The axeman cometh

1 Jul 10
The Budget revealed for the first time the scale of the austerity ahead - and it amounts to the longest and deepest period of public spending cuts since the Second World War. Rowena Crawford and Gemma Tetlow explain
By Rowena Crawford and Gemma Tetlow

10 July 2010

The Budget revealed for the first time the scale of the austerity ahead – and it amounts to the longest and deepest period of public spending cuts since the Second World War. Rowena Crawford and Gemma Tetlow explain

The coalition government last week confirmed what we had suspected but none of the main UK political parties had been willing to discuss before the election – that deep cuts will need to be made to public services over the next four years. The pain detailed in the Budget will be slightly more severe on average than was implied by the previous government’s plans, but much of it would probably still have ­happened under Labour, just a bit later on.

Part of the increase in planned spending cuts follows the latest public finance ­figures from the new, independent Office for Budget Responsibility. It estimates that the hole blown in the public finances by the financial crisis and the associated recession is 5.8% of national income, or £86bn in today’s terms.

This is slightly higher than was implied by the Treasury’s figures in the March Budget. The June Budget aimed to build on the repair job planned by Labour to plug this hole by 2015/16.

The new measures introduced in the Budget will cut borrowing by £40bn more than Labour had planned, in today’s terms. Of this, 85% is to come from spending cuts, and 15% from tax rises. This brings the overall composition of the tightening (once we include the measures already announced by Labour, of which 70% was to come from spending cuts) to around 77% from spending cuts and the rest from tax increases.

The coalition government is therefore relying more than Labour said it would have done on spending cuts, and also much more than the last Conservative government did in a similar repair job in the 1990s. The Ken Clarke and ­Norman Lamont Budgets of 1993 aimed for a roughly 50:50 split between tax rises and spending cuts.

This reliance on spending cuts implies some very difficult decisions. Although welfare spending was targeted for around £10bn (in today’s prices) of the cuts by 2014/15, public services are set to bear the brunt of the remainder.

The graph below shows the annual real increases in a broad measure of public service spending since 1949/50, and the six years of cuts planned by the coalition government for 2010/11 to 2015/16. As is clear, the cuts over the next few years will be the most sustained in this half-century − public service spending has been cut for a maximum of only two consecutive years before.

The average real cut planned over the six years ending in 2015/16 (1.8% a year) will also be the tightest six years in this period, surpassing even the stringent six years ending in 1981/82 when the UK was operating under the International ­Monetary Fund’s austerity plan.

Essentially, the plans laid out by the coalition government imply the longest and deepest sustained period of cuts to public service spending since at least the Second World War. It is clear that this will reduce the quantity or quality of public services available. Even the holy grail of efficiency savings cannot make this painless.

However, it is by no means obvious which public services will be maintained and which will be cut back or will simply have to fall by the wayside. This will not be revealed until the Spending Review this autumn, which will set out the budget each government department can expect in each year until the end of the Parliament in 2014/15.

The coalition government’s current plans for departmental spending (known as Departmental Expenditure Limits), set out in the Budget last week, show that by 2014/15 total DEL will be 14% lower in real terms than had been planned under Labour for 2010/11.

However, this pain will not be shared equally across all departments. The ­government has pledged to meet the United Nations target for spending 0.7% of national income on aid from 2013 onwards. This means aid spending will have to increase rapidly over this period.

The government has also pledged to ­increase spending on the NHS in real terms every year over the next Parliament – although it has not yet revealed exactly how large they intend these ­increases to be.

If we assume that they give no real ­increase to the NHS but simply increase the NHS budget in line with economy-wide inflation, then all other areas of departmental spending would have their budgets cut by 25% relative to what they would have got under Labour in 2010/11.

If the NHS were to get a greater real ­increase, the cuts to all other departments would be even bigger – for instance, a 1% annual real increase in NHS spending would increase the cuts to non-NHS, non-aid departmental spending from 25% to 27%. Although the NHS is to be more protected from the cuts than other departments, four years of almost no real growth would still be the tightest four-year period for spending that the NHS has experienced in its 60-year history.

Furthermore, with increasing ­pressures likely to be placed on health care from our ageing population, the choices about how to spend the NHS budget will still be challenging.

Among the ‘unprotected’ ­departments, the axe will probably not be felt equally; some will do better than average and others worse. In his Budget speech, Chancellor George Osborne stated: ‘I recognise, for example, the particular pressures on our education system and on defence’ – implying perhaps that defence and parts of education spending might be less harshly cut come the Spending Review. Of course, this will come at an even greater cost to all other departments.

If the NHS received no real increase in spending and if spending on defence and schools were cut by ‘only’ 10% by 2014/15, this would leave the other departments facing cuts to their budgets of around a third. Such cuts would be extremely painful for the spending areas in question, which include transport, housing, higher education, public order and safety, and the central government grant to local authorities.

The government has also said that some areas of non-departmental spending will be considered for cuts in the Spending Review. Therefore, to some extent the severe squeeze on departments could be lessened by reducing other government spending. This would essentially amount to cutting social security spending and/or increasing employee contributions to public service pensions (which would cut the net payment by the Exchequer to members of these schemes each year).

However, even to reduce the average budget cuts facing unprotected departments from 25% to 20% would require £13bn of cuts, in today’s prices, to be found from these other spending areas. Cuts of this size might not be easy to find: the combined effect of all the measures in the June Budget managed to shave around £10bn off welfare spending, and the remaining pot from which further savings would have to be found is only around £154bn.

The initial skirmishes of the Spending Review have now begun. Over the summer, each department will be asked to reassess all its spending and justify its required resources for the next four years to the Treasury. Ultimately, the ministers who sit on the Public Expenditure ­Committee will have to decide which areas to cut and which to save.

Whatever the final settlement, this process is likely to be the most fundamental reassessment of public service ­provision for decades.

Rowena Crawford is a research economist and Gemma Tetlow is a senior research economist at the Institute for Fiscal Studies

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