UK deficit reduction will need big tax rises after next election, experts warn

http://www.guardian.co.uk/business/2013/feb/06/uk-deficit-tax-rises-election

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Britain's leading experts on public finances have warned of hefty tax increases in the first budget after the 2015 election as the next government seeks to repair a £64bn deficit caused by a stuttering economy.

The Institute for Fiscal Studies said tax rises of £10bn-12bn might be needed in the next parliament to put deficit reduction back on track and to avoid "eye-watering" cuts in some Whitehall departments that would reduce spending by a third in inflation-adjusted terms between 2010 and 2018.

Paul Johnson, the thinktank's director, said it was not impossible for the government to achieve its deficit reduction target entirely by cutting departmental spending but it would be "very, very difficult indeed".

"I would be very surprised if it [the adjustment] all came through public spending. If I was a betting man I would say there will be a combination of spending cuts, tax increases and a delay in reaching the fiscal objectives."

The IFS said 75% of deficit cuts in the current parliament had come through spending cuts and the rest from tax increases. If the next government continued with that approach, it would need tax rises of £10-12bn, equivalent to 2.5p to 3p on the basic rate of income tax. In the past 30 years, tax rises have averaged £7.5bn in the first budget after an election.

Johnson said the need to continue the austerity programme into the next parliament had been caused by George Osborne's decision to allow borrowing to rise while the economy has moved sideways over the past two years, rather than tighten policy further.

That decision was praised on Wednesday by the Organisation for Economic Cooperation and Development in its annual survey of Britain, which said a more modest pace of deficit reduction was warranted given the poor performance of the economy.

Admitting it had over-estimated the strength of Britain's recovery from its longest and deepest post-war recession, the OECD said a "flexible approach" to budget cuts would be called for if fears of a triple-dip recession materialised.

"The fiscal stance [the strategy to cut Britain's record peacetime budget deficit] remains appropriate. However, if growth significantly underperforms expectations over the coming months, the flexibility of the fiscal framework should be utilised." Britain is one quarter of negative growth away from entering a triple-dip recession after the economy shrank by 0.3% in the last three months of 2012.

The OECD said the Bank of England should take the lead in stimulating the economy, but that Osborne had won himself enough credibility to slow up the pace of deficit reduction if that was warranted by slower than expected growth.

Angel Gurría, OECD secretary general, said the government needed to do more to protect the poor from budget cuts and to encourage people back into work. "Fiscal consolidation needs to be embedded in a comprehensive package that also promotes growth. Further structural reforms are key to a stronger, more inclusive and prosperous Britain."

The IFS said it was more likely than not that underlying borrowing would rise this year, but Osborne said the OECD report showed Britain was "on the right track".

Rachel Reeves, shadow chief secretary to the Treasury, said: "The IFS report shows how badly the government's plan has failed. By choking off the recovery the chancellor is now borrowing billions more than he planned as the costs of economic failure mount. This economic failure is why George Osborne is now being forced to find further spending cuts and tax rises."

The IFS said the government decision to ringfence spending on the NHS, international development and part of the schools' budget had resulted in other departments – such as the Home Office and Justice – facing real cuts of 20% in the current spending round.

A continuation of the ringfencing until 2018 would result in unprotected budgets being cut by 33% while public sector employment would be 1.2m lower than in 2010.

The IFS said the total was 300,000 higher than expected by the independent Office for Budget Responsibility and that avoiding such big headcount reductions would require tax increases or deeper cuts in welfare spending. In 2013-14 those in work would gain from tax cuts while those not employed would lose from benefit cuts. Families with children would see the biggest cuts in benefits over the current parliament.

Johnson said: "As economic performance and forecasts have worsened the chancellor has followed a dual strategy. He is allowing borrowing to increase substantially in this parliament – allowing the automatic stabilisers to work – whilst promising another dramatic dose of public spending cuts in the next parliament."