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Analysis Cutting it fine, by Carl Emmerson and Christine Frayne

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09 December 2005

So the chancellor has managed – just – to keep within his fiscal rules. But his Pre-Budget Report lays the ground for spending cuts that will leave little funding for services other than the government's priorities

Few will have been surprised by the chancellor's Pre-Budget Report forecast that his self-imposed fiscal rules will continue to be met. On the tax side, Gordon Brown announced a £3bn increase, the majority of which is on North Sea oil companies. Given previous decisions, this is also not surprising — and, unless it leads to higher oil prices, will be felt by a combination of the companies' shareholders and employees.

A larger deviation from past behaviour was the fact that the chancellor chose to pencil in cuts in public spending for the period that will be covered by the 2007 Comprehensive Spending Review.

Total public spending is set to increase from 37% of national income in 1999/2000 to 42.8% in 2007/08, the last year for which we have 'firm and fixed' spending plans. The next Spending Review, which has been delayed by one year to summer 2007, is intended to be a 'Comprehensive' review. This apparently means that the value of all existing programmes will be considered, rather than just new ones. It will cover the three years from April 2008 to March 2011.

The chancellor's Pre-Budget Report has pencilled in increases in total public spending, after economy-wide inflation, averaging 1.8% a year over this period.

If delivered, these plans will cut total public spending back to 42.1% of national income in what is expected to be the beginning of the next Parliament. This tight control of spending growth would be consistent with the idea put forward by David Cameron, the new leader of the Conservative Party, that the chancellor should 'share the proceeds of growth between public spending and tax cuts'.

However, would it be consistent with the government's stated ambitions for improving the quality of public services and increasing the incomes of the least well-off pensioners and children?

The very large real increases in spending that the National Health Service has received since April 2002 are based on the calculations of the Treasury-commissioned Wanless Report. This suggested that, even if the NHS were able to operate at the most efficient level assumed, it would still require increases of 4.4% a year, after inflation, over the period to be covered by the forthcoming CSR. The Treasury is currently reassessing the calculations in this report, so they could be revised either way.

However, were the NHS to receive a real increase of 4.4% a year, then this would leave real increases of just 1.2% a year for non-NHS spending.

The Labour party election manifesto also committed the government to increasing spending on overseas development from its current level of 0.3% of national income to the 0.7% recommended by the United Nations by 2013. If implemented steadily, this would necessitate real annual increases of 12.9% a year from 2008/09.

In addition, the government is very unlikely to cut education spending as a share of national income — not least because New Labour was elected in May 1997 on the back of a high-profile manifesto pledge to increase it.

Taken together then, non-NHS, non-international development, non-education spending would be able to increase at most by 0.8% a year in real terms.

The government also has commitments, and aspirations, to improve other areas of public services — most notably transport, law and order and defence.

Furthermore, beyond April 2008 there are no planned real increases in the targeted benefits and tax credits to which the poorest families with children and pensioners are entitled. If these benefits are not indexed in line with average earnings, recipients' living standards will fall relative to those in paid employment.

Of course, it might be that by the time that the final CSR allocations have to be determined, the chancellor will increase his spending plans. In principle, this could be financed in one of two ways: increased borrowing or increased revenues. Increasing borrowing would be a risky strategy as the margin with which he now expects to meet his fiscal rules is low, relative to the degree of safety he has aimed for in the past. The alternative — increased revenues — would be likely to require further tax-raising measures to be announced before the next general election.

Carl Emmerson and Christine Frayne are respectively deputy director and senior research economist at the Institute for Fiscal Studies

PFdec2005

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