News analysis: Public sector to pay the price for £90bn fiscal hole

8 Jun 09
Is April the cruellest month? By the time Alistair Darling finished his 2009 Budget speech, it was looking a lot nastier than November. The litany of figures the chancellor recited revealed just how much worse the public finances have become since the Pre-Budget Report, only five months ago

1st May 2009

By Tash Shifrin

Is April the cruellest month? By the time Alistair Darling finished his 2009 Budget speech, it was looking a lot nastier than November. The litany of figures the chancellor recited revealed just how much worse the public finances have become since the Pre-Budget Report, only five months ago.

The chancellor has drastically revised his forecasts for gross domestic product downwards, while projected public borrowing and debt have rocketed.

In November, he predicted GDP would shrink by 1% in 2009, now he is expecting a 3.5% fall. He has also acknowledged that the economic slide has brought with it sharply reduced tax receipts and increased social security spending.

Robert Chote, director of the independent Institute for Fiscal Studies, describes the damage to the Exchequer caused by the economic and financial crisis as ‘breathtaking’. And he warns that the public sector is set to pay most of the price.

The rapid emptying of the Treasury’s coffers has pushed up borrowing, which is now set to peak at £175bn this financial year – up from £118bn in the PBR. Net debt is now expected to hit 79% of GDP by 2013/14.

Chote says: ‘The Treasury forecasts now imply that the crisis has dealt a permanent hit to the Exchequer, costing around 6% of national income or £90bn a year in today’s money.’

Darling’s measures to fill the gap will bring ‘two Parliaments of pain’, the IFS says.

The headline-grabbing element of the chancellor’s new plan is the 50% tax rate for those earning more than £150,000 a year – a move that breaks a Labour manifesto commitment.

But Chote says: ‘The strain will be taken primarily by public spending’, with just 20% of the fiscal tightening planned from 2011 to come from tax rises. If anything is squeezed until the pips squeak, it will be public services.

Planned spending growth will be preserved this year and the next. But the extra £5bn efficiency savings for the period, announced in the PBR, must now be returned to the Treasury, the Budget revealed.

Almost half of this – £2.3bn – will come from the Department of Health, with the Department for Children, Schools and Families chipping in £650m.

A fresh efficiency drive, outlined in the Treasury’s Operational Efficiency Programme, is expected to produce another £9bn of savings a year by 2013/14, across procurement, back-office, IT and property running costs. The OEP also included a £16bn programme of asset and property sales – and controversial proposals to privatise the Royal Mint.

The new efficiency savings, Darling said, would ‘protect frontline public services while keeping current spending growth, in real terms, at an average of 0.7% a year from 2011/12 onwards’.

It sounded innocuous enough in the speech – but that figure marked the shift from an uncomfortable squeeze in the PBR to a more threatening python grip. Last year’s Budget promised current spending growth of 1.8% from 2011/12. The PBR reduced this to 1.2% – that is the figure now slashed to 0.7% a year.

The cuts will be particularly severe in capital spending, which will be slashed back by 17.3% a year from 2011. Total capital investment will halve from £44bn this year to £22bn in 2013/14. Total spending will fall by 0.1% a year.

Those figures conceal an even grimmer reality for Whitehall departments in the next Spending Review period, the IFS says. It warns that an 8.4% a year increase in debt interest costs and 1.7% annual growth in social security spend will cut into the cash for public services. These are significant rises on already large figures: the Budget says debt interest payments will hit £42.9bn – more than 80% of the schools resource budget – in 2010/11.

Once these factors and other central expenditure are taken into account, Whitehall departments face a real-terms cut of 2.3% a year, the think-tank calculates.

Senior research economist Gemma Tetlow says this will strip £26bn from departmental budgets. Public spending will also fall as a share of GDP. Tetlow adds: ‘Health and education are a big share [of spending]. To protect them would require even bigger cuts elsewhere.’

The Budget package prompted warnings of service and job cuts in the public sector. Local Government Association chair Margaret Eaton says the future squeeze ‘risks jeopardising’ local services. She adds: ‘Ministers should realise that they can only keep on squeezing out savings for so long and that further efficiencies will not solve the pressures caused by cuts in funding.’

At the NHS Confederation, policy director Nigel Edwards says he is expecting ‘a real-terms cut in expenditure’ for the health service after 2011. ‘The question is, how much and how long?’ There might be ‘a trade-off between pay and jobs… but also some difficult decisions about disinvestment and where programmes might need to stop’.

The IFS also warns that further austerity is on the cards until 2017/18. The first ‘Parliament of pain’ will fill only around half the £90bn gap, it says. Darling has ‘pencilled in’ further tightening for the years from 2013/14, but it is unclear how the remaining £45bn fiscal hole will be filled.

If the whole lot were drawn from public spending, this would mean an average 0.5% a year real-terms growth across revenue spending, including debt interest and social security. That would mean the public sector facing the lowest seven-year stretch of ‘growth’ since 1985 to 1992, Tetlow says.

Other question marks loom over future economic developments. The chancellor’s GDP projections were almost immediately gazumped by the International Monetary Fund, which estimates the economy will shrink by 4.1% this year and – contrary to Darling’s expectations of 1.25% growth – contract by 0.4% in 2010.

The IMF forecast was followed by Office for National Statistics figures showing GDP had dropped by 1.9% in the first quarter of this year, a much sharper decline than the 1.6% fall in the previous three months.

Economists have also cast doubt on Darling’s figures. Douglas McWilliams, chief executive of the Centre for Economics and Business Research, says the 50% tax rate will lead to an £800m loss as top earners shift their tax base abroad.

Spending cuts will not make up the difference, he argues. ‘The main clawback doesn’t come from either of those. It comes from assumptions of very rapid growth [in the economy]… But the chancellor’s numbers are in cloud-cuckoo-land.’

McWilliams says the public sector squeeze is ‘very small in relation to what most external commentators would expect’, suggesting that spending cuts of ‘about 10%’ would be required.

The advent of a general election within the year – well before Darling’s squeeze comes into effect – adds to the uncertainty facing public services. Conservative leader David Cameron is urging more spending cuts, and sooner. ‘The government should have come off the spending plans in 2009/10,’ he told the BBC Radio 4 Today programme.

Cameron was cautious about saying where the axe might fall, although identity cards and public sector pay – ‘particularly… in what I would call the quangocracy’ – are in his sights. But the Tory leader makes no bones about ‘just saying we’re going to spend less’.

All this makes planning more than a year ahead a tricky thing. Alan Downey, KPMG’s head of public sector business, says public sector organisations ‘need to take a cold, hard look at where they spend their money and make difficult choices about priorities’.

Just how cold and hard remains to be seen. There might be crueller months to come than this harsh April.

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