The spending pain to come

3 Jul 13
Paul Johnson

The Spending Review only covered 2015/16, and only told a partial story. For a full picture of the unprecedented cuts coming down the track for public services, we need to look far beyond the next election

The gory details of the 2013 Spending Review have now emerged. And we didn't need a crystal ball to predict that further sharp reductions in public spending across a range of government activities would be announced by the chancellor.

Nor did anyone need great powers of foresight to work out that the Spending Review would leave a great deal unsaid – such as, importantly, the allocation of cuts within departments. A lot of the real work on spending in 2015/16 actually starts after the Spending Review, when departments begin the tough process of working out where the actual slashes will fall.

But because this Spending Review is, for understandable political reasons, looking at spending for one year only – 2015/16 – it inevitably feels somewhat partial. It does not deal with the possibility of any tax changes after the election. And it does not say much about the years after 2015/16.

The point about the period after 2015/16 is that a very significant additional fiscal tightening – spending cuts or tax increases – will still be needed to balance the books. The working assumption is that this will come from additional spending cuts, which is what is implied by the numbers in the Budget Red Book.

Current plans suggest that these cuts will be very severe. So even on top of the 9% reductions planned for this Parliament, and almost 3% planned for 2015/16, it looks like there could be an additional 7.6% cut in public service spending in the period to 2017/18. So the total real-terms cut between 2010 and 2017/18 could be well over 18% – almost a fifth.

Nothing remotely similar has ever been attempted in the UK. And the impact on many parts of government will be even more substantial than that. The continued protection of health and schools in particular ensures many other areas of spending will be slashed by a third or more over the period as a whole.

Up to now, cuts have been achieved pretty successfully. Indeed, the Treasury managed to engineer a substantial underspend in the past financial year. Ongoing cuts of this scale must seem increasingly hard to deliver, yet that is not where the current debate is focused.
Assuming that something approaching current fiscal rules are adhered to, there are only two other alternatives.

The first one is to reduce spending on pensions and/or working-age social security. One reason for the eye-wateringly tight settlements for Whitehall departments is that the unmanaged bits of spending – social security, public service pensions and debt interest – continue to rise.

Actually, over the next couple of years, it is debt interest and public service pensions that will account for much of that. But the over £100bn a year that goes into benefits for pensioners is also very much on the protected list. Don’t expect a serious debate about these issues this side of the election. And in this context, talking about taking winter fuel allowances from pensioners who pay higher-rate tax does not qualify as serious debate – the amounts of money involved would be entirely trivial.

The second alternative would be to raise taxes. The chance of a serious debate about this option before the election is even more remote. Nevertheless, tax rises may well have an as-yet-unannounced role to play in the substantial additional fiscal consolidation that the government is planning.

Even if we didn’t know that the next government will be looking for tens of billions of pounds’ worth of fiscal tightening after 2015/16, we might want to take on board the knowledge that post-election budgets have a curious tendency to be big tax-raising events.

Looking back over 30 years, post-election budgets really do, on average, involve much bigger tax-raising announcements than other budgets.But this involves big choices about the size of the state. The remarkable fact is that after eight years of public service spending cuts, public spending in 2017/18 will be about the same as a proportion of national income as it was back in 2004, about halfway through the past government’s term in office.

All of this pain will get the state roughly back to taking its long-run average as a proportion of the national cake. That partly reflects the shock to national income and partly the increases in spending on pensions and debt interest. But the state will not look remotely the same as it did in 2004.

If we continue along the current path, we will see the shape of the state change rapidly, becoming more and more focused on paying for health and pensions (and debt interest), with much less to go on everything else. There are big choices to be made here over the composition of spending cuts – can we really afford to continue to protect health and pensions at the expense of other areas?

This takes us to the last question, which has not been answered in the Spending Review: what is the plan for the long term? We will soon start the major demographic transition that will see baby boomers entering retirement in large numbers.  Without action, that means yet more money going to health and pensions.

We might be able to delay answering questions about the amount we want to raise in tax to pay for services, and about the shape we want the state to take. But we cannot put them off forever.

Paul Johnson is director of the Institute for Fiscal Studies

This is an updated version of an article that first appeared in the July/August issue of Public Finance

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