Monday, October 19, 2009

The Man from the IFS

Two years ago I had the privilege of sharing a platform with Carl Emmerson, who is the Deputy Director of the highly respected Institute of Fiscal Studies (IFS). He was telling a rather uncomprehending crowd at NCVO that it was game-over for big public spending increases. And this was before the crash.

The IFS, for those that don't know it, run a model of the UK economy that at least rivals that of the Treasury. Some would say they predict things better than HM Government. Which is why you will often hear Carl or his boss, Robert Chote, on the radio in the morning. In short, the IFS normally get it right.

My motivation in catching up with Carl was to find out what his thinking was on the forward picture for public spending. I know what my instincts and my patchwork-knowledge tells me. But I wanted Carl's view - as a non-political, independent economist.

What he had to say was interesting. Basically, the UK's tax-take has dropped massively to the tune of about £100m pa - or roughly 15%. This is a recurrent deficit that we have to bridge. This is different from the Deficit we hear about on the news - which is the bill so far. The £100m, without corrective action, is what we will spend above what we get in EVERY YEAR from 2010-11 onwards.

Therefore we have choices. One unlikely choice is that we become Sweden: we accept current levels of spending, jack up taxes to Scandinavian levels and just live with that.

The other more likely one is that the Government immediately both raises certain taxes AND withdraws particular benefits (or Transfer Payments as they are called by economists) from groups who don't need them. Things like Universal Child Benefit, child tax credits and other "middle class" benefits come to mind.

These changes, if they are to be made, are likely in the first budget of any new Government (probably weeks after its election).

This led me to ask Carl whether a new Government would seek to implement departmental spending cuts too in that year. Carl thought probably not because budgets for 2010-11 will have already been set - and anyway, it would be likely, given the suddenness of any immediate changes that the "wrong cuts" would be made.

2010-11, therefore wouldn't be the year for actual cuts, beyond the immediate cash saving mentioned above, but the year in which cuts were planned for implementation in 2011-12, the first year of the next three year spending-period.

Interestingly, he pointed out that all of the cuts mentioned by the Tories only constitute a very small amount of the total amount to be saved annually. The truth is that the news will get a lot worse. Governments will probably need to tax more and spend considerably less for a long period.

Politically the question will be whether this period can be allowed to go on for the best part of a decade - or whether the next Government will seek to get it mostly done these next five years - to allow some light at the end of the tunnel rather than a message of "four more years of pain" in 2014.

If it is to be a shorter period, it will be altogether nastier to take out the effects of a recurrent £100m shortfall - and to pay down the existing deficit too.

I asked Carl about whether turning off the taps now, as Labour argue, would stymie recovery. He doesn't think it would be possible to do that in one go anyway and that the "now or later" question will be resolved by the fact that later isn't very far away now.

Might this kill recovery anyway? This worry, he says, needs to be offset by the risk that the markets (whose activities have a big bearing on interest rates) may be made very jumpy by any Government or prospective Government they didn't feel was committed to keeping the growing fiscal gap under control. From this point of view, a Government with this commitment and a firm majority would be the most welcome. Not the best of news for Liberal Democrats!

What was most striking talking to Carl is just the size of the gulf between what we are spending recurrently and what is being brought in - a gap currently funded by Quantitative Easing of monetary policy (or printing money). We cannot just grow our way out of this one. And while we cannot continue spending, it is worrying that neither party is publicly talking about how we can bridge that Grand Canyon.

Indeed if we were building a rope-ladder right now, even George Osborne's proposals would only stretch a few metres across!

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