Budget 2010: Keeping it sensible

This week Left Foot Forward is publishing a series of blogs looking ahead to next Wednesday’s Budget. The first is by our regular economics columnist Tony Dolphin

Alistair Darling has already warned us not to expect much from the 2010 Budget. Speaking to the BBC on 11th March he said the budget would be “sensible” and “reflect the times in which we live”. This will come as no surprise to anyone who is even vaguely familiar with the budget arithmetic as set out in last December’s Pre-Budget Report.

HM Treasury expect the fiscal deficit (public sector net borrowing) to total £178 billion (12.6% of GDP) in 2009/10 and £176 billion (12% of GDP) in 2010/11. Deficits of this size can be justified by the size and nature of the shock that hit the economy in 2008 and 2009 and by the relatively low level of government debt when the shock hit. But they cannot be sustained for long.

If the government keeps borrowing at this pace, debt will eventually reach levels that could affect economic performance, which is why there is broad agreement that the deficit must be reduced over the medium-term. There is, however, less agreement about what should be done in the short-term.

David Cameron and George Osborne continue to insist that it is necessary to “make a start in 2010”, though their message has become rather blurred in recent weeks. At the start of the year, they appeared to be calling for substantial cuts in public spending in 2010. More recently, they have suggested any additional cuts should not be “swingeing”.

They seem oblivious to the fact that the Government has already “made a start” and taken a number of decisions that will reduce the deficit over the next year. The standard rate of VAT was increased from 15 per cent back to 17.5 per cent in January. This will add about £10 billion to government revenues.

From April 2010, there will be an additional rate of income tax of 50 per cent – applied to all incomes over £150,000 – and the income tax personal allowance will be restricted for those with incomes over £100,000. Capital expenditure will also fall, according to the 2009 Pre-Budget Report, from £69 billion to £60 billion, reflecting the Government’s decision to bring some spending forward to 2009 to support the economy during the recession.

Indeed, according to the Institute for Fiscal Studies’ Green Budget, the fiscal tightening already planned for 2010/11 is £23 billion or 1.6% of GDP – more than is planned for any of the following four years. So, there would seem to be no scope to ease fiscal policy and increase the deficit in 2010 and it is too risky to tighten policy by more than currently planned and cut the deficit.

The Chancellor could, of course, increase taxes to fund some new spending announcements – but this is hardly likely just six weeks before an election. Or he could cut spending more than planned and cut some taxes – but this would be hard to justify given the size of the deficit.

The Chancellor does, though, have an ace (or rather two aces) up his sleeve. Unemployment has increased by less than expected at the time of last year’s budget, so spending on out-of-work benefits is running below its projected level and banks have not been deterred from paying bonuses by the tax on bonus payments introduced in last December’s Pre-Budget Report, so revenues from this source have exceeded expectations.

He could simply bank this money and cut his deficit forecasts accordingly. Alternatively, he could use some of it to moderate the scale of fiscal tightening in 2010/11 – arguing that this would help underpin the economic recovery. If he chose to do so, moderating the sharp drop in capital spending planned for the next fiscal year would be the best way to proceed.

If the Chancellor thinks the financial markets need more reassuring about the medium-term outlook for the deficit, he might also give us a few more details of his plans to bring the deficit down from 2011 onwards – but it would be naïve to expect much. Any tax increase or spending cut will hit someone financially – even the much-touted “efficiency savings” will lead to people losing their jobs – and so could cost votes. Similarly, while the opposition parties will no doubt criticise the budget, they will be reluctant to tell us all the details of what they would do instead.

In a properly functioning democracy, all the main political parties would set out their plans on this crucial issue and allow the electorate to choose between them on polling day. Sadly, that is not going to happen in the UK in coming weeks.