Budget 2015: how welfare cuts softened the blow to public services

Doing the numbers dance. altogetherfool/flickr, CC BY-SA

We have not seen the last of George Osborne this year, or of cabinet colleagues punching the air in delight at his statements. Get ready for a third instalment of treasury triumphalism this autumn, when the chancellor will return with his Comprehensive Spending Review. By substantially deepening the next five years’ welfare-spending cuts, he need now take only a scythe to the unprotected government departments – not the giant axe left hovering above them by the last coalition budget.

In his last budget, Osborne wanted to close a fiscal deficit still estimated at 5% of GDP by 2019/20. He proposed welfare cuts worth 1.3% of GDP, and tax increases of 0.5%. This left government departments responsible for almost 70% of the remaining deficit reduction, needing to find a savings equivalent to 3.6% of GDP. Since the NHS, schools and overseas aid are protected in real terms, that meant an unprecedented economy drive in areas such as policing, justice, business, defence, environment and energy – distinctly uncomfortable for the Conservatives who returned to run those departments in May.

The arithmetic for town halls and previously endangered Whitehall departments is now distinctly easier. Public services will get £83.3 billion more in the next five years than was allocated in March, according to the independent Office for Budget Responsibility (OBR). With the deficit down to a projected 3.7% of GDP in 2015/16, and the deadline for budget balance delayed another year, departmental spending only has to decline by 2.4% of GDP between 2015/16 and 2019/20.

That’s still an uncomfortable fall, comparable to the reductions from 2010 to 2015 with the most accessible savings already made. But the squeeze on unprotected departments will be one third less than was threatened just four months ago, on latest OBR calculations. Osborne now has the fiscal leeway to turn every school into an academy, open GP surgeries 24/7 (if there’s anyone to staff them) and keep the defence budget at a NATO-friendly 2% of GDP, as well as assign the NHS another £8 billion. And still (just) deliver a fiscal surplus by the end of the parliament.

Achieving the reprieve

To appreciate how this will be done, we should discount at least one third of the chancellor’s promise of a “higher wage, lower tax, lower welfare economy”. Tax increases will now deliver a revenue boost projected at 0.8% of GDP in the next five years, up from 0.5% in the March budget. Revenue increases from these – along with welfare curbs – will now contribute as much to the deficit reduction (2.4% of GDP) as the departmental spending cuts. Osborne has, like every chancellor, raised taxes at the start of his term so he can reduce them before the end.

“Higher wages” are important for this revenue gain, as well as to the planned reduction in tax-credit and Universal Credit costs. Rising pay, even if matched by inflation, will be used to lift more people into basic or higher rates of income tax and National Insurance. The invisibility of this fiscal drag allows the government to headline its tax reductions, despite the burden getting heavier over five years.

“Lower welfare” will mean large sacrifices for many, especially children in larger families living under lower benefit caps. By 2020, expenditure on all working-age benefits and tax credits will have dropped to little more than the uncapped cost of state pensions. Fiscal drag into the higher tax brackets, and refusal to cut the 45% top rate, ensures take-home pay restraint is spread beyond those whose working-age benefits will be frozen for four years. But the government has very deliberately chosen to shield the public services used by all (and especially enjoyed by those on middle and higher incomes), by clamping down on social supports designed for those who earn least.

Productivity bonus?

Although the social (and, given Osborne’s proven political skill) electoral risk of this strategy will have been carefully computed, one danger in the shift from public service cuts to welfare cuts is harder to quantify. Whereas a tough chancellor can control the amounts that central and local governments spend, social security costs are inherently harder to contain. Like families and football teams, welfare can at best be managed, since savings in one place often spring back as unexpected payouts somewhere else.

For example, the welfare bill rose to 20% of GDP in 2008-9 as the financial crisis unfolded and is still close to 20% in 2015/16, its share of national income having risen when the recovery paused in the Coalition’s early years. In its March forecasts, the OBR foresaw at most a one percentage-point fall before 2020:

Annual Managed Expenditure’s stubborn welfare component. Office for Budget Responsibility

Governments can normally rely on sustained GDP growth to bring down welfare costs, even without painful cuts, as unemployment falls and real wages rise. But that’s because they can normally rely on post-recession growth rates going well above the long-term trend.

The average growth rate of just below 2.5% now forecast for 2015-20 is actually lower than the long-term trend since 1948. Although impressively long, that’s an unprecedentedly weak recovery after such a steep downturn, especially given the amount of new employment that’s been needed to deliver the extra output.

George Osborne’s hopes that employers will now start to pay substantially more, raising the tax take and lowering the welfare bill, rests on a burst of productivity improvement which usually requires substantially faster GDP growth. The chancellor who has twice doubled UK budgetary output is now relying on UK industry to do the same.