Labour's pre-budget report - Drawing up the battle lines

Dec 10th 2009From The Economist print edition
The chancellor’s fiscal statement was all about politics

A YEAR ago, when Alistair Darling presented his pre-budget report, the chancellor of the exchequer unveiled an astonishing deterioration in the public finances. That got even worse in his spring budget. Judged by those titanic standards, the pre-budget report on December 9th was a tame affair. But it still mattered for what it revealed about the government’s priorities in dealing with a still-floundering economy and Britain’s huge budget deficit. Above all, it outlined the case Labour will put to voters at the election due by June.
Mr Darling had to own up to a much bigger contraction in the economy this year than he expected at the time of the budget. The Treasury thinks GDP will shrink by 4.75% in 2009, whereas in April it was forecasting a fall of 3.5%. But it still expects the economy to expand by about 1.25% in 2010, and indeed to emerge from recession in the final quarter of this year. The chancellor is sticking to his prediction of 3.5% growth in 2011, which was criticised as over-optimistic this spring, and thinks it will carry on in 2012.

One of the main dividing lines between the Labour government and its main Conservative opposition is over when fiscal retrenchment should begin. Mr Darling argued in effect that the recovery was safer in Labour’s hands because he would delay the strong medicine needed to right the deficit until 2011, when the patient would be ready to take it. He made much of various measures to support businesses in the early stages of the upturn.
For once Mr Darling was spared the embarrassment of having to unveil yet another massive deterioration in the borrowing numbers—just as well given how terrible they already were. A year ago he said that the deficit in 2009-10 would soar from the £38 billion ($62 billion) stated in the 2008 budget to £118 billion. That was revised up again in April 2009 to an even more breathtaking £175 billion. But this week the chancellor raised that by a mere bagatelle, to £178 billion, equal to 12.6% of GDP.
Mr Darling has also stuck broadly to his leisurely plan for bringing the public finances back into balance, first set out a year ago and then revised in April. As before, the chancellor expects the deficit to fall to 5.5% of GDP by 2013-14 (see chart). And as before, he postpones half the pain to the next parliament but one: not until 2017-18 is the current budget (which excludes net investment) back in balance.
Another dividing line that Labour is keen to draw has to do with readiness to raise taxes on the better-off. The chancellor continued his attack on very high earners, by reducing further the tax relief available to them on their pension contributions and unveiling a one-off tax on bank bonuses, which may reap £550m this year. He will also freeze in 2012-13 the threshold, currently almost £44,000 of earnings, at which middle-income folk become liable to pay income tax at 40%. And, in a dig at the Tories, who are committed to raising the tax-free limit for inheritance tax to £1m, the chancellor said he would freeze the current threshold at £325,000 next year.
Unfortunately for Mr Darling, the big money is in the taxes paid by the many rather than the few. As well as confirming his plan to end the temporary reduction in VAT at the start of 2010, the chancellor has turned again to his favourite levy, national-insurance contributions. A year ago he said he intended raising the rates by half a percentage point in 2011-12; now he is making that a full percentage point. The chancellor has, however, sought to sweeten the pill for lower earners (with income below £20,000) by raising the point at which people start to pay these contributions.
Raising this tax will not go down well but it was vital to enable Mr Darling to make his most important political point of all: that Labour is the guardian of crucial public services. The extra revenue will pay for most of an additional £7.7 billion of spending in 2011-12 and £6.9 billion in 2012-13. Some other improvements in the budgetary arithmetic meant that Mr Darling could unveil this extra expenditure without changing his overall forecasts for borrowing for those years.
That enabled the chancellor to make a vital pledge—that the “front-line” services that people care about will be safe under Labour, not just next year but in the following two. The pre-budget report said that in real terms 95% of the NHS budget would be shielded from cuts in 2011-12 and 2012-13, and everyday spending on schools would rise by 0.7% a year. The number of police officers would also be left intact.
Mr Darling moved a step closer to spelling out the painful clampdown on public spending that lies ahead by saying he would cap pay increases in the public sector in those two years at 1%. He also promised reforms to public-service pensions that would save £1 billion a year from 2012-13. And there was plenty of talk about vague new efficiencies that will yield sackloads of savings across the public sector.
Despite the tough rhetoric, the chancellor has taken a calculated risk in what his Tory opposite number, George Osborne, dubbed a pre-election report. The government’s plan to reduce the deficit is widely regarded as insufficient. Rather than use higher taxes to lower borrowing, Mr Darling has used them to cut spending by less. The deficit in 2013-14 could prove higher than the Treasury expects. John Hawksworth, an economist at PWC, an accountancy firm, thinks it is likely to be 6.9% of GDP then rather than 5.5%.
With an election so near, the pre-budget report was bound to be a holding operation. The real plan will come after the election, and it will involve real pain. That is the price of messing up the public finances as thoroughly as Labour has done.