THE belief that growth can solve a chancellor’s money problems is an old one. As John Maynard Keynes said in 1933, “take care of unemployment, and the Budget will take care of itself.” The idea is that when the economy improves, spending will fall, taxes will increase and the deficit will vanish.
Yet while some spending and tax revenues vary with the economy, most do not. Even if George Osborne returned the economy to full health, spending would be just £23bn lower in 2012-13 out of a £674bn total. Revenues would rise by 1 per cent, and two-thirds of the deficit would persist.
These figures aren’t surprising. The largest areas of spending are pensioner benefits and the NHS, and these do not vary with economic conditions, but reflect demographic changes and demand for public services. And the coalition has failed to get on top of spending in these areas. While it has brought forward an increase in the retirement age, it has increased costs by changing the way the state pension grows over time. Cuts to the winter fuel allowance and free bus passes have been ruled out. The cost curve in health has not been bent downward.
While Osborne correctly set out to eliminate the structural deficit, he is operating with one hand tied behind his back. David Cameron continues to rule out breaking the ring-fence on NHS, pensioner benefits, and schools spending, and also on the the smaller budgets of international aid and defence equipment.
Yet health, pensions and schools accounted for two of every five pounds spent by the government in 2012-13. They will account for 60 per cent of the total increase in spending between 2011-12 and 2014-15. Health alone will account for close to a quarter of the total increase in spending between 2011-12 and 2014-15.
Further, ring-fencing has left no headroom for unfunded tax reductions. Cuts have fallen on departments on political grounds, rather than to improve value for money. And areas like health haven’t benefited from the pressure to change and innovate, in the way that other services like policing are already showing.
Ring-fencing has also been a political own goal. As former New Zealand finance minister Sir Roger Douglas noted, it is harder to make the political case for reform when budgets are protected. Quite simply, running the value for money ruler over all spending means it is harder for ministers to complain when budgets get cut.
The result has been to create a perception of underfunding, while leaving the real drivers of spending unaddressed. In 2010, when the Comprehensive Spending Review was launched, a Treasury spokesman said: “Anyone who thinks the review is just about saving money is missing the point. This is a once-in-a-generation opportunity to transform the way that government works.” Yet by protecting the largest spending areas, the coalition has failed to achieve this vision.
We must break the UK’s overspending habit. And to do this Cameron must give Osborne the freedom to deal with the most important areas of spending in his Budget next week.
Dr Patrick Nolan is chief economist at the independent think tank Reform. Its report Not just a crash diet is available at www.reform.co.uk.