Osborne's £12bn black hole
Without further cuts and tax rises, Osborne will likely miss his pledge to eliminate the structural
As the Lib Dems fight in Birmingham to emphasise their "distinctiveness", it's worth remembering that they and the Tories are at one on the need to stick to George Osborne's deficit reduction strategy. Like Cameron and Osborne, Clegg and Cable argue that the adoption of a "plan B" would trigger a dramatic loss of confidence in Britain and a rise in interest rates. As Clegg told Andrew Marr on Sunday: "Does anyone seriously think that by ripping up the plan to balance the books, that somehow you will create growth by next Tuesday? It is a complete illusion. Actually what you would create is outright market panic, higher interest rates and more unemployment."
The coalition has pledged to meet two fiscal targets by the end of this parliament - the elimination of the structural deficit and a reduced debt-to-GDP ratio. But lower-than-expected growth (as the graph below shows, forecasters have slashed their 2011 growth predictions), reduced tax revenues, and higher-than-expected unemployment means that both goals are in doubt. Osborne was forced to announce an extra £44.5bn of borrowing at the Budget in March and the economic picture has only darkened since.
Average of independent forecasts for 2011
Today's FT offers confirmation of the Chancellor's woes. The paper replicated the model of government borrowing used by the OBR and found that the structural deficit (the part of the deficit that remains even after growth returns) is set to be £12bn higher-than-expected. Consequently, without further spending cuts and/or tax rises, it's likely that Osborne will miss his pledge to eliminate the structural deficit by 2014-15, and he may not even meet it in 2015-16. Judging by this prognosis, all thought of a pre-election "giveaway" should be abandoned. Indeed, austerity may well last into the next parliament. The FT notes that plugging the black hole at the next Budget would require the equivalent of raising VAT from 20 per cent to 22.5 per cent. But if I was Osborne I'd be more inclined to adopt a version of Vince Cable's "mansion tax" in addition to other taxes on property and land. Polls show strong public support for new wealth taxes.
Of course, Osborne and his allies will argue that all of this vindicates the government's approach. If even the coalition's austerity measures can't eliminate the structural deficit, how would Labour do? But the opposition, in the person of Ed Balls, will rightly reply that it was Osborne's decision to cut (and tax) too hard and too early, that led to reduced growth and, consequently, a slower pace of deficit reduction. The widening gap in the public finances could turn the fiscal debate on its head - and not a moment too soon.