Ruth Lea: Trim the aid budget and cut taxes

When the Chancellor stands up next Tuesday to unveil his latest policies for economic growth, we can be certain of at least one thing. He has not been short of advice, not least of all from our new-style, lachrymose Shadow Chancellor.

When he is not being moved to tears by the Antiques Roadshow or The Sound of Music, Mr Balls obsessively calls on Mr Osborne to ease his fiscal consolidation plans. But the Chancellor can claim, with every justification, that his deficit reduction plan (“plan A”) in June 2010 did, indeed, preserve Britain’s triple A rating for sovereign debt. And, this in turn, has enabled Britain to achieve “safe haven” status as the Eurozone crisis intensifies, which has led to remarkably low interest rates. The sight of German 10-year bond yields nudging above Britain’s is remarkable given our debt-soaked circumstances. How long this “safe haven” status will persist, given the poor outlook for the public sector finances, is of course a different matter. It cannot be an assumed “given”.

The Prime Minister conceded last week to the CBI “…getting debt under control is proving harder than anyone envisaged”, doubtless to prepare us all for a deterioration in the OBR’s public finances forecasts. It is not as if the numbers are not bad enough already. In March the OBR projected an increase in Public Sector Net Debt of well over £300bn over the forecast period from £1,046bn (in 2011-12) to £1,359bn (in 2015-16), nearly 70% of GDP. These projections were based on a pretty solid growth performance over the period. The OBR will however almost certainly significantly downgrade the GDP forecasts for 2011 and 2012 (at minimum), which will have unfortunate knock-on implications for public borrowing. Commentators will, in particular, be focusing on whether the Chancellor’s fiscal mandate, aiming to eliminate the structural current deficit on a 5-year rolling target, and/or his supplementary rule, targeting a falling debt/GDP ratio by 2015-16, will be missed.

The Chancellor should stick to his guns. Automatic stabilisers will in any case push up the deficit. He is right to reject the arguments for a fundamentally reworked “plan B” because the risk that investors would lose confidence in the deficit reduction plan and sell off gilts would far outweigh the likely small economic gains of turning on the spending taps. He should leave the overall totals of the spending plans, as specified in last year’s Spending Review, broadly as they are.

But there is some scope for making substantial savings in at least one programme which could then be reallocated to other programmes (preferably for capital spending) or, better still, used for tax cuts. Even at a time of relative austerity, the spending plans included a very generous allocation to the Department for International Development (DFID)’s aid budget, doubtless for political positioning purposes. DFID’s budget (excluding depreciation) is planned to increase from £7.8bn in 2010-11 to £11.5bn by 2014-15, a rise of nearly 50%. Putting aside the pros and cons of whether aid actually delivers economic prosperity in recipient countries, both the size of the budget and the rapidity of the increase has to be questioned.

This is all the more relevant in the light of the recent report by the House of Commons’ Public Accounts Committee (PAC) into the financial management in DFID (pdf). The PAC report was highly critical and makes for disquieting reading. It said that DFID “…does not quantify the likely level of leakage through fraud and corruption” and “… still has insufficient data to make informed investment decisions based on value for money.” The PAC also noted that “…the Department’s plans to increase spending in fragile states, and in sectors where it has less experience, increase the risks to value for money, especially given the Department’s patchy evidence on costs and outcomes, and its poor understanding of the levels of fraud and corruption.” Mark Lowcock, DFID’s Permanent Secretary, conceded that that he did not know how much aid money was lost to fraud and corruption when giving evidence to the PAC in July.

The PAC’s concerns were backed up by a more recent report (pdf) by the Independent Commission for Aid Impact (ICAI), which is the independent body responsible for scrutinising UK aid. ICAI commented that “..this focus on fragile states, together with the planned increase of the aid budget, will expose UK aid to higher levels of corruption risk”, adding that DFID showed a lack of a “coherent and strategic” response when dealing with countries which have a high risk of corruption.  

These criticisms of DFID are astounding and devastating. DFID seems incapable of managing its current budget efficiently never mind a substantially expanded budget. Whatever view you take about the efficacy of aid, it makes no sense to ring-fence an aid budget that cannot be properly controlled. At the very minimum the committed spending target of 0.7% of GNI from 2013 for overseas aid should be suspended until DFID can unequivocally prove that it has its financial house in order. And DFID’s budget should be reviewed with a view to cutting it back to, say, £5bn. £3bn could have been saved for 2011-12, nearly £4bn could be saved for 2012-13, and over £6bn for 2013-14 and 2014-15.

As I have already indicated these savings could then be allocated to other spending programmes or, better still, towards tax cuts. Tax reform, as has been discussed many times on this site, is one of the key factors in stimulating growth. A saving of £4bn in the aid budget could easily accommodate the removal of the competitiveness-damaging additional income tax rate (50% rate), which could cost £1.3bn. The remaining £2.7bn could be used, for example, to reduce corporation tax rates further and/or decrease NICs rates.

Ruth submitted her piece before today's Sunday Telegraph story that the government is spending £1 billion fighting climate change in Africa.