A stimulus Osborne can live with

If the Chancellor won't boost infrastructure spending, tax cuts are the best alternative.

Next Wednesday's Budget will be yet another reminder of the tough economic climate we're in. Over the past year, real GDP has increased by just 0.8 per cent, and forecasts for 2012 are not looking any better.

George Osborne will deliver his Budget against a backdrop of anaemic growth, high inflation, and unemployment rates not seen for 17 years. Consequently, he is under pressure to announce another Budget for growth. Expect Osborne to point to a previously announced cut in corporation tax to 25 per cent from April.

But one has to question if this is the best way forward, or if the Chancellor has got it the wrong way around. Sluggish growth has primarily been a result of both weak demand and squeezed household incomes. And the barrier facing companies is not high taxes but the uncertain outlook for demand. Given this uncertainty, companies are currently making a choice not to invest, or recruit employees - in effect intensifying the problem. An alternative and targeted solution would be to increase public spending, directly addressing faltering demand.

According to OBR analysis the effects of a change in spend are estimated to be two to three times greater than the effects of changes in taxation (although it focused on changes in personal tax rates rather than corporation tax). Increased public spending has a greater multiplier effect on the economy because more of the money goes straight into the UK economy, whereas cutting taxes can simply lead to people saving more and when they spend a substantial proportion of the stimulus is 'lost' overseas in the form of higher imports.

The best way to stimulate growth is to increase infrastructure spending. This would give the economy the kick it needs, boosting demand. Additionally, the benefits extend to the long term as infrastructure spending not only increases growth but adds to the UK's productive capacity. Yet there is no sign that the Chancellor will drop his rigid austerity agenda despite its poor track record - over 2.67 million people out of work - and waning support.

So what's the second best option given Osborne's unwavering political commitment to spending cuts? Personal tax cuts offer an alternative - and quick - method of boosting demand and a number of options exist. Temporary cuts in VAT or the National Insurance contribution would both serve to put more money directly into people's pockets, boosting demand and encouraging businesses to invest and create the jobs we desperately need. This could be largely paid for - over a six-year period - with a "mansion tax", which would hit only the very wealthy and so have little impact on the economy.

The economy is flatlining. To get the economy back up to speed we require measures that address the root of the problem - weak demand. While higher public spending offers the most 'bang for your buck' it is unlikely to happen. The next best thing would be to use temporary personal tax cuts to increase consumer demand.

Amna Silim is a Researcher at IPPR

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George Osborne's mistakes are coming back to haunt him

George Osborne's next budget may be a zombie one, warns Chris Leslie.

Spending Reviews are supposed to set a strategic, stable course for at least a three year period. But just three months since the Chancellor claimed he no longer needed to cut as far or as fast this Parliament, his over-optimistic reliance on bullish forecasts looks misplaced.

There is a real risk that the Budget on March 16 will be a ‘zombie’ Budget, with the spectre of cuts everyone thought had been avoided rearing their ugly head again, unwelcome for both the public and for the Chancellor’s own ambitions.

In November George Osborne relied heavily on a surprise £27billion windfall from statistical reclassifications and forecasting optimism to bury expected police cuts and politically disastrous cuts to tax credits. We were assured these issues had been laid to rest.

But the Chancellor’s swagger may have been premature. Those higher income tax receipts he was banking on? It turns out wage growth may not be so buoyant, according to last week’s Bank of England Inflation Report. The Institute for Fiscal Studies suggest the outlook for earnings growth will be revised down taking £5billion from revenues.

Improved capital gains tax receipts? Falling equity markets and sluggish housing sales may depress CGT and stamp duties. And the oil price shock could hit revenues from North Sea production.

Back in November, the OBR revised up revenues by an astonishing £50billion+ over this Parliament. This now looks a little over-optimistic.

But never let it be said that George Osborne misses an opportunity to scramble out of political danger. He immediately cashed in those higher projected receipts, but in doing so he’s landed himself with very little wriggle room for the forthcoming Budget.

Borrowing is just not falling as fast as forecast. The £78billion deficit should have been cut by £20billion by now but it’s down by just £11billion. So what? Well this is a Chancellor who has given a cast iron guarantee to deliver a surplus by 2019-20. So he cannot afford to turn a blind eye.

All this points towards a Chancellor forced to revisit cuts he thought he wouldn’t need to make. A zombie Budget where unpopular reductions to public services are still very much alive, even though they were supposed to be history. More aggressive cuts, stealthy tax rises, pension changes designed to benefit the Treasury more than the public – all of these are on the cards. 

Is this the Chancellor’s misfortune or was he chancing his luck? As the IFS pointed out at the time, there was only really a 50/50 chance these revenue windfalls were built on solid ground. With growth and productivity still lagging, gloomier market expectations, exports sluggish and both construction and manufacturing barely contributing to additional expansion, it looks as though the Chancellor was just too optimistic, or perhaps too desperate for a short-term political solution. It wouldn’t be the first time that George Osborne has prioritised his own political interests.

There’s no short cut here. Productivity-enhancing public services and infrastructure could and should have been front and centre in that Spending Review. Rebalancing the economy should also have been a feature of new policy in that Autumn Statement, but instead the Chancellor banked on forecast revisions and growth too reliant on the service sector alone. Infrastructure decisions are delayed for short-term politicking. Uncertainty about our EU membership holds back business investment. And while we ought to have a consensus about eradicating the deficit, the excessive rigidity of the Chancellor’s fiscal charter bears down on much-needed capital investment.

So for those who thought that extreme cuts to services, a harsh approach to in-work benefits or punitive tax rises might be a thing of the past, beware the Chancellor whose hubris may force him to revive them after all. 

Chris Leslie is chair of Labour's backbench Treasury committee.