Fiscal arithmetic of the next spending review cannot be avoided

Kayte Lawton outlInes the cuts that are expected in the upcoming spending review by George Osborne and the problems facing all parties to gain election in 2015.


Kayte Lawton is a senior research fellow at IPPR

Last week IPPR exposed the stark reality of cuts the NHS could face after the next election. Politicians face a major decision about whether the NHS can continue to be protected from the age of austerity. This is one of the big choices posed by the arithmetic of the next government spending review.

One of the first acts of the current coalition government was to impose tough spending cuts in order to bring down the deficit largely created by the 2008-09 recession. This round of cuts ends in early 2015 but new IPPR analysis, based on figures from the Office for Budget Responsibility, shows the pain will not end then.

The spending cuts announced back in 2010 were designed to eliminate the structural deficit – the part of the deficit that won’t go away even when the economy is at full capacity – by the end of the 2014-15 financial year.

Following weaker than expected growth, the chancellor now plans to eliminate the deficit in 2016-17, signalling two further years of spending cuts (and because his target is a rolling five-year one, he could push the date at which the deficit is eliminated back to 2017-18 in December’s autumn statement).

So far, the chancellor hasn’t said much about what these cuts might look like but spending plans covering at least 2015-16 will have to be set out before the May 2015 general election. The only real detail the chancellor has given is that £10 billion would have to be cut from the welfare bill in 2016-17 if real terms cuts to departmental budgets in the two years after April 2015 are to be only as great as in the current spending round.

Otherwise, cuts to departments like education and defence would have to be larger than we are seeing right now if the chancellor wants to stick to his overall spending plans.

Without that £10bn welfare cut, IPPR analysis shows current spending plans imply a cut to the NHS budget of around £7.8bn in 2016-17, from a total budget of £110bn. Education savings of roughly £3.8bn would be needed from a budget of £54bn. If the chancellor manages to find £10bn of welfare cuts, the savings needed in the NHS would be reduced to £4.8bn.

Cutting back on the benefits bill is not the only option available to soften the blow of departmental budget cuts after the next election. The real terms protection afforded to the NHS budget in the current spending review puts extra pressure on other departments. Removing the NHS ring-fencing in the next spending review would lessen the scale of cuts needed in education, policing and defence.

Another option would be to look to tax rises to take more of the strain. In the next spending round, the coalition’s current plans imply all of the intended deficit reduction would be achieved by cutting back on spending rather than raising more revenues.

The problem here is that relatively popular options like a mansion tax wouldn’t raise enough to make a serious impact. Shifting the balance so extra taxes make up around one third of the deficit reduction by 2016-17 would require a four-point increase in VAT or an extra four-pence on income tax, but such increases would be a tough sell to voters.

An alternative approach would be to admit that eliminating the structural deficit in 2016-17 is just too tough, particularly given the uncertain economic outlook.

Shifting this back by two years, for example, would slow the pace of budget cuts, giving departments more time to implement spending cuts. Of course, we would have to endure four years of spending cuts rather than two after the end of the current spending round, and the deficit wouldn’t be cleared until 2018-19, so debt would be slightly higher.

None of these options will look particularly palatable to politicians from across the political spectrum, eager to retain (or re-establish) an aura of fiscal credibility while convincing the electorate to return them to power in 2015. But the coalition’s decision to set up the Office for Budget Responsibility, and open up access to data about the public finances, means no party can avoid the fiscal arithmetic – no matter how gloomy.

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