The media response to the Budget is always reliably low on content and high on hyperbole. Even by these exacting standards, 2017 has been a vintage year. Coverage has focused almost exclusively on the decision to raise National Insurance contributions for self-employed workers – with some side glances to the tax treatment of dividend payments. The macroeconomic implications of the budget have passed almost without comment.
In the days leading up to the budget statement, much attention was focused on Hammond’s proposed £60bn ‘rainy day fund’ – alternatively marketed in some outlets as a ‘war chest’ or ‘gas in the tank’ – to cope with Brexit contingencies.
What form does this fund take? The average reader probably imagines that ‘putting money aside’ involves a transfer of funds into an account somewhere. Maybe the Chancellor will open up an ISA to keep his £60bn safe from the taxman until he needs it?
In fact, the Chancellor’s £60bn ‘fund’ is not yet even in his own hands – it refers to planned additional borrowing between now and 2020.
How, the reader may reasonably ask, is planned borrowing a ‘rainy day fund’? The answer is that – despite determination by politicians and the media to conflate the two – household finances and government finances do not work in the same way. The endless references to ‘living within our means’ and ‘maxing out the credit card’ are deeply misleading – usually intentionally so – when applied to public finances.
Rather than ‘cash in the bank’, the £60bn ‘fund’ is a result of the Chancellor shifting his own fiscal targets around. When he took over from George Osborne, Hammond inherited a ‘fiscal rule’ requiring the government to be in surplus by 0.5% of GDP by the 2020-21 parliament. In plainer language, this means that the government must aim to be repaying its creditors to the tune of half a per cent of GDP by 2020.
In the Autumn Statement, Hammond – taking a leaf from the Gordon Brown rulebook – shifted the goalposts. Instead of aiming at a 0.5% surplus, the new target is a 2.0% deficit. By 2020, the government will aim to be borrowing an amount equal to 2% of GDP per annum.
Incidentally, a 2% deficit by 2020 is pretty much exactly what Labour proposed at the last election. Although denounced as the height of fiscal irresponsibility by the Tories at the time, this has now been spun into a prudent ‘rainy day fund’.
At the time that the Chancellor shifted the goalposts, official figures from the Office for Budget Responsibility showed projected actual borrowing to be a bit less than the target of 2% – by a total of £27bn over the period up to 2020. Since the autumn, official predictions about the public finances have shifted slightly in Hammond’s favour: as a result of the credit-fuelled post referendum consumer spending spree, tax revenues are now projected to be slightly higher over the next few years.
If the latest round of projections turns out to be correct (they almost certainly won’t) the Chancellor will further undershoot his borrowing target, by a total of around £60bn over the period.
To use the government’s favoured credit card analogy, it is as if you were to obtain a credit card with £1000 limit, and then plan to spend only £400 – leaving you with a ‘rainy day fund’ of another £600.
But this misleading analogy shouldn’t be used. For one thing, the Chancellor is free to set his own limit: the 2% number is arbitrary. He could conjure billions more into his ‘fund’ simply by raising his borrowing target to 3%.
All this of course assumes that he doesn’t make any changes to his tax and spending plans – he could, of course, use public borrowing to fund additional spending on investment and services.
But he won’t do this. He is determined to miss out on the once-in-a-generation opportunity provided by ultra-low interest rates. Rather than taking the advice of the economics profession and spending on desperately needed new infrastructure, the Chancellor presents further austerity as prudence. It is nothing of the sort.
This highlights a more important difference between household and government finances. Spending by an individual household on accommodation, food and clothing will not affect the size of its wage packet. This is not the case for government. Increased public spending leads to higher employment and therefore to higher tax income and lower benefit payments. This is why the ‘credit card’ analogies are so wrong and so pernicious. Government expenditure and income are not independent.
This is what lies behind Keynes’ claim that cuts may not even achieve their narrow aims of reducing government debt. Spending cuts during periods of weak demand lead to lower growth and higher debt ratios. Recent research finds strong evidence for Keynes’ position: ‘Attempts to reduce debt via fiscal consolidations have very likely resulted in a higher debt to GDP ratio through their long-term negative impact on output.’
In their analysis of the budget, the Institute for Fiscal studies noted that the UK has now gone a decade without growth (on a per capita basis). Average earnings are not projected to reach 2007 levels again until 2022 – by then the UK will have gone fifteen years without a pay rise.
This unprecedented situation is man-made. It is the outcome of seven years of macroeconomic mismanagement. Hammond’s insistence that austerity is prudence brings to mind Keynes’ response to demands for budget cuts in 1930, just after the Wall Street crash: ‘I suppose that they are such very plain men that the advantages of not spending money seem obvious to them.’
Analysis by the Resolution Foundation shows that the burden of cuts in the coming years will fall entirely on those on low and middle incomes, while the better off are set to see their incomes rise.
The emergency Labour budget of 1931 was, Keynes wrote, ‘replete with folly and injustice’. The statement could equally have been made about any budget presented by George Osborne. Hammond appears determined to follow in his predecessor’s footsteps.
Jo Michell is Senior Lecturer in Economics, University of West of England (UWE). This article is cross-posted, with our thanks, from the UWE Bristol Business School blog
