five-year public spending freeze to kill off big government

Let's have a five-year public spending freeze to kill off big government

As the meltdown of the Government has been gathering pace against the backdrop of the continuing saga of MPs' expenses, another financial scandal has been rumbling on: the appalling state of the UK's public finances.

By Roger Bootle
Published: 9:55PM BST 07 Jun 2009

Comments 20

With a general election now looking possible sooner rather than later, the issue of what to do about it could soon be a live one.

How bad is the situation? Since the Budget, we have had the borrowing figures for the first month of the fiscal year. Already the Chancellor's forecasts are looking testing. Net public borrowing came in at £8.5bn compared to last April's figure of £1.8bn.

UK services sector shows surprise return to growth in MayThe Budget forecast for borrowing for this fiscal year was £175bn. I think the outturn will be more like £200bn. Next year, the Treasury expects borrowing to nudge down a touch to £173bn, but I reckon that it will probably rise further, perhaps to £230bn. This would be over 16pc of GDP and far and away the highest peacetime deficit ever.

If the election comes sooner, is there a case for an emergency Budget? There is, but in all likelihood an early election will not come before October and at that point the financial year would be more than half way through.

It would, though, be possible to implement some emergency spending cuts and certainly possible to raise VAT and excise duties with more or less immediate effect (increasing the VAT rate to 20pc would raise about £10bn per annum. It would be quite feasible to announce this new rate to coincide with the planned expiry of the temporary VAT cut in December).

But income tax measures and a wholesale review of public spending for this financial year would not be possible. The sensible thing would be to use the pre-Budget report, which is usually presented to parliament in November, to announce measures to take effect next April.

What should those measures be? There will be considerable pressure on the new government to raise taxes. Historically, this has been easier to do than cutting spending. And some leading Conservatives apparently think that this would also be easier politically.

Perhaps political considerations will require that some taxes go up, in order to "share the pain". But the economic case for higher taxes is weak.

Raising taxes in a recession is not usually to be recommended. But it is particularly not to be recommended at this juncture, when consumer confidence is so fragile. It is quite conceivable that the end result would be to depress tax revenues overall.

In Conservative mythology, the tight Budget of 1981, far from preventing economic recovery, as 364 economists famously argued that it would, actually spurred it on.

But it would be dangerous to assume that the same thing would happen this time. At that point, the tighter Budget allowed interest rates to be cut by 2pc and the pound fell sharply. This is what brought the recovery – despite, not because of, the fiscal tightening.

But the situation today is utterly different. Interest rates cannot be cut any more. The most that the authorities could do is to increase the amount of quantitative easing. But there is little evidence yet that it is having much impact on the economy. And in these circumstances a further fall of the pound is far from certain.

Moreover, raising taxes would amount to addressing the borrowing problem without addressing the side of the equation which has gone badly wrong, namely expenditure. Surely no one is saying that we have a deficit problem because tax rates are too low?

Equally, we must assume that a Conservative government would not see higher tax rates as the ultimate way forward. They would be a stop-gap until the deficit was brought down in other ways. All the more reason to go directly for the thing which is at the root of the problem and cut public expenditure.

Last week the Policy Exchange think-tank published a paper showing that the current fiscal plans envisage what amounts to a second Gordon Brown public spending splurge. This spending was not affordable when the plans were first announced but it looks ridiculous now.

In the end, what is going to bring the deficit down is the combination of economic growth and expenditure restraint. Trying to bring it down quickly through major emergency measures is both risky and unnecessary. The need for action comes from the essential requirement to retain the markets' confidence. What matters is less what the current number is, than the markets' conviction that the deficit will come down and that the Government has the will to bring it down. In that respect, raising taxes, precisely because it is apparently "easy", may not do much good.

The way forward is to freeze all public spending in nominal terms at this year's level for the duration of a whole parliament. Over and above this, there would be scope for cuts in particular areas where waste could be identified, and some or all of this money could then be allocated to other deserving areas. An overall freeze as opposed to cuts may not sound very impressive, but it would mark a huge change from the existing plans, which envisage an increase in public spending over the next two years of £58bn and a staggering £104bn over the next four years. A freeze, by contrast, would mean that, once the economy started to grow, then public spending would inexorably fall as a share of GDP.

Of course, any "cuts" of this sort would have to overcome some major headwinds. For public spending is set to be driven still higher by the increase in unemployment and related benefits as a result of the recession, and increased interest payments resulting from much higher debt.

Moreover, the Conservatives have pledged to ring-fence some areas from any squeeze, including overseas aid and health (though why we should be so keen to make sure that at this difficult juncture we give away abroad as much as possible I do not understand).

Health is a tricky issue, not just because of the Conservatives' commitment, but also because of their perception that the voters are deeply committed to the NHS. But the health budget is £100bn. If existing plans for big future increases in NHS spending are allowed to stand then the squeeze on other areas would have to be still greater. I would freeze health spending too.

This issue is not just about getting the borrowing numbers down. An incoming Conservative government will have a once-in-a-lifetime opportunity to set this economy on the right path by sharply reducing the size of the public sector. It will not come again. The time to do the really difficult things is right at the start.

roger.bootle@capitaleconomics.com

Roger Bootle is managing director of Capital Economics and economic adviser to Deloitte.

http://www.telegraph.co.uk/finance/comm ... nment.html

For Immediate Release
June 8, 2009
Contact: Joe Brettell
(202) 225-3484




Hensarling: Terminate TARP
WASHINGTON — Congressman Jeb Hensarling, the lone sitting Member of Congress on the Congressional Oversight Panel for the Troubled Asset Relief Program released the following statement regarding his legislation to terminate the TARP in six months:

“The economic justification for TARP’s creation and taxpayer assistance to financial institutions no longer exists. It’s clear to me that the original goals for TARP – primarily financial stability and taxpayer protection – are no longer the aim of the program. It is increasingly being used instead to promote the economic, social and political agendas of the administration.

“Through the stress tests regulators have assured us of financial market stability going forward – there is a defined capital hole and there is adequate unused TARP capital for this shortfall. In addition, banks are again raising capital in the private markets, which can serve to reduce the capital shortfall identified by the stress tests. If banks are unable to raise capital, there is adequate unused TARP capital for this shortfall.

“As a result, my legislation puts a firm end point in place for TARP – December 31, 2009– the stress test results and the remaining unallocated TARP authority allow me to conclude that TARP does not need to be extended.

“Members of Congress were told that TARP was an emergency measure, and should another economic emergency occur, the 111th Congress can take action. Furthermore, the Federal Reserve still retains its 13(3) unusual and exigent circumstances power, should they be needed.â€