Austerity not yet off government agenda

Posted on July 12, 2016

A video grab taken from footage broadcas...A video grab taken from footage broadcast by the UK Parliament's Parliamentary Recording Unit (PRU) shows British Finance Minister George Osborne as he presents the government's annual budget to parliament, in the House of Commons in central London on March 16, 2016. British finance minister George Osborne will unveil Wednesday his annual budget, with more austerity pain as the global economic outlook darkens, but will pledge more cash for education and infrastructure. Most economists believe Chancellor of the Exchequer Osborne will likely avoid any major shocks, with three months to go until Britons vote on EU membership in a crucial referendum. / AFP PHOTO / PRU / - / RESTRICTED TO EDITORIAL USE - MANDATORY CREDIT " AFP PHOTO / PRU " - NO MARKETING NO ADVERTISING CAMPAIGNS - NO RESALE - NO DISTRIBUTION TO THIRD PARTIES - 24 HOURS USE - NO ARCHIVES -/AFP/Getty Images©AFP

Chancelor George Osborne presents his 2016 Budget to the House of Commons

The UK has abandoned its target of reaching a budget surplus by the end of this parliament, but it is not clear whether the end of austerity has fully arrived.

While Theresa May has technically cleared the way for tax cuts or spending increases to support the economy, she has also said the government should “continue with its intention to reduce public spending and cut the budget deficit”.

    After six years of austerity, George Osborne broke his cap on welfare spending last autumn, failed to meet his target for debt to fall earlier this year and abandoned his final fiscal target — a budget surplus by 2019-20 — at the beginning of July.

    The only constraint now is whether investors are willing to loan the government money: last week they bought £2.25bn of 10-year gilts at a record low yield of 0.91 per cent, suggesting the appetite for UK government debt remains healthy.

    John McDonnell, shadow chancellor, welcomed the new flexibility, saying Labour had been “unequivocal in its opposition to failed Tory austerity”.

    But so far Mrs May has given no indication she intends to row back from the spending cuts planned for the next few years.

    While setting out “a vision of a country that works not for a privileged few but for everyone”, she gave no indication on Monday that she planned to reverse the cuts to public services and benefits that have attracted criticism for hitting the poorest the hardest.

    Even before the Brexit vote, the cuts to government borrowing had begun to falter. In March’s budget, Mr Osborne only remained on course to achieve his surplus target by bringing forward planned spending and pushing back the payment of some taxes.

    Following the Leave vote, forecasters have revised down their expectations for growth in the UK. Lower growth will lead to lower tax revenues and more pressure on benefit spending if unemployment starts to rise. These mechanical effects alone mean borrowing is expected to be higher this year than the 2.9 per cent of national income that was forecast by the Office for Budget Responsibility in March.

    If the government wants to support the economy in the short term, it will need to marshal its resources carefully, with a rapid and temporary stimulus, according to Carl Emmerson, deputy director of the Institute for Fiscal Studies.

    The Office for Budget Responsibility estimates that increases in investment spending give the largest immediate boost to the economy, followed by increases in spending on public services and benefits. The most effective tax cut is believed to be a temporary cut to VAT, such as the one introduced at the end of 2008.

    Stephen Crabb — one of the unsuccessful prime ministerial candidates — proposed setting up a £100bn investment fund, allowing the government to take advantage of low borrowing costs to make additional resources available for infrastructure investment. But it was not clear over what time period this money would be available.

    For investment spending to work, “shovel-ready projects” are required, said Victoria Clarke, an economist at Investec. But Ms Clarke, who worked in the Treasury during the 2008 financial crisis, warned that “a lot of [those projects] were done previously . . . you don’t have a lot of decent projects ready to go.”

    Mr Osborne’s proposal to cut corporation tax to 15 per cent would cost about £4bn a year, or 0.2 per cent of national income. While this policy might attract companies to the UK in the longer term, it would not provide an effective short-term stimulus.

    Such a policy could not be implemented until next April and even then would “give cash to firms with a lag and give it only to profitable firms”, said Mr Emmerson.

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