George Osborne is widely regarded as a very political chancellor. So yesterday’s announcement, in his speech to the Conservative conference, that a Tory majority government after the next general election would aim to run a budget surplus before the end of the next parliament is being seen as an attempt to draw a clear dividing line between the Conservatives and Labour. This is probably right, but the dividing line that Osborne is interested in is not on the path of the budget balance, but on welfare spending.
If the OBR’s numbers accompanying the March 2013 budget are right, public sector net borrowing (PSNB) in 2017/18 will amount to £42 billion, or 2.2 per cent of GDP. The Conservatives are claiming that holding total government spending constant in real terms for the next two years would be enough to deliver a surplus by 2019/20. However, this appears to be premised on economic growth exceeding its trend rate. If this is not the case, achieving a surplus would require more discretionary tax increases or cuts in public spending.
It should be noted in passing that it is not necessary to run a budget surplus in order to reduce government debt as a share of GDP. While a surplus is needed to cut the nominal value of debt, the ratio of debt to GDP will fall if nominal debt increases less rapidly than nominal GDP. This is exactly what is projected for 2017/18 when the OBR expects a small fall in the debt ratio despite PSNB being forecast at 2.2 per cent of GDP. If the economy is strong towards the end of the decade, it might be prudent to cut borrowing a little more in order to accelerate the fall in the debt ratio, but there is nothing special about the budget being in surplus per se. My colleague Tony Dolphin has argued that the next government should set a target for the debt ratio and then, guided by the OBR’s view on the health of the economy and the public finances, set a path for borrowing consistent with this target. In this way, a significant reduction in the debt ratio could be achieved without the budget ever being in surplus.
According to the 2013 budget fiscal consolidation during the current parliament has been divided between tax increases and spending cuts in the ratio of 20:80, with most of the tax increases having come in its first year (in particular through the hike in VAT to 20 per cent). But Osborne has promised to try to avoid tax increases in the next parliament, so it looks as if this ratio would be shifted to 0:100 (at least during an election campaign – what happens to taxes afterwards is another matter).
Osborne also announced that capital spending would grow in line with the economy, implying a modest increase in spending from the latest plans. In all probability, spending on international aid, the NHS and schools would also continue to be ring-fenced and the ‘triple lock’ on pension increases would remain in place.
That would leave the chancellor with a diminishing pot of spending from which to find the savings that he would need. Ministers in government departments that are already implementing cuts in real terms of up to 40 per cent would find it difficult to deliver more – there are already signs of a diminishing political willingness to make further cuts in areas such as defence and policing. So, the bulk of the extra cuts needed to deliver a budget surplus would have to come from annually managed expenditure.
The real point of the budget surplus announcement is therefore to justify further cuts to welfare spending. The Conservatives will set out in their manifesto plans to make further cuts in benefits, and possibly tax credits, for those of working age, and challenge the other parties to match them. George Osborne knows that the gap between the public perception of the welfare bill and the reality is dramatic and is betting that at the general election the electorate will favour a party that promises to take further tough decisions on welfare over one that takes a more ambiguous position.
This is a reasonable bet to make. As I pointed out in a previous blog, although there are signs of a softening of public attitudes on social security benefits in the most recent British Social Attitudes survey, a majority of the population still believes that unemployment benefits are too high and that most unemployed people could find work if they tried hard enough. In responding to Osborne, Labour has to think hard about what fiscal rules it would adopt in the next parliament, but it has to think even harder about what it would do about the welfare budget. They might start by adopting my colleague Graeme Cooke’s idea for a welfare cap of their own.