The government is getting itself into a spending tangle Posted by David Smith at 09:00 AMCategory: David Smith's other articles My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt. A lot has changed since the general election two months ago. Businesses and consumers are more optimistic and there should be a decent growth rebound in the first quarter, after a pretty grim end to 2019. Surveys such as the purchasing managers’ index suggest the optimism rebound was not just relief at the fact that the country avoided a Corbyn government. It strengthened through the month of January, so the final reading was up on the earlier “flash” estimate.Not everything in the garden is rosy, of course. China is now big enough to have an impact on the global
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The government is getting itself into a spending tangle
My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.
A lot has changed since the general election two months ago. Businesses and consumers are more optimistic and there should be a decent growth rebound in the first quarter, after a pretty grim end to 2019. Surveys such as the purchasing managers’ index suggest the optimism rebound was not just relief at the fact that the country avoided a Corbyn government. It strengthened through the month of January, so the final reading was up on the earlier “flash” estimate.
Not everything in the garden is rosy, of course. China is now big enough to have an impact on the global economy, and its first quarter will be very weak because of the coronavirus outbreak. As medical personnel around the world deal with the actual contagion, economists are trying to work out the economic contagion, and the impact on other countries, including Britain.
At home, some are waiting for the post-election boost in optimism to be reflected in hard numbers. Consumers were not confident enough to buy new cars last month, with sales down by 7.3% on a year earlier, driven by a large 13.9% drop in sales to private buyers. There may, however, be a lag involved. People do not make big purchases at the drop of a hat.
The question of how much follow-through there is from this optimism bounce is a key one for the economy. What will the assessment be of the Office for Budget Responsibility (OBR), the government’s economic and fiscal watchdog, which is now hard at work preparing the ground for the March 11 budget, now just over a month away? Will it buy into the bounce or will it, like the Bank of England 10 days ago, offer a downbeat view of the outlook for growth and productivity?
It matters a lot. In the OBR’s short history – it is now coming up to its 10th anniversary and looking for a new chairman to replace Robert Chote when he reaches his maximum term – it has regularly dashed the hopes of chancellors on the amount of cash they have to play with. The weaker growth is, and the longer than stagnant productivity persists, the worse the outlook for the public finances.
For, while the political landscape has changed, the eternal verities that guide the public finances remain. Governments which want to increase public spending either have to tax more or they have to borrow more. Governments which want to cut taxes, meanwhile, have to reduce spending or they have to borrow more. And, as the above logic suggests, governments which want to both increase spending and cut taxes, have to borrow even more.
That reality was in danger of being forgotten in the run-up to the election, and even after it. Suddenly, it seemed that a Tory party that had spent years being parsimonious, if that is not too kind a word, had found a pot of gold at the end of the rainbow. That may have been the impression, though it was never the view in the Treasury, using the OBR as well as the Institute for Fiscal Studies as back-up. And now, a crunch is approaching.
It is not unusual for 10 and 11 Downing Street to be at loggerheads in the run-up to a budget. A prime minister who is quick to dismiss “gloomsters” probably thinks of the Treasury as a bunch of downbeat bean-counters, though to be fair he has sided with Sajid Javid, the chancellor, on most of the important decisions. Those decisions include the policy of balancing the so-called current budget, adopted before the election.
It seemed sensible enough. If you adopt a fiscal rule which allows for a big “levelling up” boost to infrastructure spending – capital spending by government – then it made sense to reassure the markets, and establish some clear blue water between the Tories and Labour, by pledging that there will be no free-for-all when it comes to day-to-day public spending, or unfunded tax cuts.
These things can, however, have unforeseen consequences. Balancing the current budget is not an easy task. A balanced current budget, or better a small surplus, has only been achieved, when properly measured on a cyclically-adjusted basis, five times in the past 30 years, though one of those years was as recent as 2018-19.
The rule has already meant that the Johnson government has had to give up on some of its tax-cutting ambitions. The previously promised cut in corporation tax from 19% to 17%, due in April, has been dropped in favour of raising the national insurance (NI) threshold from £8,632 to £9,500. In net terms, that makes the government a tax-raiser; the corporation tax cut was due to cost about £6bn, while increasing the NI threshold has a revenue of £2bn a year. The plan to raise the higher rate threshold from £50,000 to £80,000, the point at which people start paying 40% income tax, is now lining the Downing Street litter tray.
But there is, arguably, a bigger problem when it comes to public spending. After the one-year £13bn boost in day-to-day spending announced last September, to take effect from April, the Treasury makes clear that things have to be tight from now on. Why is this a problem? Infrastructure spending, as we know, is good, the saintliest part of public spending. It suffers, however, from two drawbacks. One is that it is slow to take effect, when the government is desperate for a quick regional boost, and during the building phase, new infrastructure can result in more irritation and delays than benefits.
The other is that, though separating current and capital spending is a neat idea, in real life these things can never ben neatly separated. More capital spending is likely to require more current spending. To take a simple example, whether the government builds six more hospitals, or the 40 it claims to be planning, they cannot be expected to stand as empty monuments to the hospital builders’ art. They will need staffing, and all the extra day-to-day spending that goes with a busy hospital.
So there is a difficulty. The National Institute of Economic and Social Research, in its latest quarterly review, published last week, put it well. “The scope to raise public investment will be constrained by limits on day-to-day spending,” it said.
“Most public investment projects require not only an increase in capital expenditure but also higher current spending to pay for operating costs. Against this backdrop, the government’s proposed current spending rule leaves very little room.”
The National Institute’s fear is that this will limit the regional “levelling up” agenda even before it has got started, while also doing very little to achieve the chancellor’s ambition of significantly raising the economy’s underlying rate of growth.
There is, as always, scope for the government to bend its own fiscal rules when they are politically inconvenient. To do so this early would, however, look pretty bad. It makes the budget in just over a month’s time all the more interesting.