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ippr statement on George Osborne’s Emergency Budget

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by Carey Oppenheim, Co-Director and Tony Dolphin, Senior Economist
www.ippr.org - 22 June 2010

(Read the related press release here.)

In his budget statement, the Chancellor George Osborne made welcome noises about how ‘progressive’ this budget was – but whether it is progressive or not will only become fully clear after an assessment of the spending plans which will be published in October. In ippr’s view it needed to be much more progressive than it was to offset the impact of the deep cuts in public services that are round the corner.

ippr set a threshold of fairness to judge this budget. There were some welcome announcements, such as the bankers levy, the increases in Capital Gains Tax (though these should have gone further), the incentives for businesses to grow in hard-hit areas and the rises in child tax credit to protect the poorest.

But overall the Chancellor risks doing too much too soon to reduce borrowing and in the process increases the chances of the tentative economic recovery being snuffed out.

On the Chancellor’s philosophy

George Osborne today bet the future of the UK economy on one particular economic philosophy: that private spending is being held back by worries about the scale of government borrowing. He believes that a promise to eliminate the structural current budget deficit over the next four years will encourage households to spend and companies to invest and that this extra activity will offset contraction in the public sector.

But, with confidence still fragile after the recent recession, it is more likely that households will react to the increase in VAT and the prospect of hundreds of thousands of jobs being lost in the public sector with more caution, not less. And if households are not spending – and the UK’s main export market, the euro zone, is also struggling to emerge from recession – companies will remain reluctant to invest.

On the speed of deficit reduction

The Office for Budget Responsibility’s first report showed that the previous government’s plans were credible and sufficient to place government borrowing on a sustainable path. There is no evidence that bond investors were demanding tougher action and the Chancellor has provided no sound reason for accelerating the pace of deficit reduction.

On the split between spending cuts and tax increases

There is no solid basis for the Chancellor’s assessment that spending cuts should make up 77 per cent of the planned deficit reduction. With some departments’ budgets, such as health and international development, protected, this means swingeing cuts in the budgets of other government departments. As a result, some of the poorest and most vulnerable in society will bear the brunt of deficit reduction.

Rather than starting from an arbitrary ratio of spending cuts to tax increases, the Chancellor should have conducted a thorough assessment of where in society the burden of deficit reduction should fall, and where it should not fall.

On taxes

The £1,000 increase in the income tax personal allowance is a welcome move, showing that the Coalition is trying to shield some people on low incomes from the effects of deficit reduction.

However, there were more progressive options open to the Chancellor than an increase in VAT to 20 per cent. A staged 3p increase in the basic and higher rates of income tax, which would take the basic rate back to the level it was at under the last Conservative government in 1997, would raise £15 billion. Economic growth was not choked off by such tax rates in the 1990s and it is not clear why it should be now.

While we welcome the rise in capital gains tax, the solution the Chancellor has come up with is a political fudge. In the interests of transparency and fairness, the Chancellor should have stuck to his guns and increased capital gains tax to 40% and 50% for higher rate taxpayers, rather than opting for the uneasy compromise of an increase to 28% to assuage the complaints of Conservative backbenchers.

We welcome the Chancellor’s plan to introduce a levy on bank liabilities and the fact that it is being introduced in a coordinated fashion with the French and German governments. But given the scale of bank profits and their responsibility for precipitating the economic crash he could have been more ambitious than targeting £2bn in revenues (the last government’s tax on bankers’ bonuses raised £2.5bn). The Chancellor should also tax financial transactions. A broad-based transactions tax would raise enough money to help reduce government borrowing and to increase spending on alleviating poverty in developing economies.

On climate change

The Chancellor has also missed an opportunity to increase environmental taxes, which have fallen as a share of total tax revenues in recent years. Increasing these would have demonstrated the Government’s commitment to tackling climate change and reduced the need for other tax increases or spending cuts.

The setting up of a Green Investment Bank is welcome, but decisions on it have been deferred until the Pre-Budget Report in the autumn. A key issue is what the impact of planned spending cuts will be on support for research and development in new green technologies – this will include the research councils, as well as specific programmes in Department of Energy, the Department for Business, Innovation and Skills, and the Department for Transport. All of these departments are facing budget cuts of at least 25% over three years.

On government spending

Final judgement will have to be reserved until the details of the spending review are published in October, but we note that the Chancellor plans to recognise the special pressures on education and defence as well as to completely ring-fence spending on health and international development. This means some government departments will be facing real cuts of more than 30 per cent over the next four years. Such cuts would in all likelihood damage or destroy some important programmes – with real impacts on the economy and on the lives of ordinary people.

On welfare

The Chancellor may have made some changes to budget procedure but, like his predecessors, he could not resist keeping a couple of pieces of good news back for the very end. The news that pensions are to be linked to earnings from April 2011, one year earlier than planned, and that an extra £2bn is available for tax credits for low income families are welcome. However, the latter is largely a way of compensating for the freeze in child benefit. While freezing child benefit is an easier way of raising revenue than taxing or means-testing it, we would not want to see a return to the 1980s when child benefit was frozen indefinitely and allowed to wither on the vine.

There is no easy way to reduce spending on Disability Living Allowance. Introducing a medical assessment for claimants will reduce costs by £1bn in this area. However, it is notoriously difficult to get medical testing right. International experience suggests this kind of measure only works if attached to effective support for this group, as well as the availability of suitable jobs to improve employment prospects. Without this wider approach overall payments in this area will be unlikely to change.

On housing benefit the Government must be careful not to reduce costs in one area only to increase them in another. Reducing the amount available for housing benefit will not act as an incentive to work if people are unable to find somewhere affordable to live. A national maximum rate will hit London with its high rents and high poverty levels particularly hard. Reforms will need to be flexible enough to take into account the needs of inner city workers, many of whom are unable to find affordable housing.

If the Chancellor can deliver an austerity budget without increasing poverty it will be an achievement – though much will depend on his ability to deliver the growth needed to shrink the numbers who are out of work.

On measures to strengthen the economy in the North

The announcement that a White Paper this summer will consider the most appropriate framework of incentives for local authorities to support growth in the North – including exploring options for business rate and council tax incentives, which would allow local authorities to reinvest the benefits of growth into local communities – is welcome.

What is important for the North is the creation of jobs as this is without doubt the best way to grow the economy. We welcome policies to improve innovation and create jobs including the new tax scheme where the first 10 employees hired by a new business will be exempt from National Insurance. Attention must be paid to how public sector spending can actually help to grow the private sector; for example, capital spending from the public sector is likely to be harder to come by after today which means there will be much less money in the North for construction firms. Government must realise cuts to the region’s public sector will impact on the private sector too.

We welcome the commitment by George Osborne to invest in transport infrastructure in the Northern regions and connect those living in deprived areas to jobs in the wider city-regions. Significant questions remain however, about the relative merits of replacing Regional Development Agencies with Local Enterprise Partnerships. The structure of these organisations is perhaps less important than how much power they have to actually make changes in their area. This issue also needs to be approached region by region if we are going to see results.

On measures to improve competitiveness

The Government must have a strategy for growth as well as a strategy for deficit reduction. The Chancellor’s announcement of cuts in corporation tax and a National Insurance contribution holiday for new businesses in parts of the economy that will be worse hit by cuts in public spending is welcome, though it is unlikely to be enough to prevent higher unemployment in the next year or two.