The true meaning of the chancellor's emergency budget

John Rentoul reads between the lines of Mr Osborne's speech to pluck out his real message: buckle up, it's going to be a bumpy ride

Mr Deputy Speaker, This emergency Budget deals decisively with our country's record debts. This is an emergency Budget, so let me speak plainly about the emergency we face. The coalition Government has inherited from its predecessor the largest budget deficit of any economy in Europe with the single exception of Ireland.

Got that? It is an "emergency" Budget. As in "Not my fault." And we are a coalition Government, so these are not "Tory Cuts". They have been approved by man in yellow tie on my right, and man in purple tie on my left. Don't like it? Blame them.

One pound in every four we spend is being borrowed.

What we have not inherited from our predecessor is a credible plan to reduce their record deficit. This at the very moment when fear about the sustainability of sovereign debt is the greatest risks to the recovery of European economies.

This is what is known as the "Greek defence" – the danger of a collapse in confidence in government debt, highlighted by the Greek crisis which coincided with our general election. It's the reason given by Nick Clegg and Vince Cable for changing their mind about the need to start cutting spending this year.

This Budget is needed to deal with our country's debts. I am not going to hide hard choices from the British people or bury them in the small print of the Budget documents.

Who could he be thinking about who might have done it differently? The one MP who everyone knew was not in the House of Commons to hear his speech. Another good way to bind the coalition together: both parties, and many on the Labour side, don't like Gordon Brown.

Our policy is to raise from the ruins of an economy built on debt a new, balanced economy where we save, invest and export. In this Budget everyone will be asked to contribute. But in return everyone will share in the rewards when we succeed. The first challenge for this Budget is to set the fiscal mandate – or in other words, our overall objective for the public finances. Our fiscal mandate will be forward-looking, and the judge of whether we are on course to meet it will be the independent Office for Budget Responsibility.

Some have suggested that there is a choice between dealing with our debts and going for growth. That is a false choice. The crisis in the Eurozone shows that unless we deal with our debts there will be no growth. What is more the forecast shows a gradual rebalancing of the economy, with business investment and exports playing a greater role and government spending and debt-fuelled consumption a smaller role.

Part of the reason, as we have always argued, is that tighter fiscal policy can enable interest rates to stay lower for longer.

And as the Governor of the Bank of England confirmed this last week at the Mansion House, "if prospects for growth were to weaken, the outlook for inflation would probably be lower and monetary policy could then respond."

This is the second line of Liberal Democrat defence, the so-called Mervyn King Gambit: Clegg and Cable changed their minds because the Governor of the Bank of England told them they had to; it also helps Clegg to look as if he understands economics. No wonder he nodded vigorously through this section.

The subject of interest rates brings me to say this about attempts to directly compare last week's forecasts with this one.

As the Office for Budget Responsibility notes in today's Budget document, any such comparison would be "misleading", because last week's forecast included the lower interest rates that expectations of this week's Budget have already brought about. So as Sir Alan Budd and his colleagues have written, to actually follow the fiscal path set out by the previous Government "would lead to higher interest rates and so lower economic activity" than his forecast showed.

Very important bit. In other words, Sir Alan Budd may have appeared to be saying that the Budget would reduce growth but what he was actually saying was that it would have been worse under Labour. Few in the chamber understood it. Nick nodded emphatically.

Let me now turn to the measures in the Budget designed to deliver this accelerated reduction in the structural deficit.

The coalition Government believes that the bulk of the reduction must come from lower spending rather than higher taxes. The country has overspent; it has not been under-taxed.

My measures mean that 77 per cent of the total consolidation will be achieved through spending reductions and 23 per cent through tax increases. I believe this gets the balance right.

I have one further announcement to make regarding macro-economic policy.

I can confirm that, as set out in the coalition agreement, this Government will not be joining the euro in this Parliament.

Therefore I have abolished the Treasury's Euro Preparations Unit.

Nick Clegg, the great Europhile, grinned and decided that now was the time to engage David Cameron in small talk behind Osborne's back.

All parties in this House accept that spending needs to be cut. And we have made a start. Well-judged capital spending by government can help provide the new infrastructure our economy needs to compete in the modern world.

It supports the transport links we need to trade our goods, the equipment we need to defend our country, and the facilities we need to provide quality public services.

I think an error was made in the early 1990s when the then Government cut capital spending too much – perhaps because it is easier to stop new things being built than to cut the budgets of existing programmes.

More coalition talk: dissing the John Major government. Nick nodded.

We have faced many tough choices about the areas in which we should make additional savings, but I have decided that capital spending should not be one of them.

We have inherited from the previous Government spending plans to cut departmental budgets by £44 billion a year by 2014-15. This implies an average real reduction for unprotected departments of 20 per cent. Because the structural deficit is worse than we were told, my Budget today implies further reductions in departmental spending of £17 billion by 2014-15.

We have committed to providing the National Health Service with real increases throughout the Parliament and we will honour our international aid obligations to the poorest in the world. Once these are taken into account, the Budget figures imply that other departments will face an average real cut of around 25 per cent over four years.

Of course, not all departments will receive the same settlement. I recognise, for example, the particular pressures on our education system and on defence.

Final departmental settlements, and the final split between departmental expenditure and annually managed expenditure on welfare, will be set in the spending review.

Rather than follow the usual practice of keeping the date of that review a secret until a few weeks before it happens, let me tell the House it will be presented on Wednesday, 20 October.

Again, attacking Gordon Brown's style of Treasury obfuscation and secrecy, which goes down well with both wings of the coalition behind him.

A further way we can ease the pressure on public services is to agree that we need to restrain public sector pay in these difficult times. And we need to do something about the spiralling costs of public sector pensions. But we will protect the lowest paid.

In the past I have said we would be able to exclude the one million public sector workers earning less than £18,000 from a one year pay freeze. Today, because we have had to ask for a two year freeze, I extend the protection to cover the 1.7 million public servants who earn less than £21,000. Together they make up 28 per cent of the public sector workforce. They will each receive a flat pay rise worth £250 in both these years, so that those on the very lowest salaries will get a proportionately larger rise. In recognition of our armed services who are risking their lives in Afghanistan, we have also doubled the operational allowance to £4,800.

Over the past decade the British economy has become deeply unbalanced.

Nowhere are these disparities as marked as between the different regions of Britain. Between 1998 and 2008, for every private sector job generated in the North and the Midlands, 10 were created in London and the South.

We need a new approach. And as a step towards rebalancing our economy, we are today announcing support for those regions more dependent on the public sector.

First, even when money is so short, we will commit to these important regional transport projects: the upgrade of the Tyne & Wear Metro; the extension of the Manchester Metrolink; the redevelopment of Birmingham New Street station; and improvements to the rail lines to Sheffield and between Liverpool and Leeds.

Second, we will create a large Regional Growth Fund to provide finance for regional capital projects over the next two years.

This is the kind of ghastly, right-on, sandal-wearing do-goodery that the Liberal Democrats insisted on, but it all helps to protect me from being cast as a hard-faced Thatcherite Londoner. Nick nodded.

The sovereign debt crisis means we need to the reduce the deficit even more quickly in order to protect our economy.

And the Office for Budget Responsibility has revealed the size of the structural deficit to be even larger than we feared, £12 billion larger next year.

As a result, this Budget announces a further fiscal tightening of £40 billion a year by the end of this Parliament, including welfare and spending measures, over and above the previous government's plans.

To achieve that additional tightening while maintaining the right "four-to-one" balance between spending and taxation means that I have to announce further tax rises today.

On 4 January next year, the main rate of VAT will rise from 17.5 to 20 per cent.

The years of debt and spending make this unavoidable.

The bad news. Tell it straight. Blame it on Labour. Nick nodded a lot and urged him on as Labour noise forced the Deputy Speaker to intervene.

This single tax measure will by the end of this Parliament generate over £13 billion a year of extra revenues.

That is £13 billion we don't have to find from extra spending cuts or income tax rises.

I can also give this House a commitment that we will keep everyday essentials such as food and children's clothing, as well as other zero-rated items like newspapers and printed books, exempt from VAT over the course of this Parliament.

And in line with the increase in the main rate of VAT, the higher rate of insurance premium will also rise from 17.5 to 20 per cent, while the standard rate will increase from 5 to 6 per cent.

Let me turn to my decisions on duties. The March Budget included substantial increases in these. I can tell the House that my Budget today includes no new increases in duties on alcohol, tobacco or fuel. We will report back in the autumn on the scope for targeting alcohol duty at the products most associated with binge drinking and underage consumption.

We have decided to reverse the previous Government's plan to increase the duty on cider by 10 per cent above inflation and the reduction will come into effect at the end of this month – just in time to celebrate England's progress to the quarter finals, or else to drown our sorrows.

There are a lot of Liberal Democrat seats in cider-making areas. So the Lib Dems don't get their green plane tax – that is just to be "explored" – but even Lib Dems can be populist sometimes.

One of the most chaotic areas of tax that the new Government inherited from its predecessor is the capital gains tax regime. It is therefore right, as set out in the coalition agreement, that capital gains tax should increase in order to help create a fairer tax system.

With Osborne mentioning the coalition agreement and using the words fair and fairer repeatedly, Nick was nodding like the Churchill dog.

From midnight, taxpayers on higher rates will pay 28 per cent on their capital gains.

Let me turn now to income tax. In the current system, everyone under the age of 65 is eligible to a tax-free personal allowance of £6,475. I can announce that we will increase this personal allowance by £1,000 in April. People will be able to earn £7,475 before they have to start paying income tax. 23 million people who are basic rate taxpayers will each gain by up to £170 a year. 880,000 of the lowest income taxpayers will be taken out of tax altogether. Higher rate taxpayers will not benefit from this change, and the higher rate income tax threshold will have to remain frozen to 2013-14.

Our long-term objective remains to increase the personal allowance to £10,000.

I do not disguise from this House that the combined impact of the tax and benefit changes we make today are tough for people.

Too often when countries undertake major consolidations of this kind, it is the poorest – those who had least to do with the cause of the economic misfortunes – who are hit hardest. Perhaps that has been a mistake that our country has made in the past. This coalition Government will be different. We are a progressive alliance governing in the national interest.

Laying it on thick now: the mistake we Thatcherite Tories made in the past was allowing the poorest to bear the brunt of economic misfortune, but thanks to our new friends setting us on the path of bleeding-heart righteousness we have seen the error of our ways and understand that we, too, can use the word "progressive" because it is completely meaningless and drives the Labour lot bonkers. Nick nodded. Cameron joined in.

And that requires us to make two final decisions. First, we will provide lasting help for pensioners. I can today announce that from April next year we will re-link the basic state pension to earnings. Second, we will provide additional support to families in poverty. I have decided to increase the child element of the child tax credit by £150 above indexation next year.

Today we take decisive action to deal with the debts we inherited and confront the greatest economic risk facing our country. We've been tough but we've also been fair. We have set the course for a balanced Budget and falling national debt by the end of this Parliament. We have insisted that four pounds of every five needed to reduce our deficit will be found from government spending.

Today we have paid the debts of a failed past. And laid the foundations for a more prosperous future. The richest paying the most and the vulnerable protected. That is our approach. Prosperity for all. That is our goal. And I commend this Budget to the House.

This is an edited extract of the Chancellor's speech to the Commons

10 BUDGET BUZZWORDS Tax – 57 Debt – 27 Predecessor/previous Government/Labour Government – 18 Deficit – 18 Fair/fairness/fairly – 14 Recovery – 13 Investment – 13 Office for Budget Responsibility – 12 Growth – 11 Coalition – 8 And what he didn't say... Conservative – 1 Prudence – 2 Recession – 2 Unemployment – 3

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