Assessing the post-election implications of the parties’ different fiscal stances

Our recent briefing note In The Balance set out some indicative figures for public finances in the next parliament based on our interpretation of each of the three main parties’ highly sketchy (to date) outlines of their preferred trajectories. This note updates this work based on the new OBR figures released alongside the Autumn Statement. As well as rolling the forecast horizon forward one year to the end of the next parliament (2019-20), the new figures reflect significant revisions to outturn data made by the ONS following the adoption of new accounting standards. All figures are in 2014-15 prices.

By way of reminder here’s what we know – and don’t – about the parties’ post-election stances:

• George Osborne has stated that a Conservative government would target an overall budget surplus, and David Cameron has suggested that this “balancing of the books” would occur by 2018 (this is in addition to meeting the new Coalition target of balancing the cyclically adjusted current budget by 2017-18, which both the Conservatives and the Liberal Democrats have committed to). In meeting the goal of an overall surplus, the Chancellor has pledged to find an extra £12 billion of cuts from the welfare budget in 2016-17 and 2017-18 (although he has only specified where around one-quarter of this would come from to date). He has explicitly ruled out any increases in tax, with the party promising instead to cut taxes by around £6.5 billion[1] over the course of the parliament, funded via further spending cuts. The implication is that the remainder of the tightening required under the Conservative plan would come from further reductions in departmental spending (DEL), though the Conservatives could also seek to cut welfare by more than the £12 billion so far pledged.
• Ed Balls has set a different course, offering to get the current budget (that is, excluding investment spending) into surplus “as soon as possible” in the next parliament – leaving it unclear exactly what this means. With the capital budget coming in at around £25 billion a year, Labour would have the freedom to borrow significantly more than the Conservatives each year without breaching their target. The main limit on this freedom is offered by Balls’ additional commitment to reduce national debt (which does incorporate capital spending) as a share of national income in the next Parliament. Labour hasn’t made clear a desired balance between spending cuts and tax rises in meeting their goal, simply stating that Labour would seek to “balance the books in a fair way”.
• For their part, the Liberal Democrats plan to maintain the Coalition focus on balancing the cyclically-adjusted current budget in 2017-18. Once that is achieved, they intend to shift to a balanced budget target that includes some, but not all, elements of capital spending – excluding those parts of investment that “enhance economic growth or financial stability”. Again there is a commitment to falling national debt as a share of GDP. Unlike the other two parties, the Liberal Democrats – or more specifically Nick Clegg and Danny Alexander – have indicated that in meeting their fiscal target, they would favour maintaining the current balance between spending cuts and tax rises of 80:20.

We can assume that all parties are committed to delivering the £8 billion of cuts in departmental spending earmarked for 2015-16 as part of the 2013 Spending Review. In this note therefore, we focus on the final four years of the next parliament – from 2016-17 to 2019-20. In doing this, the key assumption relates to the fiscal position that each party would choose in the final year of the period – 2019-20. Converting the broad statements set out above into firm plans is clearly impossible and we make no attempt in this note to offer definitive evaluations. Instead, we present indicative outcomes based on a series of reasonable interpretations.

Underpinning all of our analysis is the new OBR data that sets out the fiscal implications of current Coalition plans over the next five years. These figures suggest that the current budget will reach surplus of £10 billion in 2017-18, rising to £46 billion by 2019-20. The overall budget is projected to reach surplus of £4 billion in 2018-19, rising to £21 billion in 2019-20.

Achieving such an outcome is set to require around £48 billion of tightening in the four years from 2016-17 – in the form of DEL cuts, reductions in welfare spending or increases in tax. In the absence of specific Coalition policies on tax or welfare, the working assumption of the OBR is that the full amount is drawn from departmental spending. It’s this assumption that results in its declaration that day-to-day government spending on public services is set to fall from £5,650 per person in 2009-10 to £3,880 per person in 2019-20.

In practice, each of the parties will want to introduce policies that share the burden of this tightening across welfare and tax too. We can envisage a ‘frontier’ of policy positions between the two extremes of achieving all of the required consolidation from DEL cuts on the one hand and achieving all of it via some combination of tax rises and cuts in welfare (or, more specifically, annually managed expenditure – AME) on the other. The chart below sets out just such a ‘frontier’. It captures the combination of policy choices that would achieve a given level of fiscal tightening.

By way of context, we set out the combination of action that would be consistent with maintaining the average annual pace of cuts in DEL between 2010-11 and 2015-16 (i.e. spanning this parliament and the already agreed spending review period of 2015-16). Such an approach would result in a cumulative cut in departmental budgets between 2016-17 and 2019-20 of 8.3 per cent, alongside tax increases and welfare cuts equivalent to around £19 billion. It’s worth noting however, that maintaining the current pace would in reality be likely to result in an acceleration of cuts for many departments, because of the protection that is likely to be afforded to some budgets including health, international aid and schools. Clearly a range of other outcomes could be targeted instead.

More fundamentally still, under their declared stance each of the parties has some leeway to reduce the overall size of consolidation required compared to that implied by the Autumn Statement. We consider the position of each party below.

Conservatives: overall budget surplus

The apparent Conservative promise to deliver an overall surplus in 2018 might be thought to be consistent with the Coalition plans set out at the Autumn Statement. That is, having delivered a modest surplus (£4 billion) in 2018-19, they might proceed to deliver a much bigger one (£21 billion) in 2019-20. However, they have not specified quite what their position would be after achieving balance, and it is possible that they would choose to do no more than remain at balance in subsequent years.

The loosest possible interpretation of their pledge is therefore that they end the parliament with the overall budget just in balance. That would imply a reduction in the level of required tightening from £48 billion to around £28 billion. In simple terms, this figure represents a £21 billion reduction in the required surplus plus an increase in debt interest payments of just under £1 billion associated with having a higher stock of debt than would be the case under the Coalition trajectory.

We can speculate then that the Conservatives are likely to aim for a position that sits somewhere between the Coalition ‘frontier’ and a ‘frontier’ that is some £20 billion lower, as shown on the chart. We can also attempt to pinpoint the position that the Conservatives would occupy on the frontier. Given the pledges to cut welfare by £12 billion and cut taxes by £6.5 billion, the party appears to be planning to reduce the potential £28 billion reduction in DEL by around £5.5 billion (i.e. £12 billion minus £6.5 billion). This would imply cumulative cuts in DEL over the four years of around 6.3 per cent.

This is the loosest interpretation we can envisage. At the tighter end of the spectrum, the Chancellor might want to stick to the plans set out in the Autumn Statement. We therefore estimate that current Conservative plans would involve somewhere between £28 billion and £48 billion of tightening from 2016-17 to 2019-20.

Labour: current budget surplus

At the other end of the spectrum, the loosest possible interpretation of the Labour commitment to current budget surplus “as soon as possible” is that this doesn’t occur until 2019-20. In this scenario, Labour would require total tightening over the four years from 2016-17 of only around £7 billion. In this instance, the £48 billion Coalition figure is reduced by the £46 billion projected surplus on the current budget in 2019-20 but is then increased by around £5 billion of additional debt interest payments. (Once again, none of these figures include the £8 billion of departmental cuts in 2015-16).

In the absence of any sense of when exactly Labour would want to achieve current budget balance, or what fiscal stance they would take once this level was reached, we have no way of setting out a definitive ‘frontier’ on the chart. Instead, the one we have drawn indicates the slowest pace they could take while still meeting their target (i.e. 2019-20). With no stated policy on the balance of consolidation between tax rises and spending cuts, we cannot specify where on any given ‘frontier’ Labour would position itself.

In practice, the Labour ‘frontier’ could sit anywhere between the one shown and the ‘loosest’ Conservative ‘frontier’ (i.e. the point at which overall surplus is reached), though this convergence between the parties would only occur in the highly unlikely scenario that Labour chose not to borrow to pay for any capital investment even though its fiscal rule permitted it to do so. We therefore estimate that current Labour plans would involve somewhere between £7 billion and £28 billion of tightening in the four years from 2016-17.

Liberal Democrats: budget surplus excluding some elements of capital spending

The Liberal Democrat ‘frontier’ we have drawn represents an arbitrary interpretation of the  party’s decision to exclude some, but not all, capital spending from its balanced budget target (they haven’t clarified how much). In this instance we present the implications of excluding half of capital spending in 2019-20, setting out a frontier of options between £16 billion of tax rises and AME cuts on the one hand and a 4.6 per cent cumulative reduction in DEL on the other. The specification of an 80:20 split between spending cuts and tax rises mean that we can assert that the Liberal Democrats could not be at the extreme of 4.6 per cent but, because we do not know how much they would choose to do via AME cuts, we cannot specify a precise position on the ‘frontier’.

And of course, the party could choose a tighter trajectory. They might, for instance, choose to exclude less capital spending from their definition of balance, meaning that they need to cut spending or raise taxes by more. Equally, however, they could choose a looser trajectory by excluding more of the capital budget from their target. Their stance does mean, however, that they must sit somewhere between the loosest Labour ‘frontier’ and the loosest Conservative one. We therefore estimate that current Liberal Democrat plans would involve somewhere between £7 billion and £28 billion of tightening between 2016-17 and 2019-20. This is the same range we estimate for Labour, but it is worth noting that – based on their respective statements so far – we  might well expect the Liberal Democrats to be tightening more and borrowing less for capital than Labour (though we can’t say that definitively).

Implications for the next parliament

These different approaches – all speculative to a degree – could have far reaching  implications for the size and shape of the state in 2019-20 and for the pressures that will be faced by households and by public services in the coming years.

They imply a maximum potential difference in the overall size of consolidation required after 2016-17 of up to £41 billion (the difference between the Coalition ‘frontier’ and the loosest possible Labour interpretation). The difference between the loosest Conservative and loosest Labour position is somewhat smaller at £21 billion. But it’s also the case that the differences between the parties could end up being much smaller if, for whatever reason, Labour opted not to borrow for capital spending.

Doubtless, some will seize upon a specific figure (like £41 billion) and assert that this is the difference between the parties. That would be misleading. Until the parties are clearer we can only think of the difference between them in terms of a possible range (hence we say ‘up to’ £41 billion).

To date, we have no way of judging quite where each party would place itself on this chart, nor on how they would distribute the pain between tax rises, welfare cuts and reductions in departmental spending. The choices on offer to the British electorate could differ profoundly, but voters have no way of determining quite what is on offer until the “candour deficit” is closed. We will update this work (and chart) as and when we learn more.

[1] The original costing was estimated to be higher, but the April 2015 increases in the personal allowance and higher rate threshold announced at Autumn Statement 2014 mean that part of the cost of increasing the personal allowance to £12,500 and the higher rate threshold to £50,000 by April 2020 has been brought forward into this parliament.