Tax and other giveaways are a common feature of budgets. This year’s being so close to the election, we can expect to see some voter-friendly policies. Last year’s budget included raising the income tax personal allowance, pensioner bonds for the over 65s and cancelling increases in fuel duty.
But George Osborne was supposed to be the chancellor who put deficit reduction centre stage. If he wins the next election, he is promising much larger cuts in public spending than any of his opponents. How does this square with all these tax breaks?
Emphasis on the deficit
When his government was elected in 2010, Osborne proposed a plan to eliminate the deficit by 2015. The plan was enacted over the next couple of years, along with sharp cutbacks in public investment such as school repairs and flood protection. These did considerable damage to the real economy.
The Office of Budget Responsibility estimates that austerity reduced growth by 1% in both the first two years of the coalition government. This is almost certainly an underestimate, with a lot of recent research suggesting that cuts to government spending have a larger and more sustained impact when an economy is already depressed. It is therefore fair to say the coalition’s cuts delayed the UK’s recovery from recession.
In 2012 Osborne quietly changed this plan. We can see this clearly in the chart below. Deficit reduction stopped or slowed. The official line was that he was sticking to his “long-term plan”, but as recent tax giveaways show, reducing the deficit is no longer the number one priority.
Many commentators at the time saw this change of plan as a prudent reaction to the lack of economic recovery. The economy did indeed start a sustained recovery one year later, and putting austerity on hold in 2012 clearly helped that happen. It was also clear by 2012 that the threat from market reaction to large budget deficits had been greatly exaggerated – if it had existed at all.
Interest rates on UK government debt continued to fall. In September 2012 the eurozone crisis was solved by the European Central Bank agreeing in principle to buy the debt of its troubled economies, something which the Bank of England had already been doing for the UK as part of its quantitative easing programme.
However perhaps we should have taken the chancellor at his word when he says that there has been no change to his long-term plan. The mistake was to misunderstand what this plan was. In reality it may have had nothing to do with the deficit, but instead was all about shrinking the size of the state over a ten-year period.
The problem the Conservatives faced in 2010 was that there was no public appetite for a smaller state. Surveys continued to show many more people wanted higher government spending and taxes than wanted the opposite (with a large percentage wanting neither). A focus on the government deficit presented them with an ideal opportunity to achieve a smaller state by the back door.
It was natural for people to believe that in a recession the government needed to tighten its belt – just as individuals or firms were doing – even if that policy would have Keynes turning in his grave. With more than 80% of deficit reduction taking the form of spending cuts, the deficit reduction plan was in effect a state reduction plan.
The only problem with this strategy is that, as we saw in the coalition’s first two years, it would seriously damage the economy, just as Keynes would have predicted. The chancellor has never rejected Keynesian analysis, so perhaps he was well aware of this. So the plan may have always included a temporary pause to austerity before the election, giving the economy time to recover and the chancellor scope for what he hoped would be election winning tax giveaways.
The real plan
So the real long-term plan was an initial two years of sharp cuts to public spending and the deficit, to be followed by budgets involving tax cuts that would allow growth to resume but rather less deficit reduction. If this combination was enough to win the subsequent election, the recipe could be repeated all over again. Indeed, this is what George Osborne’s post-2015 plans look like. All done in the name of deficit reduction, when the real aim is to reduce the size of the state.
For this plan to work, you need one extra ingredient: a compliant media that buys into the idea that deficit reduction is all important, and that recent growth somehow vindicates the earlier austerity. What you want to avoid at all costs are pictures like the one below, which show the economy slipping even further away from its long-run growth trend as a result of austerity.
Unfortunately, nothing like this chart will appear in any of the Treasury’s budget day briefing.