Tom Papworth: Fiscal consolidation has been implemented poorly – here's how to fix it

Tom Papworth is Associate Director, Economic Policy, CentreForum. Follow Tom on Twitter.

This is the fourth article in ConservativeHome’s week-long series on the Spending Review, and follows those by Peter Hoskin, Sean Worth and Mark Wallace. It is intended to be a “yellow” account of what should be in Review to go against the “blue” account that Policy Exchange's Sean Worth wrote on Tuesday.

Deficit reduction has been the key policy of the coalition. Despite siren calls from disgruntled former spokesmen, getting public spending under control and not bequeathing crushing debt to future generations is a basic liberal principle. The coalition is right to continue the project of consolidation, but the way the government has gone about it has been poor.

Firstly, George Osborne and Danny Alexander deserve credit for designing a fiscal consolidation that broadly aligns with economic best practice: empirical evidence shows that a ratio of 4:1 spending cuts to tax rises appears to correlate with the fastest and strongest recoveries; raising taxes to fund government spending is counter-productive. But the phasing has been all wrong. Osborne introduced the tax rises up front, while the spending cuts have dribbled in over time. It would have been both economically sensible and politically expedient to get the pain over as early in the parliament as possible and give the economy as much time as possible to recover. The political opportunity is now passed, but the economic logic remains. The remainder of the cuts should be introduced promptly, while further tax rises should be avoided.

The balance of cuts has at least been expedient, if not economically sensible. So far, 67% of the planned cuts to investment spending have been implemented, compared with just 21% of the cuts to day-to-day spending on public services. This is bad policy: capital spending typically has larger multipliers than either tax rises or cuts to current spending. That means cuts retard, and spending stimulates, economic growth far more than comparable changes in taxes and revenue spending. Yet it is broadly agreed that Britain (not, it should be said, exclusively the government) has been under-investing in infrastructure for decades. Any outstanding cuts to infrastructure investment should be cancelled and, where possible, spending on infrastructure should be increased. However, ministers must resist the urge to build prestige projects: HS2 should be cut to free resources for upgrading roads, railways and energy provision.

Not all investment needs government money: there are free lunches for those who dare dine. BAA Ltd can afford to pay for Heathrow expansion and the economic multiplier would be unparalleled: both the Tories and the Lib Dems should abandon their foolish opposition and allow the building not just of a third, but of a fourth, runway – as advocated in a joint CentreForum / Policy Exchange publication in October. Similarly, if the government had the courage to tear up our dysfunctional land use planning laws and move to a system of Community Land Auctions, we could create millions of jobs building millions of much-needed houses, and create such a windfall for local authorities that we could eliminate much of DCLG’s local authorities budget into the bargain.

Sean Worth, in his article on Tuesday, was right to describe ring-fencing as a “thorny issue”, but not to say that “it is right to protect areas like health and education”. While there may be perfectly good reasons to maintain – or even increase – spending in some departments or on some programmes, it is wrong to exclude them entirely from the review process. If health care, or international development, deserve to be protected, then the logic of that should be able to stand up to the scrutiny of a spending review. No case is so compelling that it deserves not to be questioned. It is not clear why budgets for the foreign poor are not even open for discussion, when budgets for domestic poor are; why care for the elderly is at risk but not care for the sick. The effect of ring-fencing is to put greater pressure on other departments. The Department of Health is expected to spend a fifth of Total Managed Expenditure (TME) in 2013-4. Excluding it from the entire debate pushes up the cuts facing other departments by an average of a quarter.

While the welfare bill is the largest part of the budget: DWP is expected to spend £174 billion in 2013-4. However, for all the battles over welfare reform, half the DWP budget is not only protected but is actually set to increase substantially over coming years. Pensions consume more than half the welfare bill; pensioner benefits in total make up £111 billion. Yet pensioners make up only a fifth of the population. Labour this week proposed cutting some of the peripheral benefits for wealthier pensioners, once again playing catch-up to the Lib Dems. This leaves the Tories as the sole defenders of these unfair and regressive benefits. Yet the whole discussion is marginal, tinkering nonsense. Ed Balls’ proposal would save just £100 million from Winter Fuel Payments. Limiting them to those eligible for Pension Credits would save a much more useful £1.2 billion, but pensions themselves need to be looked at.

The government’s much-vaunted “Triple Lock”, which guarantees to increase pensions by whichever is higher out of inflation, earnings rises or 2.5 percent, is a terrible policy. A case can be made for pegging pensions to earnings or inflation, but to guarantee to increase it by the higher of the two (or by an arbitrary figure if both inflation and earnings increases are low) is effectively a commitment to shift wealth ever further from young and working people to the elderly and retired. The policy is pure politics, pandering to the “grey vote” at the expense of ever-harder pressed taxpayers. The Spending Review offers the government an opportunity to abandon the Triple Lock and to choose a single benchmark against which to uplift pensions. In the short-term, uplifting pensions by 1 percent a year for three years (i.e. treating pensions the same as other benefits and thus asking pensioners to share the pain of deficit reduction alongside the rest of society) could save £2.8 billion a year by 2015–16.

As for defence expenditure, scrapping of Trident remains an obvious and inevitable course of action. As CentreForum argued in 2012, “the MOD must find £74bn of savings over ten years. Given that replacing the Trident submarines will probably cost between £25-£33bn… By scrapping Trident, the UK would be able to use the savings to increase the capacity of its conventional forces”. Whether the priority is boosting the UK’s ability to project power or reducing the deficit, Trident is a luxury we cannot afford.

Finally, there are small but valuable wins if the Lib Dems stand their ground. The Snoopers’ Charter is expected to cost £1.8bn over 10 years: it liberals can fend off Conservative authoritarians a small but not negligible sum could be saved, along with our civil liberties. That should make everybody happy.