e-mail Paul Lewis on paul@paullewis.co.ukThe Government’s debt is so big that we are all going to feel the pinch as it is reduced over the next five years. And a very big pinch it will be. Here’s the first frightening number: £952,000,000,000. That is nine hundred and fifty two billion pounds. It is the amount of money the Government is expected to owe at the end of 2010/11. This figure excludes the cost of bailing out the banks because the Treasury view is (or at least was) that the money will eventually be recouped. If it was included the total would rise to well over a trillion pounds – £1,081,000,000,000.
Here’s another whopper: £163,000,000,000. That is the amount the last Government planned to spend above its income this year. It is the difference between the spending plans of £704 billion and the expected income from taxes of just £571 billion. The gap of £163 billion has to be filled by borrowing more. By the time you read this those figures will have changed. The new Government has made some new cuts and the income from taxes may well be higher than was predicted at the time of the first Budget in March 2010. But it is still a very large problem. We owe a lot. We are spending more than we earn. And we want to borrow more to pay for it.
Living above our means
To bring these
figures down to a human scale, suppose we divide them by the 47 million adults
in the United Kingdom. Mr John Bull has an income of £11,500 a year. But he has
already run up a credit card debt of £16,500 and for some years he has not paid
a penny off it. But John likes a lifestyle that his income cannot sustain and he
spends about £15,000 a year to achieve it. To find that he goes to the bank
again to borrow another £3,500 which will take his total debt by the end of the
year to around £20,000. And by the way, his wife Jill is in exactly the same
position and so is everyone else from Alex Macpherson in John O’Groats to Tamsin
Nancarrow at Land’s End.
John Bull’s bank manager (or nowadays the customer relations officer) tells him to cut his spending and wonders if he could earn a bit more – perhaps take a second job. And she warns John Bull that without a clear plan to reduce his annual overspend the bank will charge him more for his new debt and may not lend to him at all in future.
That is exactly the challenge the Government faces. Unless
there is a clear and detailed plan to reduce the annual overspending, the
pension funds and wealthy foreign states who lend governments the money they
need will not be happy. They fear there may come a day when Britain cannot repay
the money it has been lent. It has not happened here since Government borrowing
was invented by Edward I in 1275. But without a clear plan to cut overspending
the lenders will charge us more – we already spend more on interest than on
defence – and eventually will stop lending. They do not expect the debt to come
down soon – that will not happen for many years – but they do expect the growth
in the debt to slow down and finally stop over the next five years or so.
Before the election politicians were reluctant to explain the extent of the cuts they would have to make. We got a hint of them in the statement on 24 May and there will be more in the Budget on 22 June. But the real cuts will be announed in the Autumn. Using a sophisticated spreadsheet model of Government spending I have been trying out the options. The old Government planned to keep total annual spending at roughly the same level of £704 billion over the next five years allowing for inflation. With extra taxes coming in the Labour government thought that was sufficient to cut the overspend by more than half from £163bn to £74bn by 2014/15.
Although freezing the amount we spend sounds easy, in fact it is not. Some things just have to rise which means the rest has to be cut. For example, the interest paid on the debt is expected to grow from £42 billion in 2010/11 to £67billion by 2014/15. That is mainly because the debt will be bigger but also because the rate we pay will start creeping up. Similarly social security payments – which include the state pension – will rise by 1.1% a year because there will be more people claiming them and because state pension will rise with earnings from 2011. These payments will cost £170 billion this year – the biggest single item of spending – so a 1.1% rise is expensive.
Costs hard to control
Other ‘untouchable’
spending includes the contribution to the EU – which is around £8 billion and
the new Government has no plans to change; the cost of public sector pensions –
a review is promised but that will only affect pensions earned in future; and
transfers to local councils. Before the election the Institute for Fiscal
Studies estimated that £311 billion of the £704 billion the Government spends
cannot be frozen and indeed will rise to £356 billion by 2014/15.
The problem does not stop there. Among the rest of the expenditure are other things that are hard to control. The next biggest cost is the NHS at £127 billion a year. Under the last Government it grew by 6% a year and the King’s Fund medical charity estimates that even to stand still the NHS budget has to rise by 1.6% a year to take account of the cost of drugs and medical advances. The new Government is committed to a ‘real terms’ increase in the NHS. I put in a very modest rise of 0.5% a year and it may well be more. That means the diminishing pool of spending that can be cut has to be slashed even more.
Add in the cost of raising aid to the developing world – a specific commitment of the new Government – and we face cuts of more than 20% in everything else over the next four years. But we haven’t finished ring-fencing yet. What about defence spending which has risen by 1.6% a year in real terms under the last Government? With a war going on and equipment to be replaced even a freeze will be hard to achieve but I put in 0%. The new Government is also committed to spending more on schools. It is hard to put a figure on the cost but I allow for that by also freezing, rather than cutting, spending on schools.
That leaves the full burden of the cuts on everything else – universities, roads, rail subsidies, prisons, the court service, agriculture, energy, climate change, the arts, sport, JobCentres, the collection of taxes, pension and benefits administration, the entire civil service – in fact most things that the Government does. In fact the total amount spent on all that is about the same as the £163 billion we borrow. So to balance the books today we would have to stop doing all of it. And to achieve even halving the overspend over four years everything on that list has to be cut by a third. For every £100 spent £33 has to be saved. And because much of the cost is wages tens if not hundreds of thousands of civil servants may find their jobs disappearing.
Real tax rises?
Cuts of that size would be very difficult to achieve. So it seems inevitable
that the tough choices Ministers are considering for the Autumn spending review
will include cutting what we spend on welfare benefits, the NHS, public sector
pay and pensions. We know that child tax credits will be restricted to those on
lower incomes and the Child Trust Fund will be cut in August and scrapped fro
2011. Some tax rises already planned on capital gains and flying for example
will only cover the income tax cut that has already been announced. If spending
cuts cannot produce the savings, then somewhere along the line real tax rises
that affect us all – such as VAT – will have to be considered. By the time you
read this that may already have happened.
These are indeed hard choices. But with a mandate from 59% of those who voted on 6 May and a clear five year term in office the Government may just say ‘Tough. As promised.’
e-mail Paul Lewis on paul@paullewis.co.uk