Politics is all very well, but it’s the maths that matters

The forthcoming Budget can be seen as a template into which the next  government must fit its plans; and the numbers are pretty depressing

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We are on the glide-path to the Budget, now just over two weeks away.

This will be the last substantive Budget before the general election next year, for the March 2015 version will really be no more than an election pitch. The opinion polls will tell us whether there is any chance that its proposals will be put into practice. Indeed, given the past form of George Osborne (pictured), expect this one to have a strong political spin to it.

But politics don’t change mathematics. The harsh maths that will face the next government, whoever forms it, will be that we are only half way along the path of fiscal consolidation. So, I suggest the best way to see this Budget is less as a statement about the Chancellor’s intentions and more as a template into which the next government will have to fit its plans. We will catch a glimpse of the future.

Some figures, rather depressing ones I’m afraid: if you look at the Autumn Statement of 2010, by which time the coalition had taken a decent look at the books, it forecasts that this financial year would see a budget deficit of £60bn. Actually (and allowing for changes in accounting practice) it will be about £111bn. Next financial year, the one that begins next month, the deficit was supposed to be down to £35bn. The most recent Office for Budget Responsibility estimates are that it will be £96bn. The Government inherited a deficit of £148bn. Leave aside the target of a surplus, if you say it had to get the deficit to an acceptable level of say £25bn, it has done less than half the job.

So, the next government will have to do what this one has done, but all over again. That leads to two questions that should be at the back of everyone’s mind when the Chancellor stands up. The first is: will faster growth make the task much easier, or only a little easier? The second is: what are the uncertainties on both the revenue and the spending side that might help narrow, or widen, the gap?

A word about each.

In the past, once the UK economy has picked up a bit of pace it really thumped out the revenue. But if the early stages of a boom have usually been good for public finances, this time around, so far at least, the revenue is a bit disappointing. Revenue to the end of January was up 5.2 per cent at £481bn, which is all right. But income tax, the biggest single source of revenue, was up only 3.2 per cent, and company profits tax was down. We have put on some 800,000 jobs over the past year but because pay is rising so slowly the government is not getting as much income tax as you might expect. As growth broadens and strengthens, pay, profits and employment will all pick up further, but we really need three years of 3 per cent growth before we can say that the recovery is pulling us out of the fiscal hole.

Let’s assume we get that – or rather we should look closely at the robustness of the Office for Budget Responsibility growth forecasts, which will be pretty strong. Where are the uncertainties?

On the revenue side, the most serious is that we are dangerously dependent on high earners, with the top 1 per cent of our income-tax payers contributing nearly 30 per cent of the total. It may sound odd to say it, but looking ahead over the next parliament, the exchequer very much needs the highly paid to be paid even more. As the Institute for Fiscal Studies observed in its Green Budget, the paper it prepares each year ahead of the Budget: “The increase in revenues over the next five years is forecast to come largely from income tax and capital taxes.” So, the Government is increasingly dependent on the income and tax behaviour of some 300,000 people, and to a far greater extent than 10 or even five years ago.

On the spending side, the uncertainty is whether the Government can sustain the squeeze. To put this in context, between 1979 and 1997 Gross Domestic Product (GDP) went up in real terms by an average of 2.7 per cent a year, but public-service spending went up by only 1.2 per cent a year. Then from 1997 to the peak of 2007, GDP went up by 3.2 per cent a year but spending went up 4.9 per cent a year. From 2010, when the coalition took over, through to the end of the present plan in 2018, GDP is projected to rise 1.9 per cent a year but spending will fall 1.7 per cent a year. Can it be done?

There are two broad views. One is to say that government departments have so far managed to underspend their budgets and, despite the cuts, have maintained services. (Some argue that those squeezed hardest have done best on this score.) So they should be able to find further  efficiencies. The other view is to note that the population is rising and ageing; that the easiest  savings come first; and that  people expect better services, not worse, particularly in health and education.

We can’t know. What we can see, though, is that if the first stage of fixing public finances was a desperate repair job, the next will be to figure out what sort of government we want – and what can we persuade people to pay for.

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