Cuts the best way to ensure growth

Allister Heath
TODAY is D-day for George Osborne; his first Budget, presented to Parliament at 12.30pm today, could be remembered as a turning point in modern British economic history. If he flunks it, Osborne is finished; if he pulls it off, stabilises the national debt, begins to unwind the excess of the Labour years and ensures that any tax hikes are not too damaging to competitiveness, Osborne could set in train a slow comeback and reverse this country’s accelerating decline.

One thing is clear: the coalition’s honeymoon period is over. The savage attacks from the left, Keynesians and the unions have only just begun. While there is a broad consensus that the budget deficit needs to be reined in, there are plenty of influential commentators who argue that spending cuts at this time would endanger the recovery, hurt Britain’s long term fiscal and economic prospects, send unemployment soaring again and hit the poor disproportionately. I’m not convinced by any of these claims: it seems that the opposite is true and that the UK can no longer afford to live beyond its means, with the state borrowing vast amounts of money to finance a badly managed and oversized public sector. It is not moral or progressive to borrow as if there were no tomorrow, shackling unborn generations with massive bills and risking a continental-style sovereign debt crisis. The only reason gilt yields have collapsed over the past couple of months is the belief that the coalition will tackle the deficit; if it were to wimp out now, the retribution from those whom we are asking to finance our profligacy would be as harsh as it would be instant.

A research note from the TaxPayers’ Alliance is illuminating: using the Beacon Economic Forecasting model of the UK, it argues that only ambitious cuts in spending will deliver improvements in Britain’s fiscal position as well as its economic prospects (and hence employment, asset prices and wages). Beacon is a small consultancy run by David B Smith, for many years Williams de Broe’s chief economist and now chairman of the Institute of Economic Affairs’ shadow monetary policy committee. It has won awards, including being judged the most accurate forecaster a few years ago by a Sunday newspaper; its models are especially interesting because they give an important role to the supply of money as well as to the tax burden as an influence on economic decisions.

The model finds that deficit reduction and economic recovery would be best served through a mixture of spending cuts and tax cuts – namely, immediate and substantial spending cuts followed by broad tax cuts around the 2014 Budget.

The results by 2020 – compared with keeping to the 2010 Budget’s policies, which is what those who oppose cuts implicitly support – are dramatic. The debt stock would be £1.6 trillion instead of £2.4 trillion on the no-cuts scenario; 60.6 per cent of GDP instead of 94.5 per cent. The budget would be in surplus to the tune of 1.3 per cent of GDP, instead of a deficit of 2.8 per cent of GDP.

The only way to strengthen the economy is by cutting spending and eventually taxes – not by maintaining debt-financed expenditure, let alone hiking tax (which would further squeeze the private sector and damage the UK’s long-term growth potential). Osborne must cut sensibly and thoughtfully, while making sure that the poor are protected – but cut he must.