Wednesday 13 October 2010

Dealing with the Deficit! (2) - Introduction

Of Public Spending, Budgets, Cuts, Cabbages and Kings (And why the sea is boiling hot and whether pigs have wings - well, not really.)

In the first part of this mini series, I looked at the economic arguments for and against the government's economic policy. Next I turn to the questions of whether the policy outlined in the Budget is 'Fair' and if we accept a broad number for the fiscal squeeze to bring down the deficit then what particular tax rises and spending cuts should be implemented. Since the Emergency Budget numerous suggestions and analyses have emerged, both for various spending cuts and tax rises and also of the expected impact of the fiscal squeeze, particularly the distributional impact, that is how it will proportionately affect the poor and the rich. These analyses and suggestions have branched from the sensible to sheer fantasy and back again. They are also, obviously, possibly as numerous as the amounts involved. There are literally, millions of potential ways of slicing up the spending cuts, and here I will only attempt to discuss a few of the more popular suggestions.

I will first discuss various plans for making up the amounts of spending cuts and tax rises mentioned in the budget before moving onto the question of the relative impact and 'fairness' of the government's own chosen approach. I am doing it this way round because, as you may have guessed from part 1 of this series, I broadly support the Coalition's approach, and I, hence, will explain the reasons for why I believe there is no sensible, substantive alternative, economically, and then move onto the question of, regardless of this practical point, how 'fair' this approach is. In this article I just introduce the problem.  Following this in subsequent parts I will look at proposed ideas of cuts to defence, raising taxes and then after that ring fencing areas of spending such as ID and Health. Followed by a final part about the question of 'fairness'.

The twin issues of the fairness and morality of a deficit reduction plan and which taxes/spending to alter are obviously linked. People's perceptions about what counts as a fair approach to the former will affect their outlook on the latter. There is a risk with this though. What is considered moral, or 'fair' in the immediate term may not be the most economically effective solution on a longer framework. Obviously there are basic standards of what we should and should not accept, but within that framework it is important to remember that in almost all cases greater economic activity and a swifter and better recovery is the surest and most sustainable way to restore the tax and spending levels we enjoyed before the economic crash, and to ensure greater prosperity in the future for all of society and other the long and even medium term in many cases these cumulative affects will significantly outweigh any advantage gained by a slighter higher degree of initial fairness. This, evidently, does not apply in all cases, each case must be considered on its own merits, but it is important to keep in mind when discussing various ideas.

Just to explain slightly how government spending is made up. Government spending can be roughly divided into capital and current government spending. Capital spending is spending on infrastructure, building schools and railways and on constructing buildings and bridges and other things. It is equivalent to the economic category of investment. It comes to about £60 billion. Current spending is everything else. It is itself can be divided into departmental spending and welfare and non-useful spending. Non useful government spending is the money the government spends on interest payments on government debt. This spending is non-useful for obvious reasons. It is mostly paid to foreign investors and is neither targeted nor spent on anything useful or decided by parliament. It is wasted money, money that we must raise in taxes but cannot spend on anything useful like infrastructure or services or welfare or all the other things the government does. In the UK today this amounted to about £30 billion before the recession, and is forecast to rise to about £70 billion by 2015. Departmental spending is all the money government departments spend running all the services the country requires such as the NHS, the Education system, the Armed Forces, the social services, street sweepers, road repairs the government itself, etc, etc. it is equivalent to the economic category of consumption and account for about £400 billion. It is this spending that politicians and commentators talk about when they discuss 25% cuts to departments or whatever. The final category is welfare or, more accurately, transfer payments. Whereas departmental spending involves the government spending money to then run some kind of service we either directly use or indirectly benefit from, transfer payments are when the government spends money just transferring it to citizens under various guises: the dole, the state pension, tax credits, incapacity benefit, etc, etc for various social reasons. This is different from departmental spending because it is a direct money transfer, rather than the government spending money itself on good and services for various purposes. It comes to about £200 billion. So government spending can be divided into the main categories of non-useful spending (debt interest), departmental spending, capital spending, welfare. With the last three being useful government spending, and welfare, departmental and debt-interest being current spending.

The government's plan is based on an 80:20 ratio of cuts in spending to tax rises with spending cuts spread across departmental spending, capital spending and welfare, with only the Health and International Development budgets entirely protected from cuts with DfID (the department for international development) seeing its funding increase significantly. This contrasts with the previous government's plan which was based on a plan of 2:1 ratio of spending cuts to tax rises with 'frontline' spending on schools and hospitals, etc, protected from all cuts, along with International Development and Welfare.

In both cases they diverged slightly from these intentions. Alistair Darling's budget plan involved 70:30 ratio of spending to taxes, whereas George Osbourne's was 77:23, so less divergent than initial impressions may suggest. The main difference in the Coalition's plan is the sheer scale. It involves an extra £40 billion of consolidation in addition to the £73 billion already planned by Labour. Both plans involve approximately halving capital spending for the next 5 years and deep cuts in departmental spending. To this the Coalition adds £11 billion of cuts to welfare, with more possibly coming. Also, although the Coalition is ring-fencing the entire health budget, whereas Labour only ringfenced areas of certain budgets, because they did this across multiple departments they actually managed to ringfence more than the Coalition. Due to this fact and the cuts in welfare, this meant that average cuts on unprotected departments under the Coalition's plans are only marginally higher than Labour's, 25% compared to 20%, despite the considerably higher over-all amount of spending reduction. Further to the complete ringfences for ID and Health, the Coalition has also committed to partially protecting Education and Defence from cuts, planning only 10-15% cuts in these areas. This in turn means that the cuts on those areas not protected at all rise to about 30% on average. It is also worth remembering that Welfare is treated separately to these figures, and although it is possibly losing as much as £15 billion it is the largest area of government spending by far, anyway, and hence this translates to only a 7.5% cut.

Beyond these categories, the actual numbers are that the Labour party planned a £73 billion consolidation consisting of £21 billion of tax rises and £52 billion of spending cuts and the Coalition plans £113 billion of consolidation consisting of £29 billion of tax rises and £83 billion of spending cuts. Just to give one last figure, all in all, these cuts amount to a 12% total cut in useful government expenditure. These are the figures that must be made up somehow, whether in terms of cuts to services people use, or taking money from people in tax rises.

Nominal government spending will actually rise over the next 5 years from just below £700 billion to around £760 billion, capital spending falls, even in cash terms, and current spending and welfare continues to rise. Taking inflation into account in real terms capital spending halves over this period, with current spending declining by 1%. This figure masks the spending cuts, because it includes debt-interest. Stripping this out, useful government spending falls by about £50 billion, with a little more than £20 billion from capital spending and £30 billion from current spending. The remaining number to make up the headline figures from cuts comes from the fact that some government spending naturally rises outside the direct control of government, such as pensions and others, and hence to maintain these levels, spending cuts must be found elsewhere to compensate for this within the over-all given numbers.

The current government's approach to cutting the deficit is to take a broad based attack on the problem, raising some money in taxes, and also taking money from across government departments (apart from ID and Health) as well as capital spending and welfare, at varying rates decided on due to various other considerations. All these choices can and have been questioned, most completely by the Labour party's plans, but also by a range of commentators and public bodies. As Polly Toynbee notes, 'What's your cut?' has become a popular game in the media, with various people suggesting their own swinging cuts of things they just don't care about, or they claim are unimportant, or of raising taxes they claim are painless or intrinsically 'fair' compared to the government's plans. These suggestions can be divided into two classes, those such as the Labour party's, which take a similarly broad approach to the coalition, though differing in detail, and those that take a narrow approach and suggest massively attacking a few narrow areas of policy, believed to be particularly unworthy by the suggester, with the belief that this could mean saving most of the pain elsewhere. (Though of course there's also a range in the middle.) These narrow suggestions seem to be uniformly based on the principle that their proposers believe there to be vast pots of money somewhere either just waiting to be painlessly taken in taxation, or being totally wastefully spent that can just be excised without much harm to our general body politic.

These suggestions seem to be largely motivated by the belief that our financial problems are not complicated, deeply based and systematic issues with our economic and political structure but rather a simple problem with an obvious and largely cosmetic solution. The problem with this idea is that it is total bunk, and with most of these ideas underwritten by faulty logic or data. A common thread with these ideas is that either the tax rises proposed could not easily raise nearly as much money as suggested, or the simple spending cuts would not save nearly as much money as their starry eyed proponents would hope, at least not without causing serious damage. These suggestions can be roughly divided into right-wing ideas and left-wing ideas, though both share similar characteristics, as they do with other similar examples of simplistic, near conspiratorial thinking.

I will look at the three most common areas of these suggestions, from both left and right wings in subsequent articles.  Starting with Defence, and then moving onto tax rises and ring-fenced spending.


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