'Budget will be savage – but we'll be back on road to normality'
This Tuesday we get the emergency Budget with its tax increases, cuts in public spending and all that.
But we get much more. We get an overall picture of the path back towards sustainable finances, essentially a picture of how the coalition government will seek to correct the errors of the previous regime.
All new governments do this. The big aim of Gordon Brown, back in 1997, was to avoid the failure of the Tory governments to achieve macro-economic stability, in particular the stoking up of the late-1980s boom and the subsequent early-1990s recession. He was absolutely right to do so, and the rules he imposed on himself were well-designed. Only problem: he didn't stick to them.
And now we have a new structure, the Office for Budget Responsibility. I have taken a graph from its initial report last week, showing what, on unchanged policies, might happen to both public spending and tax revenues, expressed as a percentage of GDP over the next five years. It also produced a somewhat lower growth forecast than that of the previous government, but also a slightly lower deficit forecast too. The OBR will, over this weekend, be examining the new Budget for internal consistency and will give it its seal of approval on Tuesday.
Seal of approval? Yes, because it would be unthinkable for it to say that the Chancellor's numbers were wrong, but I expect there will be a bit of to-ing and fro-ing during the next few hours. The outcome will be a slightly sharper decline in spending profile and a slightly greater rise in the tax side. I'll come to the implications of that in a moment, but first a word about the change in the decision-making process.
Under Gordon Brown and to a lesser extent under Alistair Darling, the budgetary process was a very last-minute thing. Changes were being made right up to the day of the Budget, the record being 3am that morning. Now the Chancellor cannot do that because the OBR has to have time to vet the numbers. This will enforce both order and professionalism. Budgets are and always will be political, but the politics will be more constrained than they were in the past.
And the economics? Have another look at the graph. The dotted lines are a possible profile for a faster debt reduction than that under present tax and spending plans, with, as you can see, most of the changes being on the spending side but some on the tax side. This is not the detail of what will be announced on Tuesday, but it is the sort of profile that the Chancellor is likely to move towards. It would get the deficit down to less than 2 percentage points of GDP, with spending a little above 40 per cent and tax revenues a little below.
Now think of the implications of this. If these projections are more or less right, public spending will still be higher in five years' time than it was during the long growth period between 1997 and 2005, the first two Labour terms. And taxation will be higher than at any time since 1990. The Budget will doubtless be greeted as the most savage fiscal consolidation since the Second World War and in many ways it will be. But, actually, all will be happening on the spending side is moving back to what has historically been a normal level of public spending, while taxes will be the highest for a quarter-century. It is a measure of the catastrophe which the coalition government has inherited that it has to be savage to get back to normality.
There is a further issue. Looking at these graphs, the thing that worries me most is that the Government will not achieve the tax receipts it is projecting. The OBR has done a most professional job and the very latest revenue figures have been somewhat stronger than expected. That is good news. But the Treasury has persistently overestimated revenues in the past and there are several longer-term reasons for expecting quite weak tax receipts during the coming growth phase.
These include further moves by companies to shift their headquarters offshore, including most recently much of the Zurich insurance group. There is likely to be push-back by high earners against the 50 per cent rate, with people taking lower rewards in salary, retiring earlier, moving offshore and so on.
In year one, tax receipts may rise, but as behaviour adapts, revenues then start to decline. What a few people do makes a huge difference to receipts. Remember that the top 1 per cent of income tax payers account for nearly a quarter of all income tax receipts, and when marginal tax rates were much higher in the 1970s they accounted for only about 10 per cent of receipts. Lower levels of inward migration will also cut the tax take. And it may be that the somewhat better tax receipts right now are a reaction to expected tax increases to come.
We will see. It is just that if my calculation is correct – that by 2015 the tax take will be the highest since the early 1990s – anyone under about 45 will be paying more tax than at any stage in their working lives. Not much fun, eh?
The better news is that there is a reasonable chance that the UK will retain its AAA debt rating and therefore be able to hold down its borrowing costs. It would not be a total catastrophe were we to be downgraded by the rating agencies, and that outcome is still possible. But the dynamics of the markets have shifted in the UK's favour in recent weeks, largely because it is perceived that we will, come Tuesday, have a credible deficit-reduction programme.
Sterling has recovered somewhat, and not only because of the plight of the euro, and long-term borrowing costs have already come down a little. If you have more debt, and the national debt will peak at around 75 per cent of GDP against 35 per cent five years ago, you have to pay a larger portion of tax receipts in interest. That leaves less for spending programmes. That is unavoidable. But the lower the long-term borrowing costs, the easier it is to bear the burden.
So see what is happening this week not just as a dismal bundle of tax increases and spending cuts, though it will certainly be that. See it as a return to honest fiscal accounting, independently verified, that sets out a rational path back to a situation where, if a government wishes to increase public spending, it will raise the necessary funds in taxation to do so. That surely is a much more moral policy than loading debts on to our children and the unborn. In any case, there is now no alternative.
Strange, is it not, that the financial markets have been the mechanism for forcing politicians to adopt more moral behaviour? That is not quite what is supposed to happen.