Is Kenneth Clarke really so clever? Paul Anderson examines
the tax-and-cut budget and assesses its likely impact on Britain's economic
prospects
It is easy to see why Kenneth Clarke's Tory colleagues and
the markets hailed him as a magician after he delivered Britain's first unified
budget on Tuesday.
Somehow or other, Clarke managed to produce a package of measures
to attack the public sector borrowing requirement, raising taxes and cutting
public spending – and yet he did it apparently without either hitting the most
sensitive parts of the welfare state or increasing the most noticeable taxes.
On tax, Clarke confirmed the imposition of VAT on fuel,
announced by Norman Lament in March, and cut the tax relief on mortgage
interest payments even more than Lamont planned (which will bring in an extra
£1 billion a year by 1996-97). He put up duties on petrol and cigarettes
(worth a total of £2.4 billion a year by 1996-97), promised to raise another £2
billion over three years by clamping down on loopholes (just as shadow
chancellor Gordon Brown had been suggesting) and introduced new taxes on air
travel and on insurance policies (worth another £1 billion a year from
1995-96). And he brought in changes in income tax that will yield just under £2
billion in 1996-97.
But the Chancellor softened the blow of VAT on fuel by
announcing a compensation package for pensioners and others on benefits – an
inadequate one, perhaps, as the poverty lobby and environmentalists were quick
to point out, but enough to take at least some of the sting out of criticism of
Lament's original plan.
In similar vein, the reduction in tax relief on mortgage
interest (very much in line with Labour thinking, as it happens) will cause
little pain at a time when interest rates are as low as they are today; while
the increased petrol and tobacco taxes (also very much part of Labour's
approach to taxation) can be justified on green and health grounds respectively.
Clarke's new taxes on air travel and insurance are very cleverly levied on
items of once-a-year consumer expenditure (who can remember what last year's
holiday cost?).
More important, the income tax hike was done not by
increasing rates but by freezing allowances and thresholds, allowing inflation
to increase the revenue, a trick learned from Lamont. And, most important of
all, Clarke did not extend the base of VAT as almost everyone had expected.
Much as the opposition parties fulminate about Clarke's swingeing tax
increases, there is widespread recognition among their members that it could
have been an awful lot worse – and that many of Clarke's proposals are very
similar to the ones that they would have had to put forward if they were in
government.
The story is much the same with the budget's spending cuts.
The cuts are there all right: in real terms, the "control total" of
non-cyclical government spending is set to fall by more than 1 per cent from
1993-94 to 1994-95, with next year's levels reached again only in 1996-97.
Public-sector pay is to be frozen, and there will be major
cuts in social security entitlements as, first, sickness and invalidity
benefits are merged into a new incapacity benefit, and then income support and
unemployment benefit become job seekers' allowance. Defence spending will be
cut by more than 10 per cent in real terms by 1996-97, taking it to below 3 per
cent of gross domestic product for the first time since 1945; there will be a
further move away from student grants to loans; transport spending will be
slashed.
But once again the pain is not quite what was expected. The
biggest cut is in the contingency reserve – down £4 billion on previous
projections in the next financial year and only a little less in 1994-95 and
1995-96. In real terms, local authority and health spending are shown unchanged
– and education gets a 5 per cent increase, while the social security budget
increases by 2 per cent. Pensions, unemployment benefit, income support and
child benefit will continue to be inflation-proofed. Clarke even found the cash
to introduce a childcare allowance for low-paid working single mothers and to
bring in a high-interest savings bond for pensioners.
The upshot is that most of the public spending element of
the budget will almost certainly prove difficult for the opposition to attack
with conviction. Apart from what appear to be draconian changes in invalidity
and unemployment benefits – on which much detail is still missing – there is
little for Clarke's opponents to get their teeth into. No one outside the
military and the Tory right really believes that defence spending should not be
slashed, and Clarke has easy populist arguments for public-sector efficiency to
answer the unions' howls of protest on public-sector pay. On student loans,
his point during the budget speech that bus-drivers should not be made to
subsidise the education of future lawyers is a taste of things to come.
Already, the main refrain of opposition politicians on the spending plans is
that more should have been ploughed into education and training and
infrastructural projects – hardly the
stuff to set the voters' pulses racing.
Enough, though, of the political cunning of the budget: will
it actually work? Clarke said that its purpose was to put public finances in
order once and for all, and the key projection in the Red Book that outlines
the effects of the budget is the one showing public-sector borrowing steadily
falling to zero by 1997-98 (conveniently enough allowing Britain to meet the
convergence criteria on public borrowing laid down in the sections of the Maastricht
treaty on European monetary union).
The credibility of this PSBR projection depends on what
happens to growth: tax revenue will be inadequate to cut into PSBR if growth is
low, while social security spending will be difficult to keep under control.
The assumption behind Clarke's figures is that the British economy achieves a
sustained growth rateof3.5 per cent from 1995 until the end of the century. But
such growth rates are, to say the least, highly unlikely, not least because
Europe, Britain's largest export market, is deep in recession and unlikely to
revive for a couple of years. With more realistic assumptions of growth at 2.5
per cent, as the Red Book itself admits, the possibilities of reducing the
PSBR to zero fade away.
"What the Chancellor needed in this budget was to
convince the markets that he had a credible path towards the reduction of the
PSBR to zero," says Meghnad Desai, professor of economics at the London
School of Economics and a former member of the Labour front bench Treasury
team in the House of Lords. "He has done it quite cleverly. He has
disguised the tax increases needed to get the PSBR down, he has made optimistic
projections on growth, and he has looted the reserves to balance the books.
Clarke has hidden the problems that will come to the fore, he hopes, only after
the next election. Watch out for a rush to the polls in 1995 or early
1996!"
Nevertheless, to judge from the reaction of the markets, the
scam seems to have worked in the short term at least. The consensus is now that
the way is open for the further reductions in interest rates necessary for
recovery.
Whether they will be enough on their own is, however, a moot
point among left economists. On one hand, there is the traditional Keynesian
argument that the problem with the budget is that its mix of spending cuts and
tax increases will dampen the overall level of demand in the economy to such an
extent that the recovery will inevitably be stillborn.
According to Bryan Gould, writing in New Statesman and
Society last week, the PSBR is simply the product of the recession and no
particular cause for concern. In similar vein, Jonathan Michie, a fellow of
Robinson College, Cambridge, and the author of several books arguing for a
revival of a version of the Alternative Economic Strategy that formed the basis
for Labour policy in the 1970s and early 1980s, says: "Cutting expenditure
and increasing taxes is the opposite of what is needed to bring the country out
of recession. The major worry now is what happens if it does all go wrong. If
it does, the running down of the contingency reserves means that the cuts will
be even more savage than those already announced."
On the other hand, there is widespread support for the idea
that the central focus of the government's economic policy efforts should be a
programme for European recovery – which was not mentioned by Clarke in his
speech. Stuart Holland, one of the architects of the AES in the 1970s who has
recently been advising Jacques Delors on his European recovery programme,
argues that Clarke simply missed the point.
"No national recovery is feasible if Europe stays in
recession," he says. "In today's internationalised economy,
macro-economic policy has to be internationalised. For us, that means that
macro-policy has to be European. The only way out is to increase the
macro-economic instruments of the European Union, such as the European
Investment Fund. The political space is opening up in Europe for European
macro-economic policy instruments."
The government's hope is that exports to the US and to
booming economies in the developing world – China, Indonesia, the Phillipines, Mexico – will more than compensate for the
sluggishness of the European economy until such time as lower German interest
rates have laid the basis for European recovery without recourse to an
expensive full-blown European recovery programme. It is a big gamble – but it
might, just might, come off.
