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29 September 2014

George Osborne needs wage growth not spending cuts

Tax revenues flowing into the Treasury would make a big difference to the amount of spending cuts needed.

By nida broughton

Time for some more doom and gloom today when George Osborne makes his speech to the Conservative party conference. Unlike some, the Chancellor is unlikely to forget to talk about the deficit. He has also been nicely handed the opportunity to make an entertaining quip or two at Labour’s expense.

That George Osborne’s spending plans involve some very painful cutting is hardly news. But the scale of the cuts are still breathtaking. Despite all the cuts since 2010, we are still only around halfway through the deficit reduction programme. As both the IFS and the Resolution Foundation point out, it means cutting spending by around £8 billion in the first year of the next Government, and then by another £37bn in the three years after that.

Labour was criticised last week for its pitiful suggestions as to how to close the gap – mansion taxes and child benefit caps are drops in the ocean. But the reality is that coming up with new ways of reducing borrowing is getting seriously difficult. The tax base is looking wobbly. Reducing investment seems hardly the right thing to do when we’re reaching capacity on our aviation and train networks; our roads are suffering from years of underinvestment; and our energy infrastructure is ageing. The NHS is showing signs of strain despite actually being so far protected from real terms cuts. As for other government departments, as Sir Bob Kerslake, outgoing head of the civil service put it, the easy cuts have already been made.

The Conservatives are planning to take £12bn off welfare. Given that we already know the state pension is likely to be protected, this will mostly fall on the working-age population. So far, announcements involve further reducing the total amount families can claim in benefits to £23,000 a year and taking away benefits from those aged under 21. Taking more from the working age population will be hard, coming after years of falling wages. And it would still leave a huge amount to come from departmental spending.

Unless Monday’s speech contains an announcement about an amazing new way that no one has yet thought of, guaranteed to save billions, it is hard to escape the conclusion that a future Conservative government will struggle to deliver cuts on this scale. It probably just won’t manage it.

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In fact, spending cuts aren’t going to be the decisive factor in meeting the Conservative’s target for an overall surplus in the next Parliament. If growth – especially wage growth – picks up in a strong way, the government could hit its target for a surplus much more easily. Tax revenues flowing into the Treasury would make a big difference to the amount of spending cuts needed.

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The latest figures on public borrowing show what a difference tax revenues can make. Borrowing is around 6 per cent higher than this time last year, mainly due to poor income tax receipts. If that continues, by the end of the year, borrowing will be around £19bn higher than the OBR forecast. Getting wage growth going again is the factor that separates success from failure in getting the public finances in order – not spending cuts.

George Osborne has done well to draw all the political parties into a race over who can cut the most spending. But again and again during this parliament, more cuts have had to be pencilled in as the economy has under-performed. The George Osborne version of events is going to start to wear thin if this carries on through the next few years. In the next parliament, the focus will need to switch away from cuts and onto growth. The next Chancellor will need to fix the economy to fix the deficit. Look after the underlying health of the economy, and the public finances will look after themselves.

Nida Broughton is chief economist at the Social Market Foundation