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Next cut is the deepest: a spending review preview

Whitehall is limbering up for the next spending review, due to be published before the end of 2013. It will shape a large part of the political debate at the coming general election, since it will set out government spending plans for the first half of the next parliament. Tax and spend policies are the meat and drink of party politics at any general election, but in times of fiscal constraint, they take on even greater political significance.

Weak growth and the Office of Budget Responsibility’s revisions to its capacity forecasts last year have forced the government to push back its timetable for eradicating the cyclically-adjusted structural deficit by two years, to 2016/17. Absent of new tax increases, that means total managed expenditure (TME) will be cut by a further 3.2 per cent of GDP (from 42.2 per cent of GDP in 2014/15 to 39 per cent in 2016/17). As spending on debt interest is rising, that implies further big cuts to departmental spending on public services. As the following table from the 2012 budget document shows, resource spending for departments will be cut by an annual average of 3.8 per cent in real terms in 2015/16–2016/2017. This is even bigger than the 2.3 per cent average annual real cut than departments have been given in the current spending review period.

Public spending aggregates

This is grim stuff, to put it mildly. A lot of the low-hanging fruit has already been taken out of departmental spending (DEL). By comparison with the rest of its post-war experience, the NHS is on a starvation diet. Local government, housing and regeneration spending have taken a huge hit. Universities have seen their teaching grant fall, to be replaced by student fees. The list goes on.

Departmental spending cuts

In presenting his last budget, George Osborne flagged up the possibility that welfare spending (or more broadly annually managed expenditure) could be further cut in order to give relative protection to departmental spending. The IFS produced this rather neat graph, spelling out the trade-off involved:

Departmental spending vs welfare

Some £18 billion has already been cut from benefits in this spending round, generating huge rows over tax credit and welfare entitlements. Add into the equation the ‘triple lock guarantee’ for state pensions and the pension credit and you take out £94 billion from potential savings, leaving tax credits, housing benefit and support for people with disabilities as the main items of spending. Given that across-the-board moves, like the switch from RPI to CPI, have already been made, cutting benefit spending even further looks really painful.

So unless George Osborne can kick-start higher growth, reduce unemployment and bring in fresh sources of tax revenue, we are faced with the prospect of further deep cuts to public spending. The Conservatives are likely to want to protect education, health and possibly police and defence funding in real terms, and to focus all the cuts on areas of spending that voters care about least (like housing but also perhaps international development if they come under pressure from their backbenchers).

They may also decide to announce some cuts to the benefits of better-off pensioners to take effect in the next parliament, thus protecting their existing election pledges, but the ‘granny tax’ row may have scared them away from touching their core vote. Consequently, the pressure is likely to fall on welfare spending again, where most of the losers are people who vote Labour, or who don’t vote at all.

The Liberal Democrats are in the unenviable position of having to sign up, as Coalition partners, to the outcomes of the 2013 spending review. They can flag up their own priorities, as part of their ‘differentiation’ strategy. But ultimately they will need to agree to measures that will bind the government as a whole. Their only way out will be to argue that the spending review should only specify overall annually managed expenditure totals for 2015/16 and 2016/17 and not specific welfare cuts, leaving them free to argue in their manifesto for tax rises to plug the gap. But that doesn’t look like an electorally appealing strategy. Either way, the promise to lift the personal tax allowance from £10,000 to £12,500 looks unachievable (as well as regressive in terms of distributive justice between households).

For Labour, there are two broad options. One is to stick to the 1997 script, and sign up to the government’s spending and tax plans, using small but symbolic spending switches to indicate new priorities and a sense of direction. The other is to fight the election on fairness, and argue for tax increases on the wealthy and the banks. If successful, that would slay the ghosts of 1992. As the Conservatives have found, the post-crash public mood on the excesses of the wealthy, particularly the bankers, is very different to that of the mid-1990s. Barack Obama may not be indulging in the sort of leftist populism seen in parts of Europe in recent months, but he looks set to beat an admittedly weak opponent on the grounds of fairness in taxes and government spending. So Labour may well be tempted down that path in 2015, even if only cautiously.

The stakes are very high. For the purposes of broader public debate, the key thing is not to let the next spending review be conducted behind closed doors in Whitehall, but to push fresh ideas and new ways forward onto the agenda. That’s what we at IPPR will be trying to do in the coming months.

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