How much wriggle room will the Chancellor have in the July Budget?

After the flow of easy pre-election promises, here come the hard choices of government. As George Osborne approaches his ‘emergency Budget’ attention will turn to what room for manoeuvre he really has given all the commitments that have been made. How will it all add up and is there a version of austerity that might sit slightly more comfortably with the post-election

The Chancellor’s key pre-election fiscal pledge was to achieve an overall budget surplus within the new parliament. It seems safe to assume that this will remain a fixed point. The purple line in the chart below sets out a possible path to achieving this based on the March (coalition) Budget. Relative to the current fiscal year (and before any additional in-year savings that may now emerge), the size of the consolidation required reaches roughly £38 billion by 2018-19 – delivering an overall surplus in that year. This fiscal ‘down-then-up’ trajectory means that in the final full year of the parliament, spending could be increased (or taxes cut) by around £13 billion while still maintaining an overall surplus.

But this trajectory is not fixed. Assuming that the underlying economic forecasts don’t change (which of course they will), what could George Osborne do if he wanted to create a bit more fiscal space for himself while still meeting his headline commitment? This is the subject of a new briefing by my colleague Adam Corlett.

For starters, he could choose to trim the size of the surpluses pencilled in at the Budget or the end of the parliament. Surpluses of £5 billion in 2018-19 and £7 billion in 2019-20 could simply be reduced to, say, £1 billion (the gold line) without compromising either his party’s pre-election fiscal pledges or the more formal demands of the Charter for Budget Responsibility.

More significantly, the Chancellor could also decide to aim for an overall surplus by 2019-20 rather than by 2018-19 (the party’s manifesto didn’t give a specific target date). This one year delay (shown in blue) would reduce the maximum required consolidation from £38 billion to around £25 billion. That’s a sizeable shift. It would also mean that 2017-18 could be the last year of consolidation: thereafter, overall spending could be increased very slightly, with expected revenue growth being enough to generate an overall surplus by the end of the parliament. By 2018-19, spending could be around £16 billion higher (or taxes lower) compared to the plans set out in the last Budget.

At a stroke this would make the implied cuts for non-protected departments and welfare slightly more plausible (if still very severe), mark an ‘end to austerity’ by the middle of the parliament and soften (at the margins) the pressure on the Bank to keep monetary policy on the floor. It would be welcomed by most economic commentators and receive next to no scrutiny from a weak and distracted Labour Party.

So why wouldn’t the Chancellor do this? He may well. But if he doesn’t, then it won’t just be because it would mean a slightly higher stock of debt (and debt interest payments). It’s also likely to be because it will reduce the scope for a sharp fiscal ‘rebound’ – in the form spending growth or tax cuts – towards the end of the parliament. To mix some favoured fiscal metaphors: pushing back the point of surplus to 2019-20 would partially level out the spending ‘rollercoaster’, but the ‘light at the end of the tunnel’ would be less bright. Those with a keen eye on the political-cycle might favour greater austerity upfront in return for more of a fiscal feel-good factor as we approach the next election.

Crucially, however, none of this takes into account the Conservatives’ other pre-election pledges, not least an £8 billion boost for the NHS and at least £6 billion of income tax cuts. Together, these are likely to eat up pretty much all of Osborne’s potential wriggle room. Or to put it another way, that extra leeway will have to be used just to avoid the cuts to non-protected departments and welfare being even deeper than we’d been expecting.

What other options exist? One would be to take significantly more of the strain via higher taxes. But this is going to be difficult given the commitment not to raise the headline rates of VAT, income tax or National Insurance. And recall that the pledge to raise the personal tax threshold and higher rate threshold greatly reduce the scope for fiscal drag. (True, there is no commitment to raise the lower National Insurance thresholds – but to freeze these would be an extraordinary decision: ensuring that those on the very lowest earnings are hit while others get tax cuts). Chancellors can always find new ways to raise more revenue. But this one has tied his hands more than most.

The final option is to rest on the argument, as Labour often did, that the fiscal situation could be greatly improved if growth outperforms expectations. Ultimately, this comes down to productivity growth. The trouble is, the OBR is already assuming that the seven-year stagnation will come to an abrupt end as productivity jumps to 1.7 per cent in 2016-17, and then to 2 per cent. (If this increase fails to materialise then scratch everything you’ve read above – the numbers will all be far worse.) Let’s just say it would be very brave indeed to bank on productivity outperforming OBR assumptions, and note that the Bank of England has just revised down its own expectations for 2015 and 2016. Currently, any productivity growth would be a welcome surprise.

So in theory those worried about the severity of austerity to come might hope that the Chancellor fully exploits the remaining leeway that exists in his plans. But the reality is that most of this has already been exhausted through a string of pre-election commitments. Don’t be holding your breath for a one-nation budget.