David questions economists on Budget

Tuesday, 27 March, 2012

Expert witnesses Roger Bootle (Managing Director, Capital Economics), Brian Hilliard (Chief Economist UK, Société Générale), Jens Larsen (Chief European Economist, RBC Capital Markets), and Jonathan Portes (Director, National Institute of Economic and Social Research) have given evidence to the Treasury Select Committee (TSC) on the Chancellor's Budget. David Ruffley MP questioned the experts on the Government's plan for economic growth, and the potential room for extracting more efficiency savings in the public sector.

Q151 Mr Ruffley: Roger, from your earlier comments, you think that the negative output gap is slightly bigger than the OBR do?

Roger Bootle: Yes.

Q152 Mr Ruffley: It follows from that, doesn't it, that the structural deficit is probably lower?

Roger Bootle: Yes.

Q153 Mr Ruffley: Are you aware of any figures which suggest when the structural deficit might be eliminated if the output gap is significantly bigger than the OBR say?

Roger Bootle: I have not got any precise figures to offer you on that. As I was saying earlier, it is a judgment call and it is as long as a piece of string. To the extent that the output gap is genuinely bigger then, as you rightly say, the structural deficit is smaller and could be eliminated more quickly.

Q154 Mr Ruffley: You said something very striking: to have a fiscal stimulus of £15 billion would only be about 1% of GDP. Do you think this Budget taken in the round will make any difference to economic growth?

Roger Bootle: No. I do not think it makes a blind bit of difference. There were some quite favourable measures in it for the medium-term growth outlook. I for one, and I don't think I'm alone in this, thought that the corporation tax changes were pretty favourable because not only did they immediately produce the tax impact on business, but they were a signal to business of what the Government's intentions were. So that is something that might well help to boost the animal spirits of business and therefore get investment going. I have said on many occasions in the past that I think we need something similar with regard to personal tax. There are a few straws in the wind and obviously there were some tax changes this time round. But I would like to see a forward commitment so that people could see what the structure of tax was going to be. There are major political obstacles to that, I realise.

Q155 Mr Ruffley: You said this time last year and you have repeated today that a fiscal stimulus would not necessarily spook the markets if it were for the right reason.

Roger Bootle: Yes.

Q156 Mr Ruffley: But you went on to say that it is very difficult to judge what might be acceptable to the markets given that there is a very clear plan. Were there not such a clear plan it would be perhaps easier to explain to the markets why you might want and I might want a £15 billion stimulus rather than a revenue-neutral Budget. Could you give some indication as to what you think the Government could do by way of tax cuts which would not spook the markets? You have lots of clients who are market players. If tax cuts-significant ones of £10 billion or £15 billion-were to be introduced and those were matched by commensurate further public expenditure reductions, what sort of things are we talking about? Are we talking about cuts in employers' national insurance? Are we talking about further cuts in corporation tax?

Roger Bootle: The last idea that you have introduced is an altogether different one, which is to say, without altering the overall balance between spending and tax and without altering the forecast deficit levels, cutting both tax and spending. I do not think that the markets will be spooked by that at all. Why should they be? They are concerned about borrowing levels and the path of public sector debt. If the Government were to take that sort of measure, there would be no direct implications at all. If you could persuade yourself that this would stimulate aggregate demand-some people think it would, and there is an argument that it would and one that it would not-the markets might actually take to it favourably. They might think that the structural changes that are brought about were actually going to be beneficial from a market point of view. However, that is an altogether different thing from the idea of cutting taxes without a corresponding cut in Government spending. It is completely different.

Q157 Mr Ruffley: Why is that argument not made more often?

Roger Bootle: It is not made more often because the Government have found it pretty difficult to come up with cuts in expenditure of the size that they have. They have run into enormous political difficulty. It is therefore judged that deeper cuts would get them into very deep water, but it seems to me that it is actually a serious runner to advocate further cuts in current Government spending, offset by reductions in tax.

Q158 Mr Ruffley: I think the IFS has calculated that, over the five years of this Parliament, it is about a 3.4% real-terms cut in total managed expenditure from 2010 to 2015, and that does not seem to many of us a particularly vicious axe attack on public expenditure: 3.4% in real terms over five years is not huge. Why, again, do you think that there are not more voices in the City saying that this is not really very serious?

Roger Bootle: There are some. In fact, there are more people saying that it is not serious in the world of broadcasting and journalism, but it is a very difficult question to get the balance right on, because when you look at the overall numbers the cuts do not seem to be that big. If you look at particular Departments, however, they are pretty big, and because you have the ring-fencing of, in particular, the NHS, the cuts in some Departments are going to be really very big indeed and bigger than we have been used to at any point in the post-war period, if not earlier. There is a serious debate to be had about this. If you look at the Irish experience, which I was looking at recently, there is a country that really has embraced public spending cuts in a seriously big way with, of course, big cuts in public sector pay.

Mr Ruffley: Can I just ask Jonathan Portes one question very quickly?

Chair: Yes, with a quick reply.

Q159 Mr Ruffley: On the issue of closing the output gap, what do you think are the three things that the Government should be emphasising in this Budget or implementing that will get rapid progress on closing the output gap?

Jonathan Portes: Infrastructure spending, cutting national insurance contributions for the low-paid, and house building.

Chair: That was an excellent short reply. Thank you very much. I am sure that, as a consequence of the fact that we have these exchanges, you may have further thoughts. If you do, please feed them in as soon as possible, but it would have to be pretty much by the close of play today or tomorrow if we are going to be able to incorporate them into our work. Thank you very much for coming. I am sorry that it has been somewhat curtailed, but we are on a very tight schedule.

Examination of Witnesses
Witnesses: Paul Johnson, Director, Institute for Fiscal Studies, and Carl Emmerson, Deputy Director, Institute for Fiscal Studies, gave evidence.

Q160 Chair: Mr Johnson, may I begin with you and ask whether you think that the Government have a tax policy or what you described as a "hotch-potch" of reforms?

Paul Johnson: They have a bit of both. As the previous panel said, the changes on corporate tax, for example, have been laid out fairly well. It is pretty clear what direction the Government want to go on corporation tax and the same is true on the personal allowance, but in the Budget we saw a range of other things, which appeared to be somewhat unpremeditated-for example, what happened to the allowance for pensioners, which may not be a bad move over the medium run, but shows every sign of being rather rushed. The changes to stamp duty were certainly not what one would think of as part of a long-term tax strategy, because they make further reforms to stamp duty in an efficient direction more difficult to achieve.

The way that child benefit is now going to be taxed back, although probably less damaging than what was originally proposed, creates quite a lot of complexity in the system and, as an interesting aside, adds one more bit of the tax system that is not indexed. The point at which child benefit is to be withdrawn is not indexed, the point at which the personal allowance is withdrawn is not indexed and the point at which the top rate of tax starts to be paid is not indexed. There is a whole range of different bits and pieces in there, therefore, that look like less of a strategy than the two big things-the corporate tax and the personal allowance changes.

Q161 Chair: There is always a shade of grey. Which side of the line are you? Is it black or white?

Paul Johnson: I think that I would be on the negative side of the grey here. We knew where they were on personal allowances and corporate taxes, but there was nothing new, as it were, in the sense of moving towards a strategy.

Q162 Chair: So "hotch-potch" is better than "strategy"?

Paul Johnson: I think I stand by hotch-potch.

Q163 Mr Ruffley: Two-thirds of the tax consolidation for this Parliament has been done, but about 30% of public spending consolidation. Could you indicate, wearing your public-spending-expert hat, whether you think that the spending totals that are being published will be hit?

Paul Johnson: They are going to be extremely tough to hit and it will take a significant amount of political capital to hit them. What was interesting about what we saw this year is that there have been some underspends in departmental budgets, despite the scale of the cuts intended through this year. In one sense, that is perhaps not that surprising given the political capital that would be lost if there were overspends. It is clear where the balance of risk lies.

In some sense, we have seen the slightly easier wins happening, but I certainly do not think that the public have got their head round the fact that the large majority of the cuts are still to come. The numbers that you quote-the 30% already done-are off a baseline of assuming that real freezes is a reasonable baseline. It will feel tighter than that, because the normal baseline is to move up in line with the economy.

Q164 Mr Ruffley: Where is the extra £10 billion that the Chancellor referred to in his Budget speech? Could you tell us something about that? What do you think it means and where will it fall?

Paul Johnson: Sorry, the extra £10 billion? Oh, in the future, after the next election. My understanding of what that was saying was that if you are going to have total public spending falling on departmental budgets in the same way that it has over this spending review, then there is another £10 billion that you will have to find from, for example, welfare cuts. You could do it through tax increases. If you think of a budget constraint, you have departmental spending on one side and tax increases or welfare cuts on the other. One place you could end up on that budget constraint is to have a similar level of annual falls in departmental spending as we have had before. If you do that, then you have to find £10 billion through welfare cuts and tax increases. Clearly, you could do it all on one end, or all on the other. He is telling us one point on that budget constraint.

Carl Emmerson: To give some figures on that, the £10 billion is in 2016-17 prices, so in today's terms, it will feel more like £8 billion. If you do not want to cut departmental spending or central Government spending on public services in the next Parliament, it is not £8 billion that you need; you would need £20 billion from welfare. If you do not want to cut welfare, then instead of cutting departmental spending at 2.3% a year-the current rate of cut after economy-wide inflation-you would have to cut it by 3.8% a year on average. To keep to Mr Osborne's total spending limits, those are the kind of constraints that we will be operating with in the first two years of the next Parliament.

Q165 Mr Ruffley: He needs that magnitude of fiscal consolidation to meet his 2016-17 target, which it now is, for eliminating the structural deficit. Is that right?

Carl Emmerson: It is to meet his target for getting spending down and for borrowing, taking into account the fact that social security spending and debt interest spending are continuing to rise. For example, the number of pensioners is growing, so there are some underlying positive pressures on the spending side, so it is to offset that and to meet the spending cuts that he needs to bring the deficit down in line with his plans.

Q166 Mr Ruffley: Is it the case that this is the tightest fiscal consolidation since the second world war?

Carl Emmerson: It is the longest sustained cuts to public service spending since the second world war-if they are delivered. That is certainly the case. It is almost twice as big as the seven-year period of cuts delivered between 1975 and 1982 after economy-wide inflation. That is on public service cuts.