28 November 2008
By Tash Shifrin
Tax cuts and soaring government borrowing stole the headlines as Chancellor Alistair Darling set out his Pre-Budget Report this week.
It is his third budget bundle this year – after the 2008 Budget proper and May's 'mini-budget', aimed at limiting the political fallout from the abolition of the 10p tax rate. But the chancellor's £20bn fiscal stimulus package is set to be the most controversial of the three.
The Conservatives sprang into attack over what they labelled the 'tax bombshell'. Darling was 'giving £20bn in giveaways and taking back £40bn', shadow chancellor George Osborne claimed, accusing him of manipulating the PBR for electoral ends. 'The tax rises won't come in until 2011 – I wonder why he chose those dates.'
Much of the press picked up the Tories' theme, dubbing Darling's report a 'spend now, pay later' package. But the size of the clawback to come from the public sector – a crucial element of Darling's plan for bringing borrowing back to a 'sustainable' level after the fiscal boost – attracted far less attention.
Tucked inside the complex parcel of give-and-take that makes up the fiscal stimulus package, however, is a grim message. For the public sector, it's pay now, pay later. And, if the economy takes another nose dive, the public sector could pay even more.
The chancellor painted a rosier picture in the Commons. 'We will continue to invest in public services – just as we have done over the last ten years,' he pledged. In a much-trailed move, he brought forward £3bn of spending on public sector capital projects from 2010/11.
But Darling also declared that the public sector must make an additional £5bn of efficiency savings in the current Spending Review period, on top of the £30bn already planned. Spending allocations for 2010/11 will be 'adjusted accordingly' to make sure the gains are delivered, the PBR promises.
And the squeeze won't stop there. The PBR says the Budget will set out further savings for the next Spending Review period. As a taster, the PBR includes 'improvements to NHS estate utilisation' worth £3bn and a £1bn increase in police productivity.
Spending growth projections for the three years from 2011/12 have also been slashed back. In March, the Budget said total public spending would increase by 1.9% a year in real terms. Now the PBR puts the figure at 1.1% a year – a reduction of £37bn in today's money, according to the Institute for Fiscal Studies, and well below the chancellor's projections for gross domestic product growth of 3% a year.
The PBR also makes clear that the NHS's World Class Commissioning programme, aimed at putting local commissioners in the driving seat, will be expected to meet a 'projected value-for-money impact'. This will be set out in the 2009 Budget, which will also 'report on the scope' for making savings from hospitals through the forthcoming new treatments tariff.
Public sector workers face 'continued discipline in pay awards', while the efficiency drive could include privatisation or 'alternative business models' for government bodies, including the Royal Mint and the Met Office.
Although £3bn of capital investment will be brought forward, another £14bn has been lopped off the projected allocations for the three years from 2010/11.
IFS director Robert Chote emphasises that the burden of the chancellor's plans to restore the public finances after the fiscal boost will fall heaviest on public spending. 'It is important to understand that that most of the looming fiscal squeeze comes in the form of spending cuts as a share of national income rather than tax increases.' In 2012/13, the Treasury coffers will regain £4bn from tax rises, but almost £19bn from spending cuts, he says.
Chote adds that those who are hailing a return to traditional Labour policy of redistribution of wealth 'may wish to pause briefly and consider who might be affected by the squeeze on public spending'.
Tony Travers, director of the Greater London Group at the London School of Economics, says the PBR will mean, for local government in particular, 'tight settlements for at least three, possibly six or even nine years'. There is 'no doubt that after 2011, whoever wins the election, much of the public sector will face cuts', he says.
It is not a message to cheer public sector bodies. The Local Government Association is trying to fend off the worst of the squeeze. Councils are already expected to achieve £4.9bn of cash-releasing savings in the current round and the LGA argues that new targets 'should be weighted towards other parts of the public sector'.
Unions are concerned for their members' jobs. Public and Commercial Services union general secretary Mark Serwotka says efficiency savings 'should not be a prelude to yet more job cuts, office closures and privatisation'.
Alongside these fears, there is a wider uncertainty: whether or not Darling's fiscal stimulus, and his recovery measures, will work. In the Commons, Liberal Democrat Treasury spokesman Vince Cable attacked Darling's assumptions on economic recovery as 'wholly incredible', while Osborne branded the PBR 'a reckless gamble with the public finances' that would bring the national debt to more than £1trn.
The chancellor admitted that public borrowing would hit an eye-watering record level of £118bn in 2009/10 and that debt would rocket to 57% of national income by 2013/14, busting through the 40% ceiling set out in the government's fiscal rules.
But Darling set a timescale on recovery. 'As I take action to reduce borrowing when the economy begins to recover… by 2015/16 we will again be borrowing only to invest,' he promised, airily indicating an end-point that is two general elections away.
The fiscal rules have not entirely vanished, however. The PBR sets out a new 'temporary operating rule' that will govern fiscal policy 'to set policies to improve the cyclically adjusted current budget each year, once the economy emerges from the downturn, so it reaches balance and debt is falling as a proportion of GDP once the global shocks have worked their way through the economy in full'.
Chote believes 'a rule that gives a better indicator' is needed. He warns that the effects of Darling's fiscal stimulus are 'uncertain', although 'the risk of acting may be less than the risk of refusing to'. He also stresses the importance of getting the public finances back into shape after the fiscal boost.
Martin Weale, director of the National Institute for Economic and Social Research, is not convinced the fiscal measures will be enough. He says: 'They will have a positive impact, but not very much. Darling is also making optimistic projections of GDP growth.' If GDP does not recover so strongly 'future taxes will need to be appreciably higher or [there will have to be] less spending' to bring the public finances back in line.
Others warn that the economy could go down as well as up. Alan Downey, UK head of public services at KPMG, warns: 'If the recession is deeper than forecast, or more prolonged, it is difficult to see how any government will avoid much deeper cuts in public expenditure.'
As the political wrangling over who gains or loses from the tax measures continues, public sector organisations face a grim certainty: the spending squeeze is coming – the only question is how tight.
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