The axe is coming soon and it will hurt, warns the IFS

Wednesday, April 21, 2010

Efficiency savings alone won't be enough to sort out the UK's massive deficit and there will have to be cuts in the quality and/or quantity of public services coupled with cuts to welfare benefits and increases in tax, write Rowena Crawford and Carl Emmerson of the Institute for Fiscal Studies

With government borrowing at its highest level since the Second World War perhaps the key domestic policy issue for the next parliament will how best to implement a combination of spending cuts and tax raising measures to return it, over the medium-term, to appropriate levels.

This will be painful: most likely it will come from a combination of reductions in the quality and/or quantity of public services provided and families being made directly worse off financially through cuts to welfare benefits and increases in tax. Efficiency savings alone will not be enough to fill the deficit. All three major UK parties are proposing some additional spending commitments and tax cuts – undoubtedly these could go ahead but only at the expense of adding to the pain to be felt elsewhere.

The broad fiscal arithmetic that faces whoever forms the next government was set out by Chancellor Alistair Darling in the March Budget. The fiscal repair job that is now needed as a result of the damage done to the UK's public finances by the financial crisis and associated recession is now estimated at £67bn. Under Labour's plans 70 per cent of this would be dealt with by 2014-15 – one-third through tax raising measures and two-thirds via spending cuts (to fall disproportionately on investment spending). No details have been published over the composition of the remaining 30 per cent aside from the fact that investment spending is to be spared from further cuts.

The government's plans for public spending to 2014-15 are therefore extremely challenging. Total spending, after economy-wide inflation, is to be broadly flat. But within this debt interest spending is rising sharply, and under current policies the cost of welfare payments would continue growing as, for example, baby boomers reach the state pension age. As a result, public service budgets are set for a tight squeeze. Our estimates suggest that spending on public services over the next four years would, under current policies, face the deepest cuts since the four years from April 1976 to March 1980. Central government spending on public services could be cut, after inflation, by around 12 per cent by 2014-15 relative to 2010-11 which would be sufficient to undo almost all of the increase in this spending as a share of national income since Labour came to power.

Some areas of spending are likely to receive even deeper cuts. Labour has committed to continued sharp increases in overseas aid, to some increases in spending on schools and to freeze non-investment spending on the NHS. If these pledges were made for four years (in the case of schools and the NHS the government has committed to them only for two years) then the cuts required elsewhere would, on average, reach 25 per cent of their current budgets. This would make deep cuts in spending on areas such as housing, transport and higher education unavoidable. Other possibilities to alleviate some of the pain from public services include further tax raising measures or significant cuts to welfare spending.

Unfortunately a pain-free remedy does not exist.

Rowena Crawford is a research economist and Carl Emmerson is deputy director at the Institute for Fiscal Studies (IFS)