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 Receipts | 40.4 |
38.3 |
| Current Expenditure | 38.3 |
39.8 |
| Depreciation | 1.4 | 1.3
|
| Current Balance | 0.8 | -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
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