The tide is turning on public spending

Allister Heath
IT has taken over a year but the coalition is finally getting to grips with public spending. It is still going up in cash terms, of course (there were never any plans to cut the sterling value of public spending) but for the first time it appears to have started to drop in real terms. George Osborne has therefore finally started to deliver the first part of his strategy – but he is now facing a fresh problem which could yet derail him.

Growth remains far too weak for comfort, for a variety of domestic and global reasons; this will make it tough to keep his deficit reduction plans on track for the next four years, even before what is bound to be immense political pressure to turn the taps back on, Gordon-Brown style.

Last year, the government borrowed a terrifyingly large £142.1bn (9.6 per cent of GDP); this year Osborne was hoping to borrow an almost as spooky £122bn. It is this £20bn reduction in annual borrowing that critics have laughably described as “extreme” and “reckless” – even though it is clearly extremely dangerous to maintain borrowing as such elevated levels, as debt crises from Europe to America have demonstrated all too well. But those who believe that the best way out of excessively high deficits and spiralling debt is to borrow even more ought to celebrate: Osborne now looks as if he will miss his target.

Consider the facts. Central government current spending and net public investment rose 2 per cent in cash terms compared with the same period last year in April-June, still a little higher than the 1.5 per cent expected for the year as a whole. It is hard to know what the special measure of public sector inflation will turn out to be (it will be lower than the consumer price index) but public spending is probably falling at close to the 0.7 per cent predicted for the year as a whole. Citigroup’s excellent analysis of the official figures shows that benefit payments have risen 4.6 per cent year on year so far; debt service payments are up 14.3 per cent; net public investment is down 9.4 per cent.

So much for spending. What about revenues? The picture here is far from disastrous, especially when one controls for the proceeds from the one-off bonus tax, which raised £3.5bn in April 2010 and has since been replaced by a different bank tax that raises money throughout the year. If the figures are adjusted to reflect this, receipts are up 7.8 per cent. The deficit totaled £39.2bn, only slightly down from £39.5bn in the same period a year earlier, which looks terrible. But adjusting again for the bonus tax, the deficit in April-June fell by £3.9bn, better but still suggesting Osborne will miss his target for 2011-12. He desperately needs more GDP growth.

The Chancellor’s bid to gradually cut the deficit remains essential to salvaging the economy. Osborne’s mistake has been to rely too much on tax hikes, especially April’s job-destroying national insurance increase inherited from Labour, as well as January’s VAT increase, to protect spending. He hasn’t benefited politically from this choice – everybody thinks he is slashing spending by far more than the reality – and the taxes are damaging growth. Osborne is right on austerity (though not always on how to achieve it) – but wrong not to be deregulating the economy, cutting the most damaging taxes and truly making the UK open for business again. He needs some supply-side medicine to boost growth and revenues – and fast.
Follow me on Twitter: @allisterheath