A responsible deficit reduction plan

With the Spending Review just four weeks away, pressure is beginning to ramp up on George Osborne with widespread public dissatisfaction over his cuts and a challenge from his colleague, Boris Johnson, over the strategy. Pre-empting the Labour leadership candidates’ debate on deficit reduction, I gave a presentation to the Reform think tank earlier this week setting out my own deficit reduction plan which avoids the masochistic excesses of the chopper Chancellor.

My slides started with four graphs setting out the true story about the deficit, public debt, and the bond market using figures from HM Treasury, the OECD, and Bank of England. Regular readers of Left Foot Forward will be familiar with the argument on which I elaborate below(*) but the essential point is that while the deficit has to come down, there is no compelling economic case for the pace of retrenchment that George Osborne proposes.

But since the deficit has to come down, how can we do so responsibly? My proposal is to stick to Alistair Darling’s plan to cut the deficit in half over four years but split the impact 50:50 between tax and spending cuts – precisely what Norman Lamont and Ken Clarke did in the 1990s.

This would mean £28.5 billion in tax rises by 2013-14 delivered through the 50p tax rate and fulfillment of Labour’s proposed increases to NICs. I would add to that a mansion tax, the full Capital Gains Tax rise proposed in the Lib Dem manifesto, and a doubling of the banking levy.

On the spending side, there is no need for any of the deeply regressive welfare cuts including to housing benefit, the freeze on child benefit, or tax credit reforms (though I do have some sympathy with making 16 the cut off for child benefit). Instead, I would look for an average efficiency of 8.1 per cent across all Government departments aside from DfID. This would, of course, include the Health department which makes up close to one-third of all departmental spending. A significant chunk of this could come from a 3-year public sector pay freeze (around £8 billion according to the SMF).

Before getting into the broad macroeconomic and specific microeconomic policies that are needed to deliver economic growth, this responsible deficit reduction would reduce growth by virtually half as much as the Tory programme. Using the cautious multipliers estimated by the Office of Budget Responsibility (Table C8 of the Budget), I have calculated that my deficit reduction plan would take just 1.5 per cent out of the economy compared to 2.7 per cent by the Conservatives.

The responsible deficit reduction plan also avoids the ideological and masochistic approach taken by the Tories. There is no need for a regressive VAT rise, no need for huge welfare cuts that will disadvantage the most vulnerable, and no need for 25 per cent cuts from unprotected departments.

Given the proximity of the Spending Review, I’d be very interested to hear your thoughts on this approach.

* Labour should take responsibility for running a slight cyclically-adjusted structural deficit from 2005-07. During this period it was irresponsible to allow spending to continue to rise without a commensurate increase in tax revenues. But most of that small deficit was due to capital spending and, crucially, the Tories backed Labour’s spending plans until November 2008.

The record post-war deficit seen since the recession has been due to the financial crash including bailouts for the banks, increases in spending on unemployment and other benefits, and a falloff in tax receipts. Public spending also appears to have shot up on a percentage scale since GDP has fallen by around 6 per cent.

But Britain is in a good position to absorb this increase so long as the deficit is reduced over the medium term. Labour had brought down public debt after it rose in the mid-1990s. We are well placed internationally to absorb the rise and the bond market shows no signs of raising long-term interest rates. (And, no, this is not due to George Osborne’s policies as our own Duncan Weldon and the Independent’s Ben Chu showed yesterday).

42 Responses to “A responsible deficit reduction plan”

  1. Melissa Nicole Harry

    RT @leftfootfwd: A responsible deficit reduction plan http://bit.ly/bvVT0V

  2. Andy Sutherland

    RT @leftfootfwd: A responsible deficit reduction plan http://bit.ly/bvVT0V

  3. Shamik Das

    On @leftfootfwd this morning, @wdjstraw outlines a responsible deficit reduction plan: http://bit.ly/bvVT0V

  4. David Wearing

    Will – This is certainly commendable by contrast to Osborne’s proposals, particularly in the rebalancing toward taxation at the top end and away from the regressive extremes in respect of VAT and welfare cuts.

    Two questions remain. First, though your rebalancing is welcome, it (and Darling’s plan) are rather flattered by comparison to Osborne’s crazed dogmatism. By any more sensible measure, your plan and Darling’s must still involve serious pain for people who played no part in causing the crisis.

    A 3-year public sector pay-freeze will hit many thousands of people on middle and lower incomes; by which I mean £25,000 and often much less per year to support a family and pay a mortgage. Why should such people, already in tight circumstances, take a real-terms pay cut as a consequence of the recklessness of bankers and politicians who, even taking your mansion tax, CBT and banking levy into account, will still be positively wallowing in unearnt and unnecessary riches?

    Related to this, is it realistic to demand an average efficiency of 8.1 per cent across all Government departments? Put aside comparisons to Osborne’s demented numbers and look at this on its merits. Do you have evidence that there is a average of 8.1% waste across the public sector that can be trimmed without hurting the people who rely on the public sector the most?

    Secondly, the pace of the deficit reduction. Do you agree with the 37% of the public (equal to those supporting Darling’s plan) who said that protecting jobs and vulnerable people is the priority over cutting the deficit? If so, and given that your own plan is certainly going to hurt ordinary and entirely blameless people very badly, what is your argument against slowing the pace of deficit reduction from the Darling plan, as Ed Balls has argued should happen? Why shouldn’t this take place over the medium rather than the short term, three parliaments rather than two (say), given that this could save a lot of ordinary people a lot of heartache and misery?

    Interested in your thoughts.

  5. Tam Chandler

    RT @davidwearing: RT @leftfootfwd Will Straw's deficit reduction plan http://bit.ly/bvVT0V <<– see my response below

  6. P J Ward

    I agree wholeheartedly with David Wearing’s submission(above)re the section which says “I would look for an average efficiency of 8.1 per cent across all Government departments aside from DfID. This would, of course, include the Health department which makes up close to one-third of all departmental spending. A significant chunk of this could come from a 3-year public sector pay freeze (around £8 billion according to the SMF).”
    The people who would be hit hardest are those lower grade Civil Service, NHS, Local Government, etc, who do the worthwhile jobs we take for granted. These are also the people who have heard Chancellor after Chancellor for the last 40/50 years say “freeze public sector pay” or “increase efficiency” when times are difficult but receive no recompense when the economy rallies!
    When, because of “efficiencies,” there’s no hospital porter to fetch the defibrillator when you have a heart attack in a ward, the doctor can’t save you!
    When your streets are overrun with rats and foxes, because of “efficiences,” and disease increases, what do you do!
    When there’s no Admin Assistant to process your Tax Rebate or your Winter Fuel Benefits applications, how do you survive or keep warm!
    These are the type of impacts people should be remembering, when they come out with the old maxims “freeze public sector pay” or “increase efficiency by so much.”

  7. Michael Burke

    Will

    there are two problems with the slower spending cuts outlined in Alistair Darling’s March Budget.

    First, they contain £130bn in spending cuts over 4 years compared to £216bn from Osborne. Therefore they are likely to lead to job losses (pro rata, based on the Treasury estimate of 1.1-1.3mn jobs in Osborne’s Budget) of 660,000-780,000. From a Labour government.

    Secondly, neither plan will actully reduce the deficit. Experience shows that these cuts will widen the deficit (1930s, Britain under Thatcher, Greece and Ireland currently). They do so by depressing activity which reduces the tax take and increases welfare outlays, via increased joblessness- up to 1.3mn in Osborne’s case, 780,000 in Darling’s.

  8. Michael Burke

    ps

    The OBR’s multiplier’s don’t stand up to scrutiny and shouldn’t be relied on. The Treasury’s own estimates for government spending multipliers are 1.4 (higher when there is spare capacity, as now), not the OBR’s 1. The literature cited by the OBR in the Budget document places the Treasury’s estimate within the consensus, while the OBR’s is an outlier, far too low to be credible.

  9. Sioned-Mair Richards

    Mansion tax is silly gimmick raising v little money, will require lot of work to organise and not worth the effort. Proper reorganisation of local taxation system makes more sense whether re-rating properties or adding more bands to council tax.

  10. Will Straw

    Thanks for the comments. Putting this deficit reduction plan together was not easy and there were very difficult decisions along the way.

    First up let me explain why I didn’t go with the slower Balls plan. I certainly agree that any reduction plan must be open to amendment if the economy goes back into recession. Osborne doesnt appear to have a Plan B which is essential. But it is also important to have a clear roadmap ahead in order to keep interest rates low. Osborne’s masochistic approach wont work since credit rating agencies are already talking about downgrading Britain because of the scale of public spending cuts but a plan that is too slow initially would do the same. This middle way sets out an ambition to halve the deficit in four years but would be flexible if we went back into recession. I think that’s the best way to ensure that the cost of interest payments on debt don’t shoot up and squeeze public services.

    But as all three of you point out £28.5bn of spending cuts would cost jobs. There is no hiding from it. But unless you ramp up taxes even further (which I don’t think is electorally viable) you have to cut somewhere else or go slower (and in my view risk an interest rate spike). My approach ensures that the most vulnerable are not affected by malicious welfare cuts or the VAT rise and keeps cuts in departments down to a minimum. I should, however, have been more explicit about two things. The 3-year pay freeze would not affect anyone earning under the average (mean) salary level of £22k (as per Osborne’s plan). I think this is far preferable to job losses and there are many people in the private sector who’ve been forced to take pay cuts in order to keep their jobs. I don’t recognise Michael’s spending cut figures. My plan entails under half the spending cuts planned by Osborne over four years and while this would cause some job losses, I hope this could be kept to a minimum. The 8.1% reductions are an average so if we can save more from, say, the MOD from cutting their procurement programme, that could be used to pay for lower cuts in the housing, education and health budgets.

    On Michael’s point about multipliers: I understand your argument and we’ve published your work but given how low consumer confidence is at the moment, I fear that multipliers are lower than you claim. That said, I’m sure OBR estimates are at the bottom end but since I was speaking to Reform it made sense to use cautious assumptions since I still got the point across that you can impact growth by a smaller amount through a different approach.

    As I said at the start, this wasn’t easy to put together and involved many hard decisions. If the economy slipped back into recession as many predict, we would have to go even slower. But I wanted to put together my own plan using Darling’s timetable to show quite how many of the Tories’ decisions were ideological choices rather than anything else even by Darling’s stringent approach.

    All the best,

    Will

  11. David Wearing

    Thanks for this, Will. Appreciate that this sort of analysis/policy proposal is by no means easy to assemble. And then you get smartarses like me, who didn’t put the work in, popping up and sniping from the sidelines.

    I’m going to press you on this point about interest rates rising if the deficit is reduced more slowly. A lot of pain is proposed on the basis of that assumption. How do we know it to be true? Is Britain’s long-term credibility as an economy so fragile that a slower pace would call it into question? And if your assumption is true, how do we know that the rise in interest rates would negate the reduction in social pain caused by the slowing of deficit reduction? There’s a balance to be struck, isn’t there?

    Another point. I understand that the Darling plan had a safety mechanism to pull back fiscal retrenchment if the economy tipped back into recession, and it sounds like you propose the same thing. But obviously economic growth and serious social injustice are not mutually exclusive things. A progressive deficit-reduction plan ought to have a social justice safety mechanism as well. It would be relatively straightforward to put together a set of indicators which, if they lit up, would halt or slow the process. Have you considered something like that?

    On raising taxes further, even a tiny rise will elicit an hysterical reaction from powerful forces in society, whose media, think tanks and astroturfed movements will mobilise against you. This raises big questions about what Labour wants to be going forward. Does it want to carry on as increasingly a vehicle for gaining office and managing the status quo in a somewhat more civilised fashion than other parties might? Or does it want to be a grassroots movement that squares up intellectually and politically to the injustice of the status quo, and mobilises to change it? What’s happening to Obama shows that the current conditions are making it impossible for centre-left politicians to avoid that question, or the conclusion that option 1 is no longer viable.

    I think the New Labour experience shows that the centre-left needs to be more comfortable with the idea of challenging power, and tax is one important area where that needs to happen. Obviously this is a much harder option than not challenging power. A party hierarchy can’t do it alone; it needs a movement. One thing Labour may find as these cuts kick in is that, if it wants to fight these battles, a movement may well already be emerging that can lend the strength necessary to win.

    I very much agree that slashing defence procurement is a good way of lessening the burden on other departments. We have a good opportunity here to abandon post-imperial attempts to “punch above our weight”, and effect a change that will both be cheaper and have positive effects on the ethics of our foreign policy.

    I also welcome the idea of the public sector pay-freeze not applying to those on below median-incomes, though I’d place the bar higher and compensate with more top-end taxation.

  12. Ash

    Couple of points:

    1 – the 2009/10 deficit was £12bn lower than Alistair Darling thought; hence I think one could reasonably argue that a £45bn deficit reduction plan rather than a £57bn deficit reduction plan is what’s needed to hit his target (i.e. to bring down the deficit to half of what he thought it was).

    2 – If your plan would have £3.3bn less of an impact on GDP than Darling’s – so that the tax take would be higher and the welfare bill lower under your plan – I don’t understand why the same total of spending cuts and tax rises, £57bn, is required to make the same impact on the deficit?

    I wonder if something like a £21bn from tax rises, £21bn from spending cuts, £3bn from extra growth package would be plausible.

    (One way or another, I certainly think that if we’re promoting ‘pro-growth’ policies in contrast to Osborne’s cuts, we should be putting a figure on the contribution the resulting growth will make to deficit reduction).

  13. Iain

    Interesting. At least he makes proposals unlike Byrne and others who constantly refer to their “plan” without detailing it. There is no doubt that the deficit must be cut quickly, but I would support higher taxes (which means me!)

  14. william

    Look at HMRC figures on the euphemistically called Tax Gap,which is the PRESENT uncollected taxes.Increasing taxation is gesture politics, and plays into the hands of those that remember stealth taxes.If you want Labour to be ouy of power permanently,start the manifesto with tax increases,and see what england votes for.Remember 1983.

  15. Tony Gee

    RT @leftfootfwd: A responsible deficit reduction plan http://bit.ly/bvVT0V

  16. Other TaxPayers Alli

    Interesting debate on deficit reduction at @leftfootfwd http://bit.ly/dC5vpP

  17. Chris Horner

    RT @OtherTPA: Interesting debate on deficit reduction at @leftfootfwd http://bit.ly/dC5vpP

  18. Cut to the chase – deficit reduction plans in the fight for progressive economics « Aled-Dilwyn Fisher

    […] such plan has, this week, been offered by Will Straw of Left Foot Forward, who calls for “a responsible deficit reduction package”. Contrasting his to the plans of the […]

  19. Roxanne Persaud

    RT @OtherTPA: Interesting debate on deficit reduction at @leftfootfwd http://bit.ly/dC5vpP

  20. How to reduce the deficit “fairly” « sgmpolitics

    […] sgmpolitics @ 9:42 pm For those interested in economics, Will Straw of Left Foot Forward has this piece on how to reduce the budget deficit in a way compatible with social justice. Leave a […]

  21. SMS PolicyWatch

    RT @leftfootfwd: A responsible deficit reduction plan http://bit.ly/bvVT0V

  22. Mr. Sensible

    Will, there are a lot of interesting things in here.

    I think I agree with a reasonable amount of it.

    I believe that, not only should the top rate of tax stay, I think it should be set at £100000, rather than £150000.

    Just 1 question, Will. You talk about maintaining Osborne’s plan to freeze pay in the public sector for people earning above £22000. In the Guardian in July, there was outrage expressed that this was going to apply to our armed forces, too. Do you have any thoughts on this?

    Supporters of the cuts ask us ‘so what would you cut?’ Well there are 2 things to bear in mind.

    1. At the same time as cutting spending saying we need to save money, the coalition is embarking on its own spending and tax cuts. For example, the Lib Dems talk constantly about how they’ve taken so many people out of income tax, but how is it being paid for? It, like the freeze in Council Tax, like the cut in Corporation Tax, is being paid for by the increase in VAT.

    2. Cutting things like Building Schools for the future, increasing VAT, cutting capital allowances for manufacturing will not help the economy either. These cuts won’t just effect frontline services; they could hamper our prospects for growth, jobs, and thus actually cutting the deficit.

  23. Ash

    OK – here’s my latest patented ‘we’re sticking to Darling’s target but with minimum cuts, to maximise growth and protect public services’ deficit reduction plan. This is following the Lib Dems’ announcement that they aim to raise £7bn by tackling tax avoidance & evasion. I’m supposing here that revenue gained by enforcing *existing* taxes shouldn’t be regarded as coming from ‘tax rises’ for the purposes of setting out one’s favoured tax rises/spending cuts split.

    Darling’s target: half of £167bn (projected in March Budget) = £83.5bn.

    Total deficit reduction package required to hit that target: believed by Darling to be £57bn. Now known to be £45bn (because the 2009/2010 deficit is now known to have been £155bn, not £167bn).

    Expected contribution to closing deficit of action on tax avoidance and evasion: £7bn.

    Expected contribution to closing the deficit of additional growth resulting from lower-than-planned spending cuts: £2bn. (This is pure guesswork! Needs crunching with OBR multipliers.)

    Tax rises: £18bn.

    Spending cuts: £18bn.

    That’s one third less in tax rises than the Coalition, more than two thirds less in spending cuts, and only their own assumptions on avoidance & evasion – plus a clear message that cutting less means growing more means closing the deficit further. And £18bn is an amount of spending cuts I can actually start to believe could be achieved without doing real damage to public services and the economy.

    Right, that was easy. I’ve saved the country from disaster, now for a cup of tea.

  24. Mr. Sensible

    Ash, read the comments today on that plan by Hélène Mulholland in the Guardian today:
    http://www.guardian.co.uk/politics/blog/2010/sep/20/tax-avoidance-christensen

    The tax that’s avoided in this country could probably come close to, if not fully eliminate the structural deficit.

  25. Ash

    Mr Sensible

    Thanks for that link.

    What I don’t know is how far it’s actually possible to tackle avoidance & evasion (given the wealth & cleverness of the people you’re up against, finding ways to exploit loopholes in unforeseen ways). If we think more can be done, great; meanwhile the government can hardly argue with its own target!

    The other point, I guess, is that it seems highly plausible that £7bn can be clawed back from shady tax dodgers without causing any real upset in the economy; not so plausible that shady tax dodgers would just absorb a £60bn or £120bn increase in the amount of tax they’re paying without that having implications for jobs etc.

  26. Tyler

    Will,

    Your estimate does not include two massive factors, as by the look of it you are using unadjusted GDP projections – one of the last government’s clever little ploys when arguing their deficit plans during the last election. Admittedly, its a common mistake to make.

    1. The growth drag higher taxes will engender. This has an effect at the limit, but is hard to quantify accurately.

    2. The drag on growth from higher interest payments. This is relatively easy to estimate. By 2013-14, your plan will have run up approx 60bn of extra debt. Using a rate of 4%, a yield which equates roughly to that of UK long term debt, that extra debt will be costing roughly 2.5bn a year to fund. That equates to 0.2% drag on GDP.

    That very basic calculation can easily be expanded to a full compounding calculation, including pre-existing debt, making the problem worse. I’ve seen results between 0.3% and around 1% of GDP, with the top 1% number reserved for the 90% debt/GDP ratio.

    You also seem to forget that it is not GDP which pays for increased borrowing, it is tax reciepts. A net government deficit of 10% of GDP needs an approx 30% increase in GDP to wipe it out, as tax revenues tend to be roughy 30-35% of GDP. Whereas a cut in spending is a much quicker route to a balanced real budget thanks to the 1:1 effect.

  27. Three challenges for Ed Miliband | Left Foot Forward

    […] Left Foot Forward has shown, by sticking to Alistair Darling’s timetable but switching to a 50:50 ration with no protection […]

  28. Jordan Hall

    Left Foot Forward: A responsible deficit reduction plan http://bit.ly/9IMWn2 >> Seems sensible, worth a read.

  29. How definitive must Labour be about the deficit? | WalesHome.org

    […] must follow the same mix in which spending rather than taxes takes most of the hit. Indeed, a 50-50 plan (i.e 50% of the reduction met by increased taxes) together with a removal of the English health […]

  30. Peter S

    As a retired LGO who worked in a frontline service Trading Standards I am concerned about the effect of pay and resource freezes. My concerns are loss of experienced staff through redundancy and lack of new trainee staff as well as the diminuition of the attractiveness of worthwhile public sector jobs,professions and careers.imagine a scenario: you are sold an unsafe and fraudulently described motor vehicle in 2015 and there is one part time qualified oafficer available in your local TSD to investigate; if you are a low paid Tory voter, who do you blame…If there are no fire service personnel available to tackle a fire in your cafe caused by poorly fitted electrics installed by an unregulated “electrician”, who do you blame… and so on

  31. Peter S

    Sorry about typing errors Imagine Officer

  32. Daryn McCombe

    RT @leftfootfwd: A responsible deficit reduction plan http://bit.ly/dC5vpP

  33. Cameron cuts back on truth | Left Foot Forward

    […] in four years is one alternative approach while Left Foot Forward has set out its own responsible deficit reduction plan which follows Darling’s timetable but focuses more on taxation than spending […]

  34. There is an alternative | Left Foot Forward

    […] September, Left Foot Forward set out a ‘responsible deficit reduction‘ plan which stuck to Alistair Darling’s timetable and adopted a 50:50 split between tax […]

  35. Spending review, the review: part 1 – the scale of the cuts « here's the thing:

    […] more even split is hardly without precedent. Will Straw, on his (excellent) blog Left Foot Forward, proposes a 50:50 split between tax and spending cuts, and points out that such a balance was the model used by the […]

  36. Britain's Netroots must turn online activity into offline protest in 2011 | Left Foot Forward

    […] first session of the day outlined the full impact of how the unfair and unnecessary cuts will destroy public services and affect people right across society (and especially women). […]

  37. davidf

    hi this is a better plan then the one we have at the moment. Yet there is one thing missing from all the plans and it is this i fear that will be in the long run the most disasatorus result of the defict reduction………in the very near future we will have to reform the economy (and society) to take us off of fossil fuels and onto renewables..my fear is the issue of debt is disguising this much bigger issue. The only way this can be done is for government to lead the way and it will mean more spending on capital projects (im not sure how much)………otherwise we will have not only severe global warming but oil which is beyond affordability of the average citizen. This if you like is also the “growth stratedgy” or the “green new deal” as its often called. Therefore in reality you really need two programs rolled into one:
    1. The reduction of the deficit, which i agree should be slower then what the uk govt is doing at present, otherwise we will end up like ireland which cut spending too fast and put themselves in recession, now their marekets just dont have any trust in the governemnt hence their problem finding finance.
    2. Measures which (including spending on a green new deal) will help to make our way of life more sustainable and would also include not just jobs for the long term unemployed but also help for social projects providing a real way to mend “broken britain”
    Trouble is i have no idea how to piece together all the details, i just know the borad outline.

  38. Will Straw

    @keepof4worlds This is what I would have done http://bit.ly/acLtOY

  39. Will Straw

    @GilesBradshaw I speak for myself: http://t.co/p4W9h3h

  40. Will Straw

    @pjpcfp @AndrewLilico @AllisterHeath This is what I wrote in Sept 2010 on responsible deficit reduction: http://t.co/aYVfKhbE

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