The unbearable lightness of deficit reduction

The parties' spending plans are becoming stranger and stranger.

The parties’ spending plans are becoming stranger and stranger

The shadow chancellor Ed Balls made his last party conference speech before the election today. He was remarkably consistent, the bulk of his speech repeating what he said last year: increasing the top rate of tax, a higher levy on bank balance sheets and houses worth more than £2m, confessing that spending cuts will continue.

In that vein, he added that ministers in a Labour government will take a 5 per cent pay cut and child benefit will not rise in line with inflation until 2017.

These two additions to the list of ‘difficult choices’ make almost no difference to public spending. Over the weekend, both the Institute of Fiscal Studies (IFS) and the Resolution Foundation estimated that around £37bn of further cuts, tax rises or borrowing are needed to balance the books. The new measures announced by Ed Balls wipe out something like 1 per cent from that total.

That said there were two further hints as to what else Labour might be willing to do.

The first came after Ed Balls repeated last year’s mention of a zero based spending review. Chris Leslie, shadow chief secretary, has been leading this process. One theme is expected to be the ‘de-cluttering’ of the public sector, which suggests that Labour might eradicate some public bodies.

No names were given today though Ed Balls mentioned ‘joint management’ of health and social care, suggesting perhaps job cuts in the NHS and local authority functions that provide separate management at the moment. And there was a similarly coded reference to police forces working together to make savings.

The trouble with these hints is that management overheads are pretty low in the UK healthcare system by international standards; and it’s not like police forces haven’t been forced to find efficiencies in working together already. Unless measures like these are repeated all the way across the public sector then this theme is likely to yield no more than another 1 per cent.

The second hint as to Labour’s approach to future spending choices was in a paragraph on early intervention. “We will look to prioritise early intervention now which can save billions of pounds in the future,” said Ed Balls. In fact that was the paragraph in full. No examples were given.

One area where early intervention is often touted as having the potential to save money is via high quality pre-school education. But speaking at an SMF panel on that topic today, Lucy Powell, the shadow education minister, recognised that raising quality is expensive.

She’s right. Naomi Eisenstadt, the civil servant who was responsible for setting up Sure Start under the Blair government, said on the same panel that it’s not just the issue of paying for a more qualified workforce, the integration of pre-school education with other services for families and children is vital to getting the later benefits and this is costly too.

It’s no accident that the doctrine of early intervention mentioned by Ed Balls today used to be called ‘invest to save’ by Gordon Brown. While the shadow chancellor suggested there was scope for savings, he didn’t identify the scope for investment.

Quite the opposite; he seemed to reduce the room he may have to produce such investment by saying that a Labour government will incur no new borrowing to pay for new spending.

So what we’re left with is almost no information about how Labour will reduce the deficit and yet a tightening of the fiscal rules they are adopting, potentially to rule out borrowing even for investment.

To be fair, the chancellor is begging the same question. For example, he has said that he will save a further £12bn from welfare if the Conservatives form the next government, as yet another aspiration without any policy for realising it.

The metaphysics, if you like, of the parties’ spending plans are becoming stranger and stranger: the increasing weight of the task of deficit reduction on the one hand; the increasing lightness of the measures announced for achieving it on the other.

Emran Mian is director of the Social Market Foundation

8 Responses to “The unbearable lightness of deficit reduction”

  1. Peter Martin

    Economic neo-liberals, even well meaning ones like Emran Mian, tend to think that having a balanced budget, or a much reduced deficit, is easy enough, at least in principle. Just reduce government spending and/or increase taxation. Deficits will fall and the financial markets will react by rewarding a ‘prudent’ government. Right? Well, no. That’s where they always get it wrong and they never learn from their mistake. That kind of austerity economics is always just going to send the economy into a downward spiral of recession and increased unemployment as we’ve seen happen in the Eurozone. Governments there have sought, in vain, to balance their budgets in accordance with EU rules. They are actually ‘allowed’ a 3% GDP maximum deficit.

    When sovereign governments spend they simply credit bank accounts . Much of their spending is on wages and salaries. Straightaway about 30% or so comes back in tax and other Government deductions, like National insurance in the UK. The remainder gets spent and respent. After a few respendings there’s not much left after the government has taken its cut at each stage. 20% VAT, fuel duty, corporation tax etc etc and yet more income tax. So, it’s important for Governments to recognise that the level of taxes overall doesn’t have a 1:1 level on the tax take or anything like it. But the level of spending does have close to a 1:1 effect. Of course, raising one tax will increase the revenue raised by that particular tax but reduce the revenue raised by other taxes, simply because once money is removed from the economy, by one tax, it becomes unavailable to be removed by a subsequent tax. Eventually nearly all spending goes back to government as taxes regardless of the level at which they are set, providing they are finite. It just takes longer if taxes are lower.

    Just think of it as water being pumped from a bucket and returned to the same bucket via a hosepipe. Once the system has settled down the amount of water returning to the bucket will be same as the amount leaving regardless of the time it takes to complete its journey, which is determined by the length of the hosepipe.

    All money to pay taxes, and buy government securities, comes from Government spending. We can go further and say that all money to pay taxes (inc buying government securities) and to support the profits, wages and salaries of the private sector comes from Government spending. The lower the level of taxes, the longer the money stays in the economy to benefit the private sector, but it doesn’t just magically appear from nowhere as the more vitriolic of libertarians tend to suggest when they attack all government spending as wasteful.

    There are two exceptions to the rule that issued money always comes back to government. Money which is saved by individuals and private companies, and money which is net spent on imports. The taxman can’t get that back. That is the source of the deficit. So, we can say:

    Government Deficit = Savings of the Private Domestic Sector + External Deficit

    This equation can easily be shown from a consideration of sectoral balances too.

    So, if government, in its wisdom (or folly?), does decide the deficit needs to be cut in a recessionary period, it should forget about spending cuts and tax rises. What needs to happen is for saving to be discouraged and, of course, having interest rates very low helps do that. Then imports have to be cut and/or exports increased as well. Of course that’s very difficult to do in a free society where individuals wish to purchase goods and services from anywhere in the world and save money in whatever is their currency of choice. However, if neo-liberals argue this is impossible they must also necessarily concede that running a government surplus, or even a reduced deficit, is sometimes impossible too.

    So, is there any truth at all in the conventional wisdom that cutting spending and raising taxes is the way to reduce a government’s deficit? Just a grain! It could send the economy into such a downward spiral that everyone becomes so poor they can neither afford to save nor buy imported goods from abroad. But, if that is the plan, then politicians arguing for a balanced budget should say so in advance to give us the chance of voting for someone else.

  2. blarg1987

    I am surprised that no political party has suggested renegotiating or even changing the way it borrows money for projects.
    PFI etc seem very expensive way of government to do things, if it did traditional government borrowing to spend it could bring down the deficit by reducing interest payments.
    The only side effect will be pissing off the money markets as they won;t get fantastic returns they used to.

  3. EdinburghEye

    One “early intervention” idea: give the main carer for a child a cash benefit paid to her (usually her) directly. Make this benefit substantial, not means-tested, and have it rise in line with inflation. In this way, the Labour government could ensure that all children everywhere in the UK get meaningful support paid directly to the person who cares for them.

    They could call this “child benefit”.

  4. Leon Wolfeson

    There’s massive amounts to save simply by reversing many ill-thought through cuts…
    Instead, there’s empty trumpeting about how another 12 billion will be taken from the poor.

    “Everyone” gets cut – the rich lose some spending money, the poor lose lives.

  5. treborc1

    Go to the voting booths and really toss a coin shall I go in, heads no tails why bother

  6. John Jones

    Its worth just comparing Ed Balls (2010) with the current version.

    http://www.edballs.co.uk/blog/?p=907

  7. Leon Wolfeson

    …Which of course helps the extremists.

  8. Leon Wolfeson

    Yup, moved considerably right from there hasn’t he.

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