07 March 2008
Next week's statement will be a severe test for the chancellor. There's a squeeze on spending and no appetite for tax rises, so what are Alistair Darling's options? PF convened a round table of politicians and experts to find out. Joseph McHugh reports
When Chancellor Alistair Darling reveals the contents of his ministerial red box on March 12, it will require nothing short of alchemy for him to produce a Budget that successfully marries economic necessity with political reality.
While the public finance figures make it plain that a tax-raising package is desirable, realpolitik dictates that fiscally neutral measures are required.
Almost a decade of generous public spending has now left the government with a serious financial headache: tax revenues are bringing in less than the
exchequer predicted and government borrowing has risen relentlessly to bridge the gap.
Volatility on the financial markets, a US credit crunch that has now gone global, and the huge public liabilities generated by the bail-out and subsequent nationalisation of Northern Rock, have made the chancellor's task even harder.
Public Finance, in association with Deloitte, convened the latest in its series of high-profile public policy round tables on February 27 to consider Darling's dilemma.
The UK's boom years, based on strong consumer spending that in turn has rested on a strong housing market, are coming to an end. At the same time, inflationary pressures are mounting. This witch's brew threatens an era of economic stagnation – a reminder of an Old Labour past that New Labour has worked hard to overcome.
Unfortunately for Darling, he cannot use the public finances to alleviate the effects of the worsening macroeconomic climate. It simply is not possible for him to conjure from his box of tricks a fiscal stimulus package to present to Parliament in his first Budget.
A spending spree during the boom years since 2000 means the cupboard is now bare – so an economic boost powered by tax cuts or higher public spending is out of the question. Unless, of course, the chancellor is willing to fund it with even higher public borrowing.
The public finance figures for January, published a fortnight ago, had some good news on tax receipts – but these do not reflect the recent economic turmoil. Economists are unanimous that the tax take will suffer when recent events have had time to play out. Public sector net debt, meanwhile, stands at £512.4bn, or 35.4% of gross domestic product.
Launching a spending spree on the never-never would destroy the government's chances of meeting its fiscal rules – along with its reputation for economic competence, already strained by the will-they, won't-they indecision of the Northern Rock debacle.
Borrowing to spend its way out of an economic downturn would almost certainly cause the government to break its own sustainable investment rule, under which debt must not exceed 40% of GDP.
As it is, the estimated £100bn of Northern Rock liabilities will break through that benchmark when they appear on the nation's balance sheet. However, most economists agree that these are exceptional and should not be included in the total against which the chancellor is assessed.
Breaking one of the rules on which Labour has staked its claim to sound stewardship of the economy is unlikely to appeal to Darling.
But inconveniently, a sceptical public is in no mood to tolerate any further tax increases, doubtful that those already levied are being used for their stated purposes. 'No new taxes' – visible ones at least – is a shibboleth now taken up by all three main political parties.
So, with a slowing economy needing a boost, but no reserves to fund it, and boxed in by a limited ability to borrow or raise new revenues, just what is a chancellor to do?
PF's round table brought together distinguished economists, politicians and policy experts to assess Darling's options in what will be a Budget for hard times.
The event was chaired by Tony Travers, director of the Greater London Group at the London School of Economics.
Participants included Philip Hammond, Conservative shadow chief secretary to the Treasury; Vince Cable, Liberal Democrat shadow chancellor; Robert Chote, director of the Institute for Fiscal Studies; and Doug McWilliams, chief executive of the Centre for Economic and Business Research.
Other speakers and contributors included Sir Christopher Foster, former government adviser and chair of the better government initiative; Sir Nicholas Monck, former Treasury second permanent secretary; Peter Riddell, assistant editor of the Times; and Ann Rossiter, director of the Social Market Foundation think-tank.
Chote kicked off the debate by spelling out the tension between the economics and the politics that must somehow be resolved. All the data suggest a tax-raising budget is needed, he said, but a neutral package is politically desirable.
'The government's misfortune is that spending that seemed affordable no longer is. If the tax revenue numbers had held up, the spending would have looked affordable.'
He said the Treasury had been guilty of 'mispredicting the tax revenues, not the size of the economy'. As an economic slowdown looms, 'the fact that the serial over-optimism has never been reined back means that now there's little room for manoeuvre'.
Britain is particularly exposed to the volatility of the global economy because of the exchequer's reliance on tax receipts from the financial services sector, Chote counselled. As the City loses its lustre, the Treasury loses vital revenue.
The government's failure to plan for leaner times in the good years – 'a Goldilocks economy, neither too hot nor too cold, never seemed very plausible' – stands in contrast to other countries.
One in three of the UK's fellow members of the Organisation for Economic Co-operation and Development has more assets than debts. This group, which includes the Republic of Ireland, New Zealand and the Scandinavian nations, are therefore well placed to cope with the current economic uncertainty.
Riddell said the public viewed economic management in black-and-white terms, as a question of which party was fit to govern.
'The spending slowdown is about to hit us in five weeks' time and it will have a profound effect, and the spending options are absolutely narrow. The arguments from all kinds of interest groups are going to be immense,' he said.
'You can't simply correlate it to say: high unemployment, low growth, bad for the government. It comes down to a reputational point… whether you think this lot, or the other lot, are going to be more competent, and that's where Northern Rock does matter. The gap has narrowed considerably.'
This point was taken up by Philip Hammond, Conservative shadow chief secretary to the Treasury, who drew out the profound effects that the deteriorating public finances would have on public services.
Organisations used to a healthy cash flow would have a painful reality check, he warned, as they would have to undertake radical reform to meet rising public expectations without the generous funding enjoyed in recent years.
'As the prudence of the early years has slipped into the fiscal profligacy of the present, the public services have been able to operate without any external discipline – ironically, exactly the restraints that will now be applied for all the wrong reasons. This has done a disservice to the public services by tolerating very low productivity,' he said.
'We're now going to ask our public services to radically reform, but without the budget cushion they had before to soften the transition.'
Hammond recognised the conundrum facing Darling as he prepares for March 12.
'All of this leaves very little room for manoeuvre in the Budget, very little scope for reductions in either tax or borrowing.
'It isn't realistic, unless you're of the Pol Pot persuasion, to talk about real-terms cuts [in spending]. Voters want real-terms growth for quality public services.'
Ann Rossiter, director of the Social Market Foundation think-tank, asked whether the political parties were adopting a deliberate strategy of advocating similar tax-and-spend policies, so as not to alarm voters.
'Isn't [that very closeness] one of the things that the parties are trying to achieve because of the question of competence? Direction of travel [on spending] might be something that people are trying to keep a lid on, politically.'
Liberal Democrat shadow chancellor Vince Cable acknowledged that there was little to distinguish between the main parties on their proposals for taxation.
'Neither the Conservatives nor ourselves are coming up with very exciting positions on tax. Although we are coming at the problem from opposite directions, we are at pretty much the same place,' he said. He
characterised Darling's controversial plans to levy a £30,000 one-off tax on 'non-doms' – non-domiciled people from overseas who live in the UK – as a measure targeting 'fat cats and foreigners'. Consequently, it was unlikely to incur an electoral penalty.
This measure would do little to plug the gap in the public finances, however, and Cable dismissed advocacy of greater efficiency as a means of doing so as being merely a 'sterile debate'. Instead, he posited a more radical approach, 'where government no longer undertakes certain activities'.
The LibDem deputy leader also argued for a radical overhaul of the UK's Budget-setting process, with much stronger scrutiny by Parliament and other independent institutions.
'We have no scrutiny whatever, except retrospectively through the Commons' Public Accounts Committee. There is a need for forward-looking, independent assessment of Budget measures,' Cable said. 'Assessment by the National Audit Office seems to be the way forward.'
There was general agreement around the table that the current system needed to be fixed, not least to address the widespread scepticism among the public about politicians and their promises.
Doug Godden, head of economic and fiscal policy at the CBI, highlighted the absence of any mechanisms to promote action when problems started to emerge.
'The public spending totals have been allowed to drift upwards, even when it started to look as though there was a problem with the budget,' he said.
Sir Christopher Foster, former chair of the Better Government Initiative, asked if there were any real consequences if the government did not meet its own much-trumpeted fiscal rules. 'What is the sanction – is it embarrassment?' He continued: 'We have to take seriously the notion that we have one of the weakest expenditure control systems in the western world.'
Sir Nicholas Monck, a former Treasury second permanent secretary, criticised the lack of any Parliamentary scrutiny of proposals in advance of the Budget.
'That can't be a sensible arrangement. Parliament should be able to make better arrangements for itself so there's something to look at in advance. I would hope members might look to crossbench proposals for a substantial change in Parliament's role.'
Others argued for a more coherent approach from the institutions that govern the UK's economy. Chote highlighted the lack of co-ordination between the Treasury and the Bank of England's Monetary Policy Committee.
'One of the claims made for the macroeconomic framework is that it combines fiscal and monetary policy. If I were a member of the MPC, I would expect the Treasury to come and say what it was doing,' he said.
'I'm not clear that that sort of discussion ever really takes place. There is nothing in the framework that sets up a sensible discussion between monetary and fiscal policy.'
Professor Jagjit Chadha, professor of economics at the University of Kent, agreed that the current disjunction made the job of each institution more difficult.
'Fiscal policy is going to be expansionary and make the Bank of England's job much more difficult. There's no doubt that if we can run the economy at full employment it's going to make the employment market much too tight,' he said.
Some round-table participants advocated the American model, with a powerful independent body to hold the executive to account. But Professor Michael Dempster, director of the Centre for Financial Research at the Judge Business School in Cambridge, reminded those present: 'The Budget Office in the US doesn't control expenditure, although it does make it more open.'
Such openness could help to tackle the public cynicism that prevents politicians of all political stripes from contemplating substantive changes to the tax system.
Matthew Sinclair, policy analyst for lobby group the Taxpayers' Alliance, characterised the public's attitude thus: 'What we've got is a lot of people looking at public services and saying “we've had a lot of spending, but what value has come from it?”.'
This widespread distrust is evident in the debate around green taxes, according to Sinclair, where 'people can't see the green objective, but they can see the tax objective'.
A preoccupation with tax fairness was identified as another key strand in that public discussion, which has been reflected in the attention the non-dom issue has received in recent months.
Adam Lent, head of economic and social affairs at the Trades Union Congress, rejected the idea that Darling needed to tread carefully for fear of scaring these wealthy individuals overseas. He suggested that so far there had been a lack of will in getting to grips with the issue.
'If it is difficult, then the obvious answer is an international response to issues like tax havens. It isn't, politically, down to tax mobility that these issues aren't being addressed. 'We wouldn't have the howls of protest over non-doms if it was that simple – they could just go somewhere else,' Lent claimed.
Alastair Hatchett, head of pay and human resources services for analysts Incomes Data Services, spelled out the significance of fairness in relation to public sector pay.
The Treasury-imposed 2% pay cap has fuelled anger among public sector workers and brought relations between Labour and the trade unions to a new low. They argue that the sector is being forced to bear a disproportionate share of the economic pain.
'If the government had said “we're in a difficult situation financially, we need to restrain pay”, they might have got somewhere. But instead they said, “public sector pay causes inflation”, and they lost the argument. Governments stage arbitration awards at their peril,' Hatchett cautioned.
Against this backdrop of economic uncertainty and public scepticism, Darling seems to have little room for manoeuvre. Doug McWilliams, chief executive of the Centre for Economic and Business Research, did have some good news for the chancellor.
'I doubt we will have a sharp slowdown unless the housing market really slows, but I do think there will be a protracted slowdown of perhaps three years,' he predicted.
But there is no doubt that Darling will have to act to avoid the worst of the stormy economic weather ahead.
'The chancellor will probably avoid the additions to public spending that we've seen in the past ten years. But what that leaves is scope to do very little on tax,' McWilliams said.
He did raise one tantalising glimpse of what lies ahead. 'One of the things I think we'll see is a shift in taxation from central to local, as government tries to get away from the blame for having to put up taxes – as the situation demands they do.'
Chote, though, warned that the old tax-and-spend strategy was a non-starter in the modern political age.
'The public doesn't trust that tax rises will be spent on the intended purpose, and that if they're cut then services won't be affected,' he said.
As the national spending spree subsides and people start to count those pennies, a Treasury tax grab on March 12 would be politically dangerous. But so, too, would be a failure to act to stave off an economic slump. The way ahead is fraught with risk in every direction.
Do be careful, Darling.
Participants
Vince Cable MP Liberal Democrat shadow chancellor
Professor Jagjit Chadha
Professor of economics, University of Kent
Robert Chote Director, Institute for Fiscal Studies
Tom Clougherty
Policy director, Adam Smith Institute
Professor Michael Dempster
Director, the Centre for Financial Research, Judge Business School
Sir Christopher Foster
Former government adviser and chair of the Better Government Initiative
Doug Godden
Head of economic and fiscal policy group, CBI
Philip Hammond MP
Shadow chief secretary to the Treasury
Oliver Marc Hartwich
Chief economist, Policy Exchange
Alastair Hatchett
Head of pay and HR services, Incomes Data Services
Michael Kell
Director, economic consulting group, Deloitte
Simon Kirby
Senior research officer, National Instituteof Economic & Social Research
Adam Lent
Head of economic and social affairs, Trades Union Congress
Doug McWilliams
Chief executive, Centre for Economics & Business Research
Sir Nicholas Monck
Former Treasury second permanent secretary
Peter Riddell
Assistant editor, The Times
Ann Rossiter
Director, Social Market Foundation
Matthew Sinclair
Policy analyst, Taxpayers' Alliance
Ian Stewart
Associate partner, Deloitte Research
Tony Travers (Chair)
Director, Greater London Group, London School of Economics
PFmar2008
