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Danger of double-dip

John Grieve-Smith challenges the Coalition on budget deficit reduction

The Coalition government's mode of attack on the budget deficit raises serious dangers both of aggravating the unemployment problem and damaging public services. Premature action to cut expenditure or raise taxes will slow down recovery from the recession and prolong the current state of serious unemployment. The G20 group of leading nations at its meeting in Toronto in June emphasised the risk that 'fiscal adjustment across several major economies could adversely impact the recovery'. The problem is how to reduce deficits in such a way as to have the minimum or no effect in reducing demand and employment.

Cutting public expenditure affects employment both directly and indirectly. It reduces the number of people working in the public sector, and then those who lose their jobs spend less on consumer goods and services, leading to further job losses in the private sector. Tax rises could have less effect on employment. Higher income taxes on the rich, or increases in inheritance taxes might well have only limited impact on consumption. The proposed Bank Levy could be a good move. But the increase in VAT from 17.5 per cent to 20 per cent is likely to lead to a corresponding reduction in the volume of consumption by poorer income groups.

The proposed reduction in Corporation Tax from 28 per cent to 26 per cent is inappropriate. A modest increase could probably raise additional revenue without any noticeable effect on demand. Any such increase should be a uniform one across the EU – all members of which need the money. The Treasury should be supporting tax harmonisation in this field, not opposing it.

Although much greater attention should be paid to the possibilities of raising additional revenue from taxation, there may still be a need to trim public expenditure. But it is important to realise that the Labour government had already set very tight limits on expenditure, which would in themselves have led to difficulties. The use of the phrase “real increases in expenditure” has had a major effect in confusing the issue in fields like education and health, or the armed forces, where there is little or no scope for increasing productivity. More children per teacher, or patients per nurse, mean a fall in standards, not an increase in productivity.

A so called “real” increase is an increase greater than the general rise in the price level. On the normal Treasury assumption for Budget purposes that income per head rises on average by 4 per cent a year, overall productivity by 2 per cent, and prices by 2 per cent, any increase in expenditure over 2 per cent is regarded as a so called “real increase”. But if public sector workers are to get the same increases in pay as those in the private sector, a 4 per cent increase in expenditure, ie 2 per cent in “real” terms, is needed to keep the same number of staff and maintain existing standards.

So, any talk about real increase can be very misleading – such as the credit claimed in Alistair Darling's last budget for a 0.8 per cent a year real increase in total current expenditure from 2010-11 to 2014-15, and a 0.7 per cent real increase for “frontline” spending on schools, which implied a cut in numbers, or a reduction in relative pay, for teachers.

The immediate objective should be how to limit expenditure in the short run without damaging major public services. From this point of view, some temporary reduction of public investment is justified – the counterpart of speeding up projects and increasing investment when faced with a recession. The Coalition Budget, however, envisages a decrease in public sector investment from £69 billion in 2009/10 to £43 billion in 2013/4. A reduction of this order will need to be done with great care, and the current disruption of new school building has been a bad start.

The Budget shows current expenditure as set to continue rising - from £601 billion in 2009/10 to £679 billion in 2013/4, 3 per cent a year. If public service pay was to go up at 4 per cent a year, in line with the customary Treasury assumption for the economy as a whole, these expenditure limits would be insufficient to keep the same number of people in public sector employment. As is evident already, there will therefore be efforts both to keep down pay, and reduce numbers, in the public sector. This implies either privatisation, or a deterioration in standards, in public services.

Whatever David Cameron and the Tories say at the moment, this provides them with a golden opportunity to fulfil their long held desire to cut down the 'size of the state'. Labour must fight hard to preserve public services such as education and health, and put the case for higher income and inheritance taxes on the rich instead. There is already widespread public antipathy to current inequalities in income which should make a more progressive tax policy an increasingly acceptable alternative to cutting public services.