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NEF - Budget 2015: what next for the UK economy?

POSTED BY: JAMES MEADWAY / JULY 8, 2015

George Osborne’s first Budget as Chancellor of a Conservative majority administration wasn’t quite as severe as previously warned.

Osborne has taken the opportunity to ease off the pace of spending cuts slightly from the sharp decreases implied in earlier forecasts.

His date for achieving a budget surplus - an excess of taxes over spending – has been pushed back by a year. But the Chancellors plans still entail an eyewatering programme of cuts, which look set to compound the adverse effects of those made under the previous Parliament.

The new Living Wage: good news?

Osborne’s talk of a new “National Living Wage” has grabbed most attention. Pinching the TUC’s slogan, “Britain deserves a pay rise”, the Chancellor confirmed the introduction, from April next year, of a £7.20 an hour National Living Wage, rising to £9 an hour by 2020.

The Conservative benches were ecstatic – Iain Duncan Smith punching the air with glee – and it’s not hard to see why: Osborne had, seemingly, both made good on his promise to put hard cash in the pockets of workers and deftly staked a claim straight in Labour’s territory – outflanking the opposition’s election pledge for an £8/hour minimum wage by 2020.

The increase in the minimum wage is certainly meaningful, up 70p from at present. But it falls short of what the Living Wage Foundation currently considers to provide a minimally acceptable standard of living. For those outside of London, this now stands at £7.85 an hour. Inside London, this rises to £9.15 an hour. Workers on the new “National Living Wage” will not, in fact, be earning the living wage.

Worse, the Living Wage Foundation’s figures were set under the assumption that tax credits will be available to top up low pay. With dramatic reductions in these forming the centrepiece of Osborne’s swingeing £12bn welfare cuts, hourly pay would have to rise sharply to compensate. Osborne’s National Living Wage will not achieve this.

If tax credits were no longer paid to those on low incomes in London, the current Living Wage in the city would need to rise to an extraordinary £11.65 an hour, on average. For a single parent with two children,Resolution Foundation estimate £14 an hour would be needed – nearly double the proposed level.

Osborne’s new measures are likely to worsen levels of UK inequality. Low earners will see a direct hit to their finances, but because many of those moving on to the “National Living Wage” level will be second earners in a household, many of those at the top end of the income scale will actually stand to benefit. The government’s forecasters, the Office for Budget Responsibility (OBR), have modelled for this impact. They think that “around half the cash gains in household income may accrue to the top half of the household income distribution.”

The graph below is from the OBR’s analysis. It’s clear the bulk of the gain flows disproportionately to wealthy households. This wouldn’t matter too much if the tax and benefits system operated to redistribute in favour of the poorest. But Osborne’s changes to tax credits will most likely have the opposite impact, although it’s currently hard to know for certain – the Treasury’s usual “distributional analysis” accompanying the Budget has undergone significant change from previous years. Further work will be needed.

Average annual gains to gaining households

Corporation Tax cuts

Alongside cuts to benefits, Osborne has also introduced a further cut to Corporation Tax (CT). Already among the lowest headline rates in Europe, the cut from 20p to 18p over two years will mean only Estonia and Ireland rank lower.

The US headline corporation tax rate is 40p. In Germany it is 33p. There seems to be no reasonable grounds for thinking the UK should be setting so far out of line with similar economies, and the result, overall, has been to weaken the tax base and therefore weaken the government’s spending capacity.

I’ve taken the below graph from the excellent Flipchart Rick blog. It shows how low revenues from CT have been since the recession –despite a recovery in corporate profits, to record levels in the services sector. Without the surprise increase in VAT, made by Osborne shortly after he became Chancellor in 2010, there is no doubt the UK’s finances would be in a far more parlous condition by now.

As Rick says, “Record numbers of people in employment, it seems, hasn’t led to record levels of income tax,” reflecting the low-paid work that has been created. (This issue lies behind the oft-repeated claim that the rich are paying a greater share of all taxes paid: true, but a direct result of them taking a greater share of income earned.)

 

UK tax receipts since March 2008

The effort to restore those public finances to a stable position is given as the motivation for what will, assuming Osborne’s targets are achieved, be a full decade of continual austerity by 2020. Osborne has somewhat softened the pace of spending cuts for this budget, smoothing out what would otherwise have been a similar pattern of steep cuts to those seen over 2010-2012, and aiming for a budget surplus by 2019-2020, a year later than originally planned. Only half of the cuts have been presented in this Budget; the rest will have to wait for the spending review, due in autumn this year.

Public savings, private debt

Osborne didn’t achieve his deficit reduction target over 2010-2015, and there is no reason to suppose he will this time, either. Another recession would knock all spending plans off course; turmoil in the eurozone, or in China, could easily spill over here. And an important but often overlooked side-effect of Osborne’s spending cuts is the impact they are having on household debt.

The OBR’s forecast shows this impact at work. The graph below, again, is taken from their July 2015 forecast document. It shows what the OBR think has happened to household debt, shown relative to income, and what they think will happen. As you can see, household debt is expected rise even above the record levels seen prior to the crash of 2007-8. This rise in household debt is the direct effect of government spending cuts.

As government spending is pulled back, some other part of the economy has to step its spending up to compensate, or else the whole economy would be pulled into recession. That response is predicted to come from households, who have shifted, in the aggregate, from repaying their debts to taking on more loans.

But this isn’t sustainable. Any increase in the level of debt, relative to income, implies that the debt is becoming more insecure over time. The income is needed to repay the debt; as debt rises, it becomes, of necessity, harder to repay. The risk of crisis increases. Far from promoting “responsibility”, as Osborne claimed, austerity is promoting irresponsibilityon a large scale.

An interesting paper, published earlier this year, from the National Bureau of Economic Research (NBER) argues that Bill Clinton’s efforts to achieve a budget surplus in the 1990s fed directly into the property bubble of the 2000s. With government debt being repaid, investors (especially outside the US) had fewer and fewer safe assets to put their money into. They turned, instead, to the US property market, driving down interest rates and encouraging borrowing. This fed the bubble and, eventually, its spectacular collapse. Something similar can be imagined for the UK, with austerity in place, but driven more by domestic borrowing than international capital flows.

There is, in short, absolutely no merit in a government attempting to achieve surpluses – and many reasons to think it is a seriously bad idea.

This expected ballooning of debt constitutes the biggest single domestic threat to economic stability. A government serious about its responsibilities would not, given this likely impact, be seeking to proceed with its austerity programme in the way this new government is. Far better to ease off on spending cuts and think more creatively about how government could use its powers than to work on the assumption that its spending, rather than itssaving, was the main problem. Short of that, we are heading, slowly but surely, for a fresh round of debt crises. 

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