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How George Osborne Would Allocate (Some of) the Pain

30/09/2014 10:03 BST | Updated 29/11/2014 10:59 GMT

The Chancellor, George Osborne, told the Conservative Party Conference on Monday that a further £25billion of permanent savings will be needed to eliminate the UK's fiscal deficit, and he also began to set out how a Conservative government would find these savings.

First, he rules out increases in taxes - other than closing some loopholes that allow for corporate tax avoidance. This is an important change in policy compared to the last five years. At the beginning of the current parliament, when he hoped to eliminate the deficit by the current fiscal year, the Chancellor said that the deficit would be cut by a mixture of 80% cuts to public spending and 20% higher taxes. Hence, he increased the main rate in VAT from 17.% to 20%.

If he was sticking to this ratio, then a further £5billion of tax increases would be required. If not, as seems to be the case, then the cuts to spending will be so much bigger.

Second, he announced a freeze on most working-age benefits, including Jobseeker's Allowance, universal credit, child benefit, income support and tax credits. Rather than increasing in line with consumer price inflation in 2016/17 and 2017/18, these benefits would remain at their 2015/16 levels. The welfare cap would also be reduced from £26,000 to £23,000. These changes would save over £3billion.

Consumer price inflation is expected to be close to 2% in 2016/17 and 2017/18, in line with the government's inflation target. Freezing these benefits in nominal terms, therefore, implies a 4% fall in their real value. The Chancellor believes this is justified because the value of benefits has increased by more than average earnings since the financial crisis.

Benefits did, however, increase by less than average earnings before the crisis. The Chancellor's move to freeze benefits raises a question about the appropriate way of indexing these benefits in the long-term. If the Chancellor plans to revert to indexing them in line with price inflation once average earnings are increasing at a faster pace than prices, then he has created a system in which they increase by the lower of price inflation and wage inflation. In the long-run, this can only mean that their real value will fall over time.

The Chancellor has said that he wants to reduce the welfare bill by a further £12billion in total. There were no details, not even a hint, as to where the remaining £9billion would come from. More needs to be done in this area because otherwise the pressure on departmental spending is too great. It has been made clear though that the state pension, which accounts for around half of welfare spending, would not be affected by further cuts. A reduction in spending on the winter fuel allowance (perhaps through means-testing) might be considered though.

Inevitably, the effect of the cuts announced today will be felt hardest by people, other than pensioners, in the bottom half of the income distribution, including those who are in work, because - with the exception of child benefit - they are the main recipients of the affected benefits. Meanwhile, thanks to the 'triple lock' which ensures the state pension increases by the highest of price inflation, wage inflation and 2.5%, pensioners will be better off. It is more than a little rich, therefore, that the Chancellor is still claiming that we are all in this together.

Third, by implication, the cuts to departmental spending will have to total around £13billion. There are no details about where these would be made and how badly services would be affected. Assuming that spending on the NHS, schools and international development is exempt from cuts, and possibly defence spending too, this means further swingeing cuts for other departments, which will have experienced cuts of 40 to 50% in real terms by the end of the next parliament.

A cynical reading of the Chancellor' speech, therefore, would note that having announced that £25billion of spending cuts are needed, he only detailed where £3billion would be found. What about the other £22billion? It's a safe bet that we will not hear much about them before the general election.

The same though is likely to be true of the other main parties. Ed Balls's 1% cap on increases in child benefit in the first two years of the next parliament would raise just £400billion. And don't expect Danny Alexander to announce a raft of spending cuts at the Liberal Democrat conference next week.

Before the 2010 general election, Labour, Conservatives and Liberal Democrats all identified some areas of spending to cut, but on nothing like the scale needed to tackle the deficit, even though that was seen as the single most important issue facing the country. Sadly, we can expect a similar conspiracy of silence over the next seven months.

Tony Dolphin is Chief Economist at IPPR, the Institute for Public Policy Research