some default text...
Budget 2010 - Treasury Contents


Written evidence submitted by Martin Weale, National Institute of Economic and Social Research

THE BUDGET AND THE CHOICE BETWEEN TAX RISES AND SPENDING CUTS

  1.  The Budget promises unprecedented fiscal tightness. Budget 2010 (table B10) shows that real government consumption is planned to fall by 1.5% in 2011 and a further 2% in 2012. This offers the best guide to what the Treasury expects to happen to government provision of goods and services overall. As chart 1 shows such a change has not happened since the 1950s; however, the cuts between 1953 and 1958 were achieved by reversing the build-up of defence spending that had taken place as a result of the Korean War, and did not affect other government consumption. Indeed, apart from this period there has not been two years' reduction in government spending in a row and in no single year was there a cut as large as the 2% planned for 2012 since 1950.


  2.  Although fiscal policy has played a valuable role in supporting the economy, the discussion of how best to return to budget balance suggests that the basic economic fundamentals underlying this part of the policy response have been missed. The country's income has probably fallen by around 4-5% as a result of the crisis and a rational starting point would therefore be to consider reducing all expenditures (including benefits) by 4-5% relative to what had been planned previously, so as to deliver roughly the same expenditure share. Some forms of expenditure are contractually set (debt interest and existing public sector pension commitments), pointing to somewhat larger across the board cuts in other forms of spending, or perhaps providing a reason for letting the expenditure share rise slightly, with corresponding increases in taxes.

  3.  There has probably also been a reduction in the tax take—the amount of tax collected by the tax system at any given rate structure. A rational starting point for considering how to address this would be to propose increases in tax rates to compensate for this.

  4.  Some impact of the changed circumstances can be seen by comparing the Budget 2007 shares of current receipts and current expenditure with those shown in Budget 2010. Budget 2007 assumed that the economy would be on trend in 2010, and the receipts and expenditure shares indicate what was thought appropriate given this assumption. Budget 2010 assumes that the economy will be close to, but still below trend in 2015.


Budget 2007—Projections
for 2011-12
Budget 2010—Projections
for 2014-15


Current Receipts40.4 38.3
Current Expenditure38.3 39.8
Depreciation1.41.3
Current Balance0.8-2.8




  While the 2007 budget projected a current surplus for 2011-12, it should be noted that, given what has been learned since about budgetary risks, this surplus is in fact probably too small for normal times to guarantee overall sustainability. But the main point is, compared to what had been regarded as reasonable pre-crisis, receipts are about two percentage points too low and expenditure is about one and a half percentage points too high. This suggests that, to restore balance beyond what has already been planned, more of the adjustment should be put on tax increases than on expenditure cuts.

  5.  There are two reasons why one might want to depart from these rules of thumb. First, one might consider that there was in any case too little or too much government spending proposed in the 2007 Budget. Secondly, one might be concerned that the excess burden—the economic loss associated with taxes over and above the cost of paying those taxes—is higher for the tax structures that would be needed nowadays than it was for the taxes which had been proposed in the 2007 Budget. The first point is more a matter of political than economic judgement, while the second point is unlikely to be of great practical importance.[3]

  6.  None of this is to say that the government current account should necessarily be brought into balance or surplus by 2014-15. The government has to make a number of judgements including taking account of the risk of economic weakness as a result of early retrenchment and the risk of a financial crisis as a result of failing to retrench. But the analysis does provide a guide how one might think of spreading the overall fiscal adjustment which is needed.

  7.  As far as adjusting expenditure goes, of course there has been considerable discussion of what will ring-fenced and very little of what will be cut. Very obviously, the more that is ring-fenced, the larger must be the cut on non-ring-fenced spending and the discussion does not reflect this economic reality. To give an example of the misallocation which is likely to result from ring-fencing, the general view is that health expenditure tends to rise in line with, or more than in proportion to income as income rises, reflecting a public desire to spend disproportionately on health care as incomes raise. This creates a good argument that with a reduction in income, spending on health should fall in line or more than in proportion.

CONCERNS ABOUT THE BUDGET FORECAST

  8.  Separately the National Institute has considerable doubts as to whether the government's programme will be adequate to deliver the hoped for budgetary outturn in 2013-14. These doubts arise because i) we expect the recovery to be slower than does the government and ii) we expect tax revenues to be weaker.

  9.  The speed of the recovery is a balance between the support offered by very low interest rates offset against the weakness to demand resulting from both the government and the household sector trying to reduce their indebtedness and the unprecedented nature of the current circumstances mean that, even though the Treasury's position is perfectly reasonable, there have to be concerns that growth may be slower than is hoped.

  10.  Much has been made of the fact that tax revenues were higher than the Treasury forecast in the Pre-Budget Report and this might be grounds for continuing optimism over tax revenues. However the National Institute had, in January 2010, forecast net borrowing of £164.5 billion for 2009-10 and we nevertheless have considerable doubts that tax revenues will be as buoyant as the government hopes. In particular we have doubts that housing and financial sector receipts will show recover to the extent shown in Box C3.

  11.  Our own forecast is for the deficit in 2013-14 to be larger than the government hopes by just over 1% of GDP. However, the point made repeatedly after previous budgets is of equal importance today. If revenues prove stronger than forecast, a strong case can be made for saying that the deficit should be allowed to decline faster. The key question is what the government proposes to do if revenues prove weaker than hoped.

March 2010







3   Current receipts in the early 1980s were well above 40% of GDP without obvious damage to the economy. Back


 
previous page contents next page

House of Commons home page Parliament home page House of Lords home page search page enquiries index

© Parliamentary copyright 2010
Prepared 16 April 2010