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David Alexander: Ending universal benefits may be the least worst option as the Government attempts to deal with the deficit

Picture 17 David Alexander was a senior adviser to John Howard's government in Australia and is a former economics editor of the Canberra Times who is now resident in the United Kingdom.

PJ O’Rourke once famously recommended the circumcision approach to public spending: you can cut 10 per cent off the top of anything and not affect its essential function.

It was a good point, but with looming cuts to all bar two government departments set to average 25 per cent, or even 33 per cent if defence and schools are partially shielded, it looks less like a little snip and more like heading into Lorena Bobbitt territory.

For a bloated state like Britain, such a level of spending cuts is highly desirable in economic terms, but if cuts of this size in a short time frame are not politically feasible, then the exercise could turn out badly.

The political opposition is going to be ferocious when the gory details of the Spending Review emerge, and the most difficult to manage criticisms for the government are likely to come from its own backbenches, from both parties.

In the face of the looming storms, some in government might be tempted to slacken the deficit reduction schedule to ease the pain, but the pounding to the Government’s economic credibility from such a move would be just as damaging, if not worse.

Finding agreement between the coalition partners on the cuts to make in the Spending Review will be extremely challenging, but if they cannot reach agreement then the coalition government is finished and a period of serious economic and political instability wiould follow.

Clearly there is a strong incentive to look for other ways of saving to take pressure off the radical departmental budget downsizing.

Welfare savings would be economically sound, but would the Liberal Democrats agree to large cuts? Hardly, given the intense internal heat that they are already facing after the emergency budget.

The only way the Liberal Democrats could agree to further tough welfare measures is if taxes were raised on higher income earners. But raising tax rates now leads back to the bloated state problem, would look very scrappy, and if such measures cut into middle-income earners the government leadership would face its own revolt from the Conservative Party.

The fundamental problem is that spending cuts are the most effective way to deal with the deficit, but spending cuts on such a scale will tend to have a regressive impact. How to solve this conundrum is the greatest challenge facing the coalition.

The regressive impacts of spending cuts will mean great political difficulties for the Conservatives, but a possibly insurmountable hurdle for the Liberal Democrats.

Nick Clegg has said that progressivity will be assured through future unspecified measures, but what can this mean in practice? The tax options will tempt him as the most Lib Dem friendly way to balance the now famous pain distribution table. The much-studied Canadian deficit reduction included higher taxes on higher income earners, a temporary measure partially intended to act as a signal of fairness.

There is one avenue for significant cost savings that might ameliorate the problem - not popular, but progressive and consistent with conservative philosophy: much tougher means testing and targeting to restrict benefits and entitlements to lower income earners.

Consider the case of Australia, the means testing and targeting capital of the developed world, with the lowest share of transfers going to the wealthiest half of the population of any country in the OECD.

It is not coincidental that in 2009 Australia had the lowest government spend/GDP ratio in the OECD, equal with South Korea. And where government spending falls, so taxes shall tumble down too. The government revenue take in Australia in 2009 is also the lowest in the OECD (both figures from the OECD).

Means testing does carry its own secondary issues regarding marginal incentive structures, but the simple robust philosophy behind it is that the state should only raise taxes to fund those genuinely in need.

Taking transfer payments away from middle and upper income earners is of course likely go down like a lead balloon amongst those receiving them, but the unfortunate fact is that this may be a least worst option for helping to tackle the problem.

The threat of cuts to middle class benefits has seen the emergence of a coalition even stranger than the Con-Lib Dem crossbred. Opposing means testing sees the Fabian Society, which says that it threatens “social solidarity,” and Ed Milliband, who says the same thing, joining forces with the Daily Mail and numerous Conservatives who want benefits to go right up the scale.

The rough choices for the government now in dealing with its "regressivity" problem is to either (a) break promises of universality, introduce means testing and face the wrath of the Big State Coalition; (b) stay the course, keep the benefits for higher income earners, face the Institute for Fiscal Studies accusation that the government is hurting the less well off more than the better off, and tough it out; or (c) introduce some tax hikes at the upper end.

Nobody said government was easy.


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