15 December 2006
The chancellor – whoever that might be in 2007 – will have to conjure up a way of meeting expensive government commitments while implementing a tight public spending squeeze in the years ahead
Next year's Comprehensive Spending Review could be the first big policy announcement by Gordon Brown's successor as chancellor. The tentative plans for overall spending set out in last week's Pre-Budget Report suggest that this will involve a cut in the share of the economy spent by the government, and a significant slowdown in the rate of growth in priority areas such as education and health.
The review will set out plans for government departments for the three years from April 2008 to March 2011. While the overall spending envelope has not yet been confirmed — that announcement is expected in the spring Budget — the figures presented in the PBR give an indication of the chancellor's plans. These show total public sector spending rising by 1.9% a year after economy-wide inflation. This would be significantly slower than the average growth of 3.3% a year seen over the ten years from 1997/98 to 2006/07.
The size of the state as a share of national income was 40.8% of national income in 1996/97 when Labour came to power. It is forecast to peak at 42.5% in 2007/08 before falling to 41.9% in 2010/11. This planned decline would also be consistent with Conservative leader David Cameron's pledge to share 'the fruits of economic growth between lower taxes and strengthened public services'.
So what might this spending envelope — if kept to — mean for individual spending departments? Some allocations have already been set. The last Budget announced that the Home Office's budget would be frozen, and that four other smaller departments would see their budgets shrink by 5% a year in real terms.
This includes the administrative budget of the Department for Work and Pensions, which has targets for increasing the employment rate of lone parents and reducing the numbers receiving disability benefits, and also has to reform the failing Child Support Agency.
The PBR announced that the Department for Constitutional Affairs would receive a cut of 3.5% a year, and that the budgets of five further small departments would shrink by 5% a year.
Other departments will have to wait until next year. However, by looking at the government's commitments and the choices that it has made to date, it is possible to calculate a plausible allocation. There is a manifesto commitment to increase spending on overseas aid to 0.7% of national income by 2013, which would require real increases averaging in excess of 10% a year from April 2008.
As the government is likely to want to make further inroads into reducing child poverty, we assume that spending on social security benefits and tax credits is increased by 2% a year. This would still represent a lower rate of increase than has occurred since Labour came to power.
The two biggest areas of spending that remain are the NHS and education. Assuming that all other budgets — including defence, housing, environmental protection and transport — have their spending frozen, this would still allow the combined budgets of the NHS and education to grow by only 3.4% a year after economy-wide inflation.
While this is greater than the expected growth in the economy, it would be significantly lower than the 7% a year that the combined budgets of these two departments have received between April 2000 and March 2006. It would also require some tough choices over the relative merits of increasing spending on either schools or hospitals.
Compared with the four spending reviews that have occurred in the past ten years, next year's CSR is set to be particularly challenging. One possible outcome is that the initial allocations for departments are indeed relatively tight but that education and the NHS are found additional resources over the following three years. This is what happened with the first Comprehensive Spending Review of July 1998, with the spending plans for both education and the NHS being topped up in the Budgets of 2000 and 2001.
However, lower-than-expected unemployment and interest rates, which reduced expenditure on benefits and debt interest repayments, meant that those plans could be topped up without increasing overall spending. Whoever succeeds Gordon Brown at the Treasury might have similarly good fortune.
If not, then he or she is likely to face the tough choice of either reining back some of the government's aspirations for improving public services and reducing poverty in the UK and overseas or announcing further tax raising measures.
Carl Emmerson and Christine Frayne are respectively deputy director and senior research economist at the Institute for Fiscal Studies
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