Osborne’s gambled on the wrong policy

Allister Heath
THERE is a striking paradox at the heart of George Osborne’s approach to the economy, as demonstrated yet again in yesterday’s Budget. He was remarkably risk-averse with his tax and spend policies, refusing to embrace the kinds of shock and awe tax reforms many of us wanted, or to cut spending faster, though he did introduce minor improvements. But he was breathtakingly and dangerously radical when it came to credit policy, embarking on a madcap scheme to subsidise home ownership and even effectively buy stakes in private homes, a move which could have been directly inspired by the sub-prime fiasco.

We saw paralysis on all the big aggregates on the tax and spend front; lots of tinkering, some of it positive, most of it useless; no movement on red tape; but a ludicrous, senseless dash for cheap credit when it came to housing, as if to desperately prop up what is left of the housing bubble. The only surprise was that his reform of the Bank of England’s monetary policy committee remit appears surprisingly mild – the inflation target remains, with some flexibility and the introduction of long-term guidance – but that was probably because his scheme to create Britain’s equivalent to America’s disastrous Fannie Mae/Freddie Mac combination will already provide him with all the easy money in the world.

There are two Osbornes: the dangerous gambler addicted to cheap credit; and the fusty purveyor of “steady as she goes, tax cuts cannot be afforded” fiscal orthodoxy. It is such a shame it isn’t the other way around: we need a fiscal revolutionary but monetary conservative. By taking the wrong kind of risks, he is storing up massive problems for the future.

There was some incremental good stuff, and a few surprises. Corporation tax will fall to 20 per cent in 2015; the first £10,000 of most people’s salary will be income tax free by 2014; beer tax is down (but lots of other levies are up); petrol tax isn’t going up; stamp duty is being eliminated for Aim-listed shares (shame it remains for others); and a better regime is being introduced for fund managers. The £2,000 per firm employers’ national insurance tax cut has excited a lot of people, but it will only really help micro-firms hiring their first or second employee, and won’t make a difference to the marginal cost of anybody else taking on an extra worker.

But the bigger picture gets grimmer by the Budget. The tax system is becoming ever more complex, with myriad special provisions, tweaking, tinkering, loopholes and fiddling. On Lombard Street Research’s new index of meddlesome chancellors, Osborne ranks as badly as Gordon Brown. Why? It is almost as if Osborne fancies himself as the puppet-master general, pulling the strings of the economy from the centre, just as Brown used to do. The only notable exception to this Osbrownomics is the merger of the small and large corporation tax regimes, a good simplification.

Growth forecasts have been slashed for this year (to 0.6 per cent) and next (1.8 per cent). At the same time, the Office for Budget Responsibility is continuing to predict that the good times are just around the corner – every few months, the return to boomtime is pushed back, but its prospect is always there, almost within reach. The same is true of inflation, which is miraculously always assumed to return to target a few years down the line. These broken models are becoming tiresome and are camouflaging the true extent of the crisis facing the UK.

The problem is that Osborne, even more than before, is relying on proper rates of growth returning to salvage what is left of his fiscal projections – and with more GDP, a resurgence in tax receipts. The predicted drop in the tax and spend to GDP ratios is primarily not being caused by actual cuts but by the hope of a growing economy. The official forecast is now that total spending will be just 2.7 per cent lower in real terms in 2017-18 than it was in 2010-11, when the coalition came to power. Between 2011-12 and 2014-15, the annual cut will be just 0.5 per cent in real terms; spending is then expected to go up by 0.2 per cent in 2015-16 before falling by 0.4 per cent during the subsequent two years.

Within this tiny overall real terms spending cut, some areas of expenditure are of course being slashed: capex will collapse by 21.9 per cent between 2010-11 and 2017-18, while current spending will drop a trivial 0.9 per cent. The departmental budget component of total spending will be slashed by 16.7 per cent, but overall current spending is being propped up by welfare and other areas.

In cash terms, spending keeps going up: from £693.6bn in 2011-12 to £765.1bn in 2017-18. Households and companies state their own accounts in nominal terms, so the figures are useful as a comparator.

The deficit is no longer going down: it was £121bn in 2011-12, £120.9bn in 2012-13 (suspiciously, this tiny fall is accounted for by delayed payments to international institutions; it appears deliberately engineered to avoid accusations of a rising deficit) and £120bn in 2013-14, when stripping out various exceptional measures. This is utterly dreadful.

The national debt was originally meant to peak next year as a share of the economy, and then start to fall, according to the chancellor’s original, uber-optimistic 2010 emergency Budget.

In reality, it is exploding: public sector net debt will hit 85.6 per cent of GDP by 2016-17, around 15 percentage points of GDP higher than the chancellor first thought. In cash terms, it will rise from £1.104 trillion in 2011-12 to £1.637 trillion in 2017-18. Gross debt as a share of GDP – the Maastricht definition more commonly used overseas – will end up even higher. We are reaching the levels that choke off growth.

If the chancellor’s inability to tackle our fiscal crisis is frightening, his attempt at trying to recreate a private sector housing bubble is truly terrifying. In the 1980s, Margaret Thatcher’s right to buy policies helped created a sustainable home-owning democracy, based on individual responsibility and genuine private property, and Osborne’s small extension to that scheme is good news.

But his help to buy policies are a perversion of that Thatcherite tradition, which helped millions of ordinary, hard-working aspirational folk declare their independence from the state and from social housing. Osborne’s plan achieves the opposite: it injects social democracy into home ownership and is making people more, rather than less, dependent on subsidies.

Help to buy is made up of two schemes – an “equity loan” where the government lends buyers who put in a five per cent deposit up to 20 per cent of the value of a new build home and a “mortgage guarantee” where lenders will be incentivised to make more mortgages available, with the government shouldering a vast amount of risk. Both these policies are absurd and will merely push prices up, while encouraging people to take on excessive risks.

On the one hand, the authorities have tried to make banking safer and discouraged high loan to value mortgages – on the other, they are subsidising them and exposing the taxpayer to them. The problem in the housing market – including that of excessive prices – is an insufficient supply of the right kinds of homes in the right places, which is damaging the quality of life of millions. The best way to tackle this deplorable situation is to drastically increase house building, and the supply of homes, not to further increase demand. Sadly, this isn’t on the cards: one of the Budget’s many failings was that it didn’t deregulate the UK’s antiquated planning laws.

Instead, we are left with a system which will turn thousands of homeowners – with properties worth up to £600,000 – into recipients of other taxpayers’ largesse. The 20 per cent loan is interest free for the first five years. From year six a fee of 1.75 per cent is payable on the equity loan, which rises annually by RPI inflation plus one per cent.

What will happen to all these new, riskier home owners with tiny deposits when interest rates eventually go up, or if house prices slump? It will be a catastrophe, and taxpayers will bear the loss. In the short-term, this policy may well buy votes; it is, however, bound to end in tears. It is astonishing how some people simply do not learn any lessons from history.