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).

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42 Responses to “A responsible deficit reduction plan”

  1. 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

  2. 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.

  3. 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).

  4. 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!)

  5. 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.

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