The economics of the spending review

We need to start from the current reality. Spending soared in the August figures, up more than 10% on the same month last year. In September there was a record deficit, thanks in part to the very small increase in Income Tax revenue. Slow or no wage growth and the impact of 50% tax rates on the the numbers of high income people here to be taxed and on the timing of their bonuses dampened receipts.

The government was right to make curbing the deficit its first priority. Its clear wish to do so has stablised the market in government  debt, driving down  the cost of government  borrowing  further. To sustain this gain it needs now to show that the deficit is coming under control. The government is right to think there is no choice between curbing the deficit early and leaving it to later. The latter course could bring us quickly  into Greek and Irish crisis territory.

The risks of the strategy are twofold. The first risk is Can the government deliever sufficiently constrained public spending, given the difficult politics of public sector management in the UK?   The second is, can the “Growth Strategy” succeed in so stimualting the private sector recovery that enough tax revenue and additional jobs are generated?

I discussed the politics of the public spending yesterday, and made some suggestions of other ways to achieve the savings needed that might be better politically. The government’s chosen route depends substantially on welfare and benefits reform which will prove difficult, but could be done, as President Clinton showed in the USA. It also depends on holding the line with local governemnt, who will not be too happy about their settlement. The government needs to be tough from today on extra spending in all areas. This is not time to be buying new cars, new computers, or even adding to the stocks of cartridges for printers.

Generating the revenue according to Treasury plans requires  above trend growth in each of the years from 2012 to 2015. The revenue forecasts also assume that higher rates of Income Tax and CGT raise more revenue, whereas past experience shows that above a certain rate taxpayers leave, work less hard  or find ways round the tax.

The curbs on public spending announced are not large enough overall to cause a second dip or recession. The end of increases in the public sector payroll will free some good people to work for an expanding private sector. This year there has been good job growth so far.

The government will be well advised to reduce the risks of the economic strategy by coming up with an ambitious growth package with  measures that  set a tax and regulatory framework which is compellingly attractive for enterprise.

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23 Comments

  1. P H
    Posted October 23, 2010 at 7:10 am | Permalink

    "An ambitious growth package with measures that set a tax and regulatory framework which is compellingly attractive for enterprise"

    YES PLEASE

    That is what is needed but businesses also need to think the government is going in the right direction and is likely to remain in power for two or three terms.

    So far they have only taken tiny steps in the right direction I am not encouraged.

    There are many pointless jobs in the state sector and the private sector which should go as the absurd HIP packs already have. (Energy performance certificate people, the alternative energy nonsense, many litigation lawyers, employments tribunals, some of the absurd things tree protection and planning officers do. All need clipping down to size at the very least.

    Litigation systems in the UK tend to have been structured by lawyers in their own interest. The systems should have a degree of certainty to outcome and a balance or risk rewards. No one should be able to take actions without any risk to them. Heads I win tails I do not loose should not exist.

    Legal cost are absurd and lawyers frequently increase disputes for their own personal advantage in divorce and litigation in particular. Release have the lawyer so they can get a useful job.

    The danger with local authorities is that they will seek to increase their income by fee income from extra regulations on say planning, bin fines, motorist mugging, parking fines/charges etc. which will simply damage local businesses.

    One gets the impression that the main purpose of bus lanes, parking and bin controls etc. is to generate fine income.

    Sent the right message now with:

    Easy hire and fire and small financial upper limits on compensation/redundancy.

    Bonfire of daft regulations (most are)

    Sensible business tax rates

    Some sensible bank lending to businesses

    No pointless over priced green energy schemes forced on to people

    Proper control by shareholders of top staff pay. (a no more Fred Goodwins bill)

    Finally a lot of government effort is spend trying to get other government departments rather than them to pay for things rather than them. These waste money and achieve nothing overall for the state so some system to sort these out cheaply and quickly.

  2. Alan Jutson
    Posted October 23, 2010 at 8:44 am | Permalink

    Part 1.
    Fully aware that you perhaps cannot revise the Benefits and Welfare System overnight, I fear delay (until two Parliaments time) will in part undo Government figures and plans.

    For many it is not an easy life on Benefits, but then it is meant to be ?
    But why when you talk of wage freezes in the Public sector, perhaps natural wastage, job losses, and in the private sector shorter hours to preserve jobs, and tax increases for all, do you wish to still increase some Benefit rates which are tax free.

    The Benefits and Welfare Sytem are now intertwined in every part of our lives, such has been successive Government wishes over the years, to control and protect everything that goes on in our personal lives.

    The System is so complicated that it now subsidises low wages.
    So complicated that most people are not even aware of what the rules are, let alone what they can claim for,

  3. The Engineer
    Posted October 23, 2010 at 8:45 am | Permalink

    When I heard the the science budget was being protected I was initially quite pleased but now I hear that the the "Living Climate Change Directorate" at the University of East Anglia is getting £1 Billion. Doubtless to be spent on more (of the kind of work -ed) that (some of us think -ed)yet more money is wasted in this area.

  4. Alan Jutson
    Posted October 23, 2010 at 8:51 am | Permalink

    Part 2.
    The System is so expensive to administer and police, with forms so complicated and lengthy, that mistakes (genuine) and fraud (deliberate) are substantial.

    Perhaps we really do need to take an axe to the present system to make it more simple, and more relevent to todays world, perhaps time limited, and perhaps only available to those who have paid in for a number of years.

    One thing is for sure:
    If you extend the Welfare System even further, it WILL cost more money.
    If you exclude those who have attempted to look after themselves, it will discourage responsibility.

  5. nick
    Posted October 23, 2010 at 9:42 am | Permalink

    Additional jobs. Will they generate enough cash?

    2.5 million unemployed. Lets go for the magical (unbelievable figure) that 2 million get jobs.

    How much tax does that raise?

    Most will be on the dole because they are low skilled. Assume minimum wage. That's 2.5K per person on min wage. So getting them all to work will gain an extra 5 billion in tax.

    Meanwhile the government overspend is 160 billion.

    So its a complete myth that getting the unemployed back to work will raise the tax needed to close a 160 billion a year deficit.

    Ah, but what about the reduction in benefits? Lets be generous. 15K a year, tax free for someone on benefits. 2 million, that's 30 billion reduction in spending.

    So we're up to 35 billion in savings. Where's the rest going to come from?

    Growth we here. There is a lie when politicians say growth. Growth doesn't do anything. The only thing that works is growth in taxes. Pure and simply when every you here politicians say growth, they really mean growth in taxes. We're going to tax you till the pips squeak. It's clear to see why. It's only taxing more that closes the gap without cutting spending.

    Like a drunk elephant, the government carries on increasing spending when it needs to cut 28% and return to the spending levels of the year 2000. Was 2000 a disaster? Was there mass destitution? No.

    So its just getting worse, and all the fiddles are just delaying tactics till the inevitable. Politicians (the all take the blame, just like they blame all bankers for the 20 billion hit), have run up 6-7,000 billion of debt. That means 300,000 pounds for every person in the UK. Double that if you say that its only tax payers who will pay the bill. Since the median taxpayer is on 25,000 a year, its clear its unsubstainable.

    • Norman
      Posted October 23, 2010 at 4:52 pm | Permalink

      Remember, income tax and employees NI are a tiny part of what the government steals from us. There are taxes on everything we do bar breathing and sleeping (and I'm sure that would be taxed if they could find a way).

      When someone does find a job the employer will pay employers NI and, hopefully, the employee will make the company more profits, creating more corporation tax revenues and allowing the untaxed part of the profits to be plowed back to to further grow the company. At some point those minimum wage employees will get promoted, or move on to better paying jobs.

      Whilst I agree that government spending is careering out of control getting the unemployed back to work should always be high priority.

    • simon
      Posted October 23, 2010 at 6:55 pm | Permalink

      (More) IMMIGRATION is the coalitions plan for increasing tax revenues and it starts in December 2010 .

      (Many) Indian workers are on their way to work on British soil when the EU signs the "free trade" agreement with India with mode-4 arrangements for trade in services . Hague and Osborne have given it their blessing .

      Unfortunately it will render British I.T. workers ,Accountants and other professionals redundant or reduce their pay to min wage .

      Why would anyone want to take on a massive student loan for a min wage job ?

      75% of workers in the private sector are going to retire with virtually no pension or savings . Thus the taxpayer of the day will be faced with paying out decades of old age benefits for them .

      We are going to have to import more and more of our energy .

      Britain in suffering from never having a written constitution and the Govt not being subject to the same recognised accounting rules as companies , for instance FRS17 .
      Use of cash rather than accruals based accounting is too much of a temptation for any politician , Gordon Brown must have thought he had found the holy grail .

    • THE ESSEX GIRLS
      Posted October 23, 2010 at 9:25 pm | Permalink

      Nick – that would have been a good stated Coalition objective on coming to office:

      " HELP US RE-START THE MILLENIUM!"

      ie Roll back the state to before Gordon went haywire with our money…

    • simon
      Posted October 24, 2010 at 6:59 pm | Permalink

      None of them will get jobs anyway .

      Plans are in place to (allow in many more migrants to take jobs -ed).

      Find it unbelievable ? – EU-India “free trade” agreement mode-4 arrangements . To be signed in December 2010 and Parliament isn’t opposing it .

      Virtually nothing in the media , very hush hush .

  6. Brian Tomkinson
    Posted October 23, 2010 at 9:49 am | Permalink

    JR: "Spending soared in the August figures, up more than 10% on the same month last year. In September there was a record deficit"
    Why was spending allowed to soar in August? The more I hear and read the less convinced I am that any appropriate action has been taken or will be taken. Even you, John, are now giving me the impression that you support high level of government spending. I shall not be surprised if even higher taxes are announced in the next budget.

  7. lola
    Posted October 23, 2010 at 10:11 am | Permalink

    The second is, can the “Growth Strategy” succeed in so stimualting the private sector recovery that enough tax revenue and additional jobs are generated? Only, as your last paragraph implies if you cut taxes and regulation. The disgraceful RDR (the failed FSA sponsored and misnamed ‘retail distribution review) is typical of the wealth destroying initiatives carried over from the previous administration and suppported with entirely misguided enthusiasm by your colleague Mark Hoban – a bloke who seems to have very little real world commercial experience according to his CV. (sentence deleted for inaccuracy)
    Do something about it.

  8. S Matthews
    Posted October 23, 2010 at 12:39 pm | Permalink

    Let me add to the above. The stupidity of spending tax payers money on subsidising windfarms beggars belief. The evidence is clear; the electricity produced by them is expensive and unreliable. If we want growth then we need cheap power as one of the pre-conditions. Its very simple.

  9. Lindsay McDougall
    Posted October 23, 2010 at 12:58 pm | Permalink

    The government must be as hard as nails during this FYR and FYR 2011/12, otherwise the markets will lose faith. And is very foolish to rely on GDP growth pa in excess of 2.1%. There must be no counting of chickens.

  10. Posted October 23, 2010 at 2:14 pm | Permalink

    …Its clear wish to do so has stablised the market in government debt, driving down the cost of government borrowing further. To sustain this …"

    Didn't you used to talk about a 'bubble' in government bonds? I think you might have been right the first time.

  11. electro-kevin
    Posted October 23, 2010 at 3:37 pm | Permalink

    Reports of hospital beds being limited and essential services being cut back by councils.

    How can we be sure that the cuts are going to be directed to where they really need to be ? Superfluous bureaucratic empires and the like ?

    The temptation for public services managers to punish the taxpayer for voting coalition by leaving streets uncleaned and unpoliced must be irresistable.

    The betting is that not one five-a-day coordinator or outreach worker gets the chop.

    Then – coming on top of cuts and tax rises – is alarming levels of price inflation on essential goods and services. Increasing overseas aid at such a time really is unpopular and stretching our loyalty somewhat.

  12. GJWyatt
    Posted October 23, 2010 at 3:46 pm | Permalink

    The public finances are now too constrained to sustain any "Growth Strategy" other than via longer-term supply side considerations. For "growth" to alleviate the deficit it has to reduce the spare capacity in the economy, i.e. come from the short-term demand side. But, quite obviously, this cannot come from the public finances because government expenditures and revenues are both being driven in the wrong direction in an attempt to close the deficit. So the stimulus to (short term) growth must come from the monetary side of the economy, i.e. the Bank's programme of "quantitative easing". QE could work through wealth effects on consumer spending, or through stimulating private investment, or through a weakening of the sterling exchange rate. The last of these three channels seems the likeliest prospect, though it has a flavour of the beggar-thy-neighbour policies deplored by the finance ministers in Seoul yesterday. Had we ditched sterling for the euro we'd now be with the piigs, deep in it.

  13. Rob
    Posted October 23, 2010 at 5:44 pm | Permalink

    The problem with the growth strategy is it somewhat naively assumes that the newly public sector unemployed will take private sector jobs. In my opinion this is highly unlikely. Whilst it is quite likely the private sector generates 1M+ new jobs a good 70%+ of these will be absorbed by the flexible and motivated migrant worker. Hence I think you will have continuing high unemployment (relative to govt predictions).

    • simon
      Posted October 24, 2010 at 6:56 pm | Permalink

      The EU (with Hague , Osborne and Cable's blessing) are changing the rules to pave the way for millions of Indian workers to move to British soil .

      Thus unemployment of British Citizens is set to rise and wages of those who keep their jobs plummet .

      I've tried to warn everyone – you'll do well to find anything in the media because it's all being hushed up .

      GATS Mode-4 in the EU-India trade agreement – movement of workers from India to UK .

      At least it will prop up the housing market for a while and protect MP's property portfolios !

  14. Martin
    Posted October 23, 2010 at 6:26 pm | Permalink

    Re missing tax revenue in Irland and indeed the UK – I suggest HM treasury takes a look at this
    http://www.bloomberg.com/news/2010-10-21/google-2

    It explains a lot!

  15. Alan Wheatley
    Posted October 23, 2010 at 7:32 pm | Permalink

    One really depressing piece of news to come out of the Spending Review is that the Government are going to press ahead with HS2 – the high speed rail line from London to Birmingham. Apparently Philip Hammond has said that the necessary funding has been secured; we can expect more information next week.

    We do not need to spend £17.8B on this vanity project. If anyone thinks there is a good, economic case for HS2 I suggest they read the article by Chris Stokes (former Executive Director of the Strategic Rail Authority) in the October edition of Modern Railways, who shows the case in favor has been made by stary-eye optimists, and there are far better ways of spending money on our railways to improve the service.

  16. THE ESSEX GIRLS
    Posted October 23, 2010 at 9:52 pm | Permalink

    In a slightly different take on the spending review some papers today have taken up the Rooney story to compare his inflated pay package with the travails of the kind of folk with whom he was brought up.

    This led us girls onto looking at it in a different way from the blokes. We reckon the American owners of Man U. have shown some business acumen often lacking in the emotion and petulance of big soccer in the UK (not to mention government!)
    Our theory is this:
    With no new contract Rooney could have walked for free in 18 months. No transfer fee of £40m-ish?
    With the new 5-year contract he can't do that until he's over the hill at 30. Asset secured.
    Man U could still get shot of him in a year or 2, especially if he doesn't start performing, and get a biggish fee then.
    So for another £5m pa (or half that as he'd have got 150k pw anyway) they've got his services and safeguarded their £40m capital.
    And I bet there's a lot of Wazza merchandise unsold in the Man U shop and now saved from the discount market!

    What do you fellas reckon?

    • Alan Jutson
      Posted October 24, 2010 at 8:40 pm | Permalink

      Essex Girls.

      Two opposite cases.

      I reckon he will be sold in a year, Man U were protecting an asset that could have bought himself out of his own contract for £5 milion next year and got nothing. Now they will get Tens of millions and probably will not pay any more in wages within his current contract time. It happened to Ronaldo !

      Chelsea let Joe Cole go for nothing this year (out of contract) they could have given him £100,000 a week on a new contract, and then sold him for in excess of £10 Million and then made some money.

      Two different Clubs, Two different policies.

  17. colin
    Posted October 24, 2010 at 4:43 am | Permalink

    "This is not the time…"to be increasing our contribution to the E.U. either

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    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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