Something has to give. If the British state is to avoid shrinking back to the size it was when Churchill was fulminating against appeasement, taxes have to rise, borrowing has to increase or welfare has to face deeper cuts. That was the message from the Institute for Fiscal Studies as it skewered George Osborne over the spending plans laid out in the autumn statement.
The chancellor has had better days. He woke up to find the Today programme concentrating on what his deficit reduction plan meant for the size of the state rather than what his stamp duty reform meant for homebuyers. He took exception to the suggestion that his spending plans will lead to government being pared back to its smallest level as a share of the economy since the 1930s. He said the IFS was wrong in its analysis of the impact of his deficit reduction scheme on Whitehall budgets. And he accused the BBC of hyperbole.
Osborne needs to tread carefully. To be sure, the deficit reduction plans sketched out in the autumn statement are not in set in stone. No question, there are ways of filling the gap in the public finances that do not involve reducing the number of bobbies on the beat and soldiers in the field.
But it was the independent Office for Budget Responsibility, which the chancellor set up, that drew the comparison with the 1930s. And the IFS is not the sort of organisation to make wild claims. As Oscar Wilde might have said, to be at odds with one group of fiscal experts is unfortunate. To be at odds with both looks like carelessness.
The IFS was certainly not in any mood to back down when it delivered its usual “post-match” analysis on the autumn statement. Its director, Paul Johnson, said there would need to be “huge” spending cuts in order for Osborne to deliver his proposed £23bn budget surplus by 2019-20. “The chancellor is right to point out that it has proved more than possible to implement substantial cuts over this parliament”, Johnson added. “One cannot just look at the scale of implied cuts going forward and say they are unachievable. But it is surely incumbent upon anyone set on taking the size of the state to its smallest for many generations to tell us what than means.
“How will these cuts be implemented? What will local government, the defence force, the transport system, look like in this world?”
The short answer to Johnson’s question is that the cuts will probably not be delivered in their entirety. It is not really conceivable that ministers would sit on a £23bn surplus in the run-up to the next general election. It would shower voters with spending increases and tax cuts. But the IFS took the chancellor at his word. It assumed he was deadly serious about his deficit reduction plan and showed what it implied for government departments. It split the decade from 2010 to 2020 into two parts, the period up until 2015-16 when the Treasury has specified how budget savings will be made and the period after that when cuts have so far not been allocated.
In the period from 2010-11 to 2015-16 spending by departments was reduced by 9.5% after taking account of inflation. But the NHS, day-to-day spending in schools, and overseas aid were given preferential treatment. Spending in these three areas rose by 6.5%, leaving non-protected departments with bigger cuts of 19.9% on average.
But the savings made so far only amount to 40% of the total expected by Osborne by 2019-2020. A further 14.1% real reduction in departmental spending will be needed by 2019-2020 if the Treasury is to meet its plans. On the assumption that spending on the NHS, schools and aid will be ring-fenced but will not actually increase, that would require unprotected departments to take another 26.3% hit on average.
The cumulative impact of the cuts over the entire 10-year period would see overall departmental spending fall by 22%, spending on the protected areas rise by 6.5% and spending in unprotected departments cut by 41%.
Osborne said it was wrong to assume that all the burden of deficit reduction would fall on departments, so the IFS modelled some alternatives. Raising taxes or cutting welfare by £21bn would enable the government to continue cutting departmental spending at its current rate of 2% a year. By abandoning his plans to run a £23bn surplus by the end of the next parliament and taking another £12bn out of the welfare budget, Osborne could limit the spending cuts in unprotected departments to 12.3% after 2015-16 (and by 6.6% overall) while at the same time delivering the £7bn of income tax cuts promised at the Conservative party conference.
Labour’s plans, which would allow borrowing to cover the 1.2% of national output spent on capital projects, would mean small departmental spending cuts after 2015-16 of 2.3% for unprotected parts of Whitehall and 1.3% overall, assuming no tax increases or further welfare cuts.
The two main parties, therefore, go into the election battle with quite different approaches. Osborne would like to run a budget surplus by the end of the next parliament. His Labour shadow Ed Balls is only aiming to balance the budget for day-to-day government spending and would borrow to invest. The gap between the two main parties is at its widest for decades.
