Patrick Nolan: There really is no money left and no scope for giveaways in next week’s budget

Patrick Nolan is the Chief Economist at the pro-market think tank Reform. Its report, “Reformers not spenders,” is available here.

In a foreword to Reform’s alternative Budget in June 2010 Paul Martin, the former Canadian Prime Minister and Minister of Finance, argued that Canada’s successful fiscal consolidation in the 1990s was based on clear fiscal targets and a position that these targets would be achieved “come hell or high water.” In a report released today Reform highlights that when it comes to fiscal consolidation the current UK government is, in comparison, wobbly.

When faced with difficult circumstances the Chancellor’s response has been to shift the goal posts. Rather than eliminating the structural deficit by 2014-15 (the target set in the 2010 Budget), last year’s Autumn Statement said this would happen by 2016-17. Rather than public sector net debt of 69.4 per cent of GDP by 2014-15, debt is expected to be 78.0 per cent. Rather than spending 40.9 per cent of GDP by 2014-15, spending will be 42.2 per cent.

This means that claims that the Coalition is meeting or beating its fiscal targets must be taken with a pinch of salt. Net government debt is still expected to increase by £471 billion over the next 5 years. Far from being out of the danger zone the public finances remain fragile. People who argue that the Coalition should ease up on its spending plans or introduce tax cuts do not grasp the fiscal position. There really is no money left and no scope for giveaways in next week’s budget.

Reform’s report also highlights the Coalition’s mistake of continuing to ring fence health and parts of the welfare budget, such as pensioner gimmicks like the Winter Fuel Allowance. Tim Montgomerie has argued powerfully on this site that ring fencing is a mistake. It weakens incentives for reform and encourages groups to lobby for special treatment. It means that cuts elsewhere have to be deeper than otherwise.

This idea that nothing should be off limits applies to the tax system too. The UK government has a spending problem and so the large majority of the work in rescuing the public finances must come from spending cuts. Yet tax reform must play its part. Tax revenue should not, however, be confused with tax rates, and more stable revenues do not need rates to rise. The focus must be on broadening the tax base – especially very narrow base for the UK’s VAT.

The tax system also needs to get better at collecting revenue from people who should owe it and so the tax gap must be closed. Yet HMRC estimate that around half of the tax gap can be attributed to SMEs and Coalition policies are encouraging these businesses to plan their affairs to avoid tax. By cutting company tax rates while simultaneously increasing personal allowances and personal tax rates the Coalition is getting its tax design seriously wrong.

Since the early part of this Century the policy response to any squeeze on family incomes was to increase government spending. Given the state of government accounts this is no longer possible. Rather than recognising that more spending is not the answer, some commentators have said that this funding challenge can be simply reconciled through increased taxes on, or reductions in relief for, higher income earners. This is little more than a “lite” version of the previous Government’s approach.

More spending does not necessarily lead to better outcomes. Indeed, in the case of childcare a major result of the increase in spending over recent years was simply increased costs. Measures targeting high earners can also become own goals and increase the squeeze facing middle income families. However unpopular it is to say, commentators must not fall into the trap of thinking that making high earners worse off will automatically make other people better off. High pay is needed to help grow the tax base which will increase resources available for spending, debt repayment and tax reductions. High pay was also not the cause of the problems facing the public finances. It did not, for example, lead to the welfare budget doubling in real terms over the last two decades, or the health budget doubling over the last.

As Reform argued late last year austerity is the new normal, with the challenge of rescuing the public finances lasting well beyond the end of this Parliament. This means that fiscal discipline must no longer be treated as just a political slogan but as a necessary part of everything the UK government does.