it was investing, so the "golden rule" of public finance would be fully observed. This, however, would place no upper limit on the PSBR per se. A high level of public investment would automatically justify an increased level of borrowing. So in order to overcome this concern, the shadow chancellor has also said he would seek to stabilise the ratio of public debt/GDP at a "prudent and sensible level". This latter objective would place an upper limit on the PSBR, probably at an average of about 2.5 per cent of GDP (pounds 20bn) in the course of the cycle.
By coincidence, this PSBR objective is almost exactly equal to what the Conservatives have achieved in the past decade, a fact that has encouraged the conclusion that the fiscal stance would not change much under Labour. But it is the future that matters. The key question is how the path for the PSBR on unchanged policies might compare with Labour's objectives. Table 1 makes this comparison. On present economic policies the PSBR would most likely drop from pounds 27bn this year to pounds 18bn in 1996-97, and then down to zero by the end of the century. This path assumes the Government maintains its objective of holding the growth in public spending to 1 per cent per annum in real terms, while the economy as a whole grows at about 2.75 per cent per annum. Although this may look draconian, it would in fact involve a slower reduction in borrowing than was planned by Kenneth Clarke last year. Consequently, if he chooses to stick to last year's targets (which is unlikely), he would need to raise an extra pounds 5bn a year in the November Budget.
Labour, by contrast, would not seem to face the same dilemma. It would aim not for a budget surplus, but for a PSBR of 2.5 per cent of GDP when the economy is next at mid-cycle (i.e. when GDP is at trend). The key question is exactly when this will be. The economy was last at trend in 1990; if we simply extrapolate the GDP trend line from that date onwards at the economy's long-term growth rate of 2.2 per cent per annum, we find that GDP is unlikely to return to trend until 1998-99 at the earliest. So if Labour aims for a PSBR target of 2.5 per cent of GDP in that year, it could borrow about pounds 16bn more than present plans imply.
This might look too good to be true, and there are several ways in which this margin could shrink. First, an incoming Labour chancellor might decide that an easing in the underlying fiscal stance would be inappropriate for demand-management reasons. Table 2 shows what would happen if the next government left the underlying fiscal stance unchanged up to 1998- 99, eliminating the large fiscal tightening planned by the Treasury. The PSBR target would need to be pounds 15bn in 1998-99, instead of the pounds 20bn suggested by the golden rule and public debt requirements. This would cut Labour's scope for fiscal action from pounds 16bn to pounds 11bn.
Second, the next chancellor might decide it is imprudent to assume GDP will be at trend only in 1998-99. There is some evidence the trend rate of growth in GDP may not have been as high as the usual 2.2 per cent per annum since 1990, because of a period of low growth in the labour force and chronic under-investment. Just to be on the safe side, it might be wise to assume that trend GDP will be attained earlier than 1998-99. But for each year we bring the crucial date forward, Labour's scope for fiscal manoeuvre is cut by about pounds 5bn.
Third, the plans bequeathed from the present government would of course be nothing more than figures written on pieces of paper - the intended tough control over public spending is just a promise. If Labour could not deliver the same tight control over the public sector as promised by the Tories (especially on public sector pay), the entire scope for fiscal action could be absorbed by spending overshoots.
Finally, of course, Mr Clarke may not be too keen on leaving a nice little nest egg for Mr Brown to spend. He may start to loosen the reins on public spending, or pre-announce a phased programme of tax cuts for the medium term, which would eliminate all of Labour's scope - and indeed leave Labour in serious difficulty with the PSBR if the economy should hit an early recession.
At the moment, though, the Chancellor does not seem to be thinking in these terms. Instead, he seems determined to play the card of fiscal stringency, and is presumably ready to denounce the opposition if it should try to argue borrowing is being reduced too far. That may well be laudable from an economic point of view. But once Mr Clarke has set his budget targets for public spending in 1996-97, it will be difficult under the new control system subsequently to relax them. This looming crisis about the provision of public services should be the real focus of attention, not endless navel-gazing about the prospect of achieving modest tax cuts in November.
Scope for fiscal relaxation
PSBR on PSBR target Fiscal room
unchanged Conservative* Labour1 Conservative Labour
1995/96 26.6 21.5 - -5.1 -
1996/97 17.9 13.0 - -4.9 -
1997/98 10.3 5.0 20.1 -5.3 9.8
1998/99 4.7 -1.0 21.0 -5.7 16.3
1999/2000 -4.7 -9.0 22.4 -4.3 27.1
*PSBR targets in 1994 Budget 1Assumes the PSBR should be at 2.5% of GDP when the economy is approximately working at normal capacity
PSBR projections on 'neutral' fiscal policy
PSBR on PSBR on Planned fiscal Tightening as
'neutral' present tightening % of GDP
fiscal policy* policy (cumulative)
1995/96 26.6 26.6 - -
1996/97 21.5 17.9 3.6 0.5
1997/98 19.1 10.3 8.8 1.1
1998/99 15.4 4.7 10.7 1.3
1999/2000 11.3 -4.7 16.0 1.8
*Neutral policy in the years after 1995/96 is defined to include 2.2% pa real growth in the public spending control total (ie in line with trend GDP), and unchanged tax rates
Source: Goldman Sachs