Austerity after 2015: why the worst is yet to come

Without further welfare cuts or tax rises, the next government will have to cut departmental spending 50% faster.

With a week to go before the Spending Review, reports suggest that the Treasury has secured just a third of the £11.5bn of cuts planned in 2015-16. Yet amid the claim and counter-claim about how far departmental budgets can be squeezed, it is worth reflecting on how the review fits into the broader context of deficit reduction. If current plans are to be delivered, this round of cuts is merely an hors d'oeuvre for a far more painful set of decisions to be made after the next election.

New analysis by the Resolution Foundation shows that departments are already expected to be some 9% smaller on average in 2014-15 than in 2010-11 as a result of cuts in the 2010 Spending Review. With spending on health, schools and overseas aid protected, these have been far starker for some departments. At the extreme, the Foreign Office will be just half of its previous size, while the communities department will have shrunk by more than two-fifths. More typically, the defence budget will have fallen by 17%, while the Home Office will have suffered a 25% cut.

Not surprising, then, that the 2.6% of additional savings called for in 2015-16 are proving hard to find. With health, schools and overseas aid once again protected, the government’s plans imply average cuts of 8% across all other departments. With every additional pound of savings harder to identify than the last, don’t be surprised if the Chancellor decides to raise extra revenue from further welfare cuts.

Yet the new analysis also shows that - if the current deficit reduction timetable is adhered to — there’s (much) more to come. Painful though the current process is, existing plans imply a further £26bn of cuts between 2016 and 2018. This would mean either accelerating the pace of departmental cuts or introducing major new welfare cuts or tax rises. As tough as 2015-16 may be, this year’s Spending Review would merely be the calm in the eye of the storm.

What does this mean in practice for the years after 2015? Delivering the current plans without further welfare cuts or tax rises would imply speeding up departmental cuts by 50%. If health, schools and aid spending is again protected, that would imply cumulative cuts to unprotected departments by 2017-18 that begin to look implausible. Defence and the Home Office would be between one-third and one-half smaller than in 2010-11. The Foreign Office would be two-thirds smaller than it was seven years before.

This scenario would have profound implications for the role and shape of the state. Total departmental spending would have fallen 18% between 2010-11 and 17-18. Within that total, the proportion going to health would have increased from one-quarter to one-third, while spending on defence would have fallen from 10% to 8%.

Of course, the government could decide to ease post-2015-16 departmental cuts by seeking more from welfare or tax. Yet our new analysis reveals that simply keeping post-election departmental cuts to their current pace will require an extra £10bn from welfare or tax over two years. For a sense of scale, this is the equivalent of finding more in two years than will be cut from the tax credit budget in seven (£9bn). Alternatively, it would mean raising VAT from 20% to 21%. Hardly options that will help to ease the decade-long squeeze on living standards.

In reality, any post-2015 government would be likely to adopt a combination of measures. In particular, we can expect to hear more in the coming weeks and months about a potential cap on ‘structural’ aspects of Annually Managed Expenditure (AME). While both the government and the opposition have declared an intention to grapple with these aspects of spending, practical and political constraints mean their options are limited. Once we rule out the non-welfare parts of AME (e.g. debt interest payments) and politically-sensitive benefits (the state pension) that leaves less than one-third to work with. Within this envelope, housing benefit, tax credits and the employment and support allowance would appear to be in line for cuts. Determining which aspects of such payments are structural and which are cyclical will be a difficult task.

Finally, we might expect calls for cuts in pensioner benefits to intensify. Under current plans, the proportion of welfare spending accounted for by the State Pension and associated benefits is set to increase from 42% in 2010-11 to 48% in 2017-18. The government’s ‘triple lock’ means that this is a product not just of demographics, but of increased generosity per pensioner. Average pensioner payments are set to increase by 6% over the period at the same time as average working-age support declines by 15%.

Of course, we shouldn’t forget that all of these numbers depend heavily on deeply uncertain estimates of the output gap, a figure that has been revised dramatically in the past and may well be revised again. But it’s difficult to see past the likelihood that the post-election period will bring with it a new suite of difficult choices, from departmental cuts that look increasingly hard to deliver to further cuts to working-age support or the introduction of unannounced tax rises. Ultimately, we might be looking at further slippage in the deficit-reduction timetable. Don’t rule out the chance of it being all four.

Matthew Whittaker is senior economist at the Resolution Foundation

George Osborne during a visit to a branch of Lloyds bank on June 19, 2013 in London. Photograph: Getty Images.

Matthew Whittaker is senior economist at the Resolution Foundation

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Geoffrey Howe dies, aged 88

Howe was Margaret Thatcher's longest serving Cabinet minister – and the man credited with precipitating her downfall.

The former Conservative chancellor Lord Howe, a key figure in the Thatcher government, has died of a suspected heart attack, his family has said. He was 88.

Geoffrey Howe was the longest-serving member of Margaret Thatcher's Cabinet, playing a key role in both her government and her downfall. Born in Port Talbot in 1926, he began his career as a lawyer, and was first elected to parliament in 1964, but lost his seat just 18 months later.

Returning as MP for Reigate in the Conservative election victory of 1970, he served in the government of Edward Heath, first as Solicitor General for England & Wales, then as a Minister of State for Trade. When Margaret Thatcher became opposition leader in 1975, she named Howe as her shadow chancellor.

He retained this brief when the party returned to government in 1979. In the controversial budget of 1981, he outlined a radical monetarist programme, abandoning then-mainstream economic thinking by attempting to rapidly tackle the deficit at a time of recession and unemployment. Following the 1983 election, he was appointed as foreign secretary, in which post he negotiated the return of Hong Kong to China.

In 1989, Thatcher demoted Howe to the position of leader of the house and deputy prime minister. And on 1 November 1990, following disagreements over Britain's relationship with Europe, he resigned from the Cabinet altogether. 

Twelve days later, in a powerful speech explaining his resignation, he attacked the prime minister's attitude to Brussels, and called on his former colleagues to "consider their own response to the tragic conflict of loyalties with which I have myself wrestled for perhaps too long".

Labour Chancellor Denis Healey once described an attack from Howe as "like being savaged by a dead sheep" - but his resignation speech is widely credited for triggering the process that led to Thatcher's downfall. Nine days later, her premiership was over.

Howe retired from the Commons in 1992, and was made a life peer as Baron Howe of Aberavon. He later said that his resignation speech "was not intended as a challenge, it was intended as a way of summarising the importance of Europe". 

Nonetheless, he added: "I am sure that, without [Thatcher's] resignation, we would not have won the 1992 election... If there had been a Labour government from 1992 onwards, New Labour would never have been born."

Jonn Elledge is the editor of the New Statesman's sister site CityMetric. He is on Twitter, far too much, as @JonnElledge.