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A fiscal drag act

In his speech to the Conservative party conference, chancellor George Osborne has said that it is fanciful to believe that the ‘wallets of the rich’ can bear the burden of fiscal consolidation alone. But he has also said that the better-off will pay the greater share of the government’s deficit reduction.  So has what he’s proposed achieved that balance?

Today, Osborne’s focus was on 2015/16, for which spending totals must be set before the general election. In that year, the Treasury has already indicated that it believes cuts of £6.6 billion in welfare spending (or more broadly Annually Managed Expenditure) will be needed if departmental cuts are to be maintained at the existing pace, not a higher level; followed by £10.5 billion in 2016/17 (with a further £14 billion of departmental cuts). All this is a matter of political choice, of course: deficit reduction could be slowed down, or achieved by tax rises as well as spending cuts. But the chancellor’s current plan is to cut welfare spending still further, as he set out today.

Where will the chancellor get £10 billion in welfare cuts? He has all but confirmed that housing benefit will be withdrawn from under-25s, although it is impossible to see how that could extend to homeless families with children, and therefore that the putative savings of £1.8 billion could materialise entirely from that source. Likewise, it isn’t obvious that huge sums can be generated by restricting child benefit or child tax credits for workless families who have more than three children. That’s just straightforward right-wing populism of the ‘welfare queen’ variety.

So it now seems very likely that the chancellor will uprate those non-pensioner benefits that are not already frozen to average earnings for 2013/14, rather than to the consumer price inflation (CPI). Earnings growth has been weak this year, and using the relevant three-month average figure to July 2012 would mean benefits are uprated by 1.5 per cent, rather than the 2.5 per cent expected level of CPI. This might not look like much, but it will be applied to a baseline of some £50 billion of spending, depending on how wide the chancellor casts his net, and the new baseline will then be lower for the uprating in subsequent years – such that, by 2016/17, the government will be making quite large benefit savings. This kind of fiscal drag for the poor is a favourite Treasury manoeuvre to cut social security spending. It will be too late to make this switch in next year’s autumn statement, since earnings and inflation are likely to be in broad parity in 2013 (indeed the OBR has previously predicted that earnings growth will outstrip CPI each year onwards from next year).

What about the tax rises for the wealthy that Liberal Democrat sources have said will be their price for welfare cuts? The options don’t begin to get close to £10 billion. A mansion tax on properties worth £2 million and above could net £2 billion or more, but the chancellor has ruled that out. The rate of capital gains tax could be increased from 28 per cent, but it would have to rise sharply to nearer 40 per cent to raise an additional £1 billion or more on the projected yield of £7.5 billion in 2016/17. Stamp duty will net over £11  billion in 2015/16, assuming that the housing market doesn’t crash, but the new 7 per cent rate on the most expensive properties is projected to bring in only £300 million extra in 2016/17, so it looks unlikely that more than a few hundred million could come from that source. Council tax brings in some £30 billion a year, so adding a couple of bands could raise some handy sums – but again, it doesn’t look like these reforms could get close to raising the billions the Liberal Democrats might want.

All in all, we are not much clearer after this year’s conference season to knowing how each of the parties will meet the fiscal challenges of the next parliament. But the shape of the debate is becoming clearer – and it doesn’t look nice.

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