Deficit reduction will require cuts in public spending AND higher taxes

In April’s Budget the Government forecast that it would have to borrow £175 billion in the current financial year. After seven months it has already borrowed £87 billion and is on course to reach, or even exceed, this projection. We shall find out the Government’s latest estimate of this year’s borrowing in next week’s Pre-Budget Report (PBR).

The PBR will also set out the Government’s plans for reducing government borrowing over the medium-term, including halving it over the next four years. In part, it will rely on an economic recovery to increase tax revenues and to reduce spending, for example on out-of-work benefits. But the scale of the deficit is such that discretionary fiscal measures will also be required.

Calculations based on the numbers in the Budget show that, if no further tax increases are proposed and the benefit system is left unchanged, substantial cuts in departmental spending will be required – and that these cuts will have to be even larger if certain areas are ring-fenced. For example, if current spending on health and children, schools and families is protected from real cuts in spending, then spending by other departments would have to contract by 12 per cent in real terms between 2010/11 and 2013/14. Cuts on this scale would inevitably affect the quality of public services, including those that the most vulnerable in our society rely on.

To reduce the deficit, once the economy is recovering from recession, it will be necessary to reduce public spending AND increase taxes.

Ideally, the higher taxes should fall on ‘bad things’ and on those who can most easily afford them. So more green taxes and reform to the council tax system, so that those who live in the largest houses pay more, should be near the top of the Chancellor’s agenda. A concerted effort to tackle tax avoidance and to close the loopholes used by the rich to limit their tax bills would also help raise the revenue required. But even that might not be enough and, if the Government’s deficit reduction plans are to be credible, the burden of higher taxation might need to be shared by the richest third, sometimes erroneously referred to as ‘Middle Britain’, for example by increasing the 1 per cent rate of national insurance contributions for those earning above £44,000.

Public spending will have to be reduced too – though only when the economy has recovered from recession – and there are some smart principles that the Government can adopt when deciding where to cut. It should seek to preserve spending on investment and preventative measures, rather than ‘salami-slicing’ across all areas. It should avoid ring-fencing; given the large increases in spending on health and schools in recent years, they should not be spared from restraint. It should seize the opportunity to force through reform in areas like policing, where it is long overdue. And it should concentrate its limited resources where they are most needed; spending cuts need not mean an end to redistribution.

None of these measures is likely to prove popular – but they will be necessary if the Government’s plan for deficit reduction is to be credible, which it needs to be for financial and political reasons.

More details can be found in ippr’s Opportunities in an Age of Austerity, available from http://www.ippr.org/publicationsandreports/publication.asp?id=720