No-one knows just how much a country can borrow before the lenders worry, demanding higher interest rates, or refuse to lend more. Most people agree there does come a point where a country, like a company or an individual has borrowed too much. Once that is generally the view the options for that country narrow to the unpleasant or even to the self defeating. If you cannot borrow more you have either to cut your spending or increase your revenue, or a combination of the two. Until the potential lenders are convinced you can do it sufficiently, you are unable to borrow at affordable rates. You can end up like Greece, having to squeeze both the public and private sectors too much, the one with spending cuts, the other with tax increases. You can end up in vicious circle of cuts, slump and more cuts. Borrowing more is not an option because no-one will lend you all the money you think you need.
The UK government’s critics mainly tell it to spend and borrow more. They usually are unaware of the cash increases in spending in current plans, totally ignorant of the increased spemding and borrowing put into the 2nd Coalition budget comparted to the first, and only just aware of the clause which says if the economy grows less fast the Chancellor plans to borrow more. In other words, their Plan B is largely the Chancellor’s Plan A presented differently.
The problem with Plan B if taken further than the Chancellor’s revised plans of March is it would reach the point where the markets no longer believed in the deficit reduction approach. Lenders might then decline to lend at managable rates. Given the heavy reliance on extra revenue from growth some contributors to this site seem to favour a Plan C, which would cut the risk of the levels of borrowing becoming too high.
What would these commentators’ Plan C look like? A modest Plan C could, for example, have stuck to an increase of just 2% per annum in cash spending, instead of allowing the 9% plus increase in spending in the first two years of Plan A. This would have meant an £18 billion lower spending increase in 2010-11, and a £30 billion lower spending increase in 2011-12. Over the whole five years it would have reduced the spending increases by a cumulative £138 billion, and cut the proposed additional borrowing from £485 billion to £347 billion. As we now know the markets can live with the prospect of borrowing an additional £485 billion over five years, this would have given welcome leeway in case growth comes in below forecast. It could also have allowed no VAT increase, cutting the squeeze on the private sector and reducing the inflation rate in 2011. Restoring Labour’s top rate of Income Tax and CGT rate could probably have increased revenues over the five years as a whole compared with the higher rates levied by the Coalition.
Such a plan is not going to be adopted, but I thought I should introduce it into the debate given the interest by some contributors in what would happen if spending controls were stricter. It would of course still be possible to do more by way of spending control this year. Plan C is a theoretical comparison to Plan A and any bigger borrowing version called Plan B. It would produce a less pronounced private sector squeeze in years one and two, and keep interest rates lower in years 3-5. As illustrated it still allows public sector cash spending to rise every year by the pace proposed for the last three years of Plan A. If public sector costs were kept under control it would mean important public services could still experience real increases in funding. It is interesting to note that in yesterday’s IMF Report on the UK they propose tax reductions to add stimulus should the growth rate drop too low. Plan C’s mixture of tax cuts, less inflation, and a smaller private sector squeeze should deliver better growth than Plan A. Ths in turn would deliver more tax revenue, and reduce the deficit more quickly.