George Osborne is considering writing a commitment to reducing the budget deficit by 2018 into law. This would be wholly counterproductive, giving austerity a legal basis and constraining the ability of a future government to break with a failed policy.
· The Financial Times reported last week that George Osborne is considering making his deficit reduction plan legally binding. This would create a new law in which the “structural” or “cyclically-adjusted” deficit would need to be zero by 2018.
· Austerity would, under this plan, therefore become a legal requirement, further tying the hands of any future government.
· There are three major issues with this. The first is least discussed, but critical to the government’s problems. The “structural deficit” is supposed to be the gap between what a government receives in taxes, and what it spends, after taking account of the business cycle.
· The business cycle is the (relatively) regular oscillation of the economy between booms and recessions. It affects the deficit because during a recession, tax receipts drop and spending on things like unemployment benefit rises. This is because there is less activity to tax, and more people out of work. In a boom, the reverse applies.
· This movement of the deficit due to tax and spending changes are sometimes called “automatic stabilisers”. This because they work in the opposite direction to the economy, pumping demand in when the economy is in recession, and sucking it out (through falling spending and rising taxes) when a boom occurs. This happens without any government intervention.
· The “structural” deficit attempts to take account of these automatic movements. It is an attempt to see (as the name says) the underlying structure of government tax revenues and spending, ignoring the impact of the economy in general.
· It depends, then, on correctly measuring the business cycle. This is because you need to know when the recession starts, and when it stops, in order to judge how much of a government’s deficit is due to the recession, and how much would be there anyway.
· But business cycles are notoriously hard to judge. As is well-known, Gordon Brown regularly shifted his timings of booms and recessions in order to meet his own fiscal spending rules, which applied over the cycle. Similarly, recent revisions to GDP figures by the Office for National Statistics found that the recession ended sooner than was previously thought.
· In other words, the “structural deficit” is highly subjective. In a sense, it doesn’t really exist, since there is no hard-and-fast rule about when a recession starts or finishes. Attempting to target the structural deficit is, in the first instance, chasing an imaginary, moving target.
· Second, austerity has been colossal failure until now. To recap, the government has attempted to cut public spending very dramatically in the last few years, with at least another £45bn still to come. But this has not reduced the deficit, which has risen by 10% over the last year to £100bn. The government’s original target for this year was a deficit of £40bn.
· This failure to meet targets has been due to very weak tax revenues, with corporation taxes falling 14% since 2010, and income taxes not rising at all – despite economic growth. Taxes have not risen as planned since average real incomes have fallen by around 10% since 2008. As a result, whilst the government has cut public spending, tax revenues have also fallen, resulting in a wider deficit.
· At the same time, the government has also cut taxes for some people. Recent research by LSE and the University of Essex found that, taken together, the impact of welfare spending cuts and tax cuts was fiscally neutral – that is, the two cuts balanced each other out, having no impact on the deficit overall. But since welfare spending cuts hit the poorest, and tax cuts have mainly benefitted the richest, the government has (in effect) taken money from the poor and given it to the rich.
· Third, austerity is still acting as a drag on the economy, helping to explain why real incomes are falling. The UK has had the slowest economic recovery on record, and even now is failing to produce rising real incomes for most people. This drag on growth has been overcome only through rising inequality, and rising debt.
· Meanwhile, new figures from ONS this week show business investment falling (by 0.7%) in the last three months, having risen over the last year. And mortgage approvals are 16% down on this time last year. Consumers and businesses appear, perhaps temporarily, less willing to spend money, pointing to a weakening of the economy.
· The worst possible course of action for a government to follow in a weak economy is to cut its spending. If everyone else is cutting their spending, and this is driving the economy into recession, government spending cuts will simply deepen the recession.
· In short, Osborne’s proposal is nonsense in theory, and will (in practice) simply worsen circumstances for the majority of Britons. This, and similar attempts to tie future governments’ hands, should be completely opposed.
James Meadway is the Senior Economist at the New Economics Foundation
Yorkshire Post (26 November 2014), “Deficit reduction could become legally binding”: http://bit.ly/1202KSI
Portes, J. (October 2012), “Self-defeating austerity”, NIESR blog: http://bit.ly/1runIzZ