A failure on three fronts

Alastair Darling's pre-budget report has been something of a disaster. It has failed on three counts:

1. From an official Treasury viewpoint, the main short-term objective was to stabilise the markets. But there has been a flight from gilts.
2. It has not provide a platform for a Labour revival, given that it has managed to upset a range of target voters.
3. It has failed to provide a credible plan for dealing with the structural deficit.

Indeed, the fiscal position has got worse because Ed Balls and Yvette Cooper managed to persuade Gordon Brown that there should be a real increase in capital spending on school buildings. The more programmes are ring fenced, the harsher the axe that has to fall elsewhere to the extent that it is likely to do real and lasting damage. The authoritative Institute for Fiscal Studies has estimated that public spending will be have to be cut by as much as a fifth in areas such as defence, higher education, housing and transport.

Gordon Brown is also reported to have vetoed a VAT increase, meaning that there had to be a national insurance increase which in terms of the addditional levy on employers is a tax on jobs. The Conservatives are likely to increase VAT and possibly broaden its range, although targets such as children's clothing, books and newspapers would be controversial.

The IFS has also pointed out that the government's calculations do not really take account of the effects of an ageing population which would mean high public sector debt levels for a generation or more unless taxes were raised substantially or public spending was cut further.

Stand by for ten years of 'fiscal consolidation'.

A political pre-budget report

Not surprisingly, the pre-budget report was a highly political document. It postponed most public expenditure cuts until 2011 and was not specific about where these would fall. However, given that schools, the police and the health service will be 'ring fenced', this implies cuts of something like 5 per cent a year for three years in other services, unprecedented cuts in the post-war period.

Quite a lot of taxation pain will fall on those on middle incomes with the further rise in national insurance contributions which are in effect an income tax (except that those of pensionable age do not pay them) but are not perceived as such by voters. The 40 per cent threshhold has been frozen for the next tax year which will drag more people into paying a higher rate of tax.

The whole plan is based on a return to growth rates of 3.5 per cent which look excessively optimistic. When the economy grows above the trend rate of 2.5 per cent, this is invariably not sustained for very long and brings problems in its wake.

By 2012 about half of public expenditure will be Annual Managed Expenditure. This surely argues for some cuts in entitlements, but poltically that is very difficult to do. As it is, the 2.5 per cent rise in the state pension next year amounts to a 4 per cent increase in real terms.

The model Labour is advancing amounts to deal with about two-thirds of the structural deficit through spending cuts and one-third through taxation whereas Treasury research suggests that a 80:20 split works best.

Labour clearly lacks an appetite for cuts on the scale required, which is perhaps understandable. Local government is going to take a hit and will increasingly have to provide services on an 'Easycouncil' model with a basic core service being offered and charges for anything which goes beyond that.

The attack on bankers' bonuses may be seen as a cynical ploy and could actually reduce revenue. Politically, this PBR does little for Labour's election chances and it looks as if the poisoned chalice will fall to Dave Cameron.