The Overspend Gets Bigger

See you at the airport

So what do we make of the budget?

Given his starting point, George did a reasonable juggling job, and managed to sound as if he's serious about getting the economy moving again. His moves on company taxation and fuel duty are welcome, if relatively small... er... beer. His fresh attempt to inject life into the housing market is also potentially helpful, although we need to see more detail before we can be sure it won't simply re-inflate the property bubble and/or expose taxpayers to a huge Freddie and Fannie style default crisis. 

However, looking at the big picture, he failed once again to tackle the rampaging elephant that's still smashing up the fiscal room. That is, he did nothing to bring government spending back down into line with sustainable tax revenues.

Yesterday I took part in a TPA/IEA panel discussion on the budget, and the excessive level of public spending was by far the main concern for both panellists and audience. Unfortunately, nobody could see the current government gripping it this side of the 2015 election, and a Miliband government - with or without the Lib Dems - won't even try. 

By the end of the session I was ready to book a one-way ticket to... well, to where exactly? Cyprus would now appear to be out, and Mrs D's arachnophobia rules out the more exotic destinations. Must get back to researching it.

The following is a summary of my own presentation (some bits are updates of recent blog posts, and I'm afraid there are quite a lot of numbers).

As the Chancellor highlighted in his speech, government departments have been significantly underspending against their original budget allocations. The underspend for 2012-13 is now put at £11 billion, an unprecedented shortfall which has narrowly prevented this year's borrowing increasing above last year's (£120.9bn vs £121.0bn). However, of much more significance is the continuing overspend against the government's revenue base, a problem he did not address in the budget.

The Coalition's first budget in June 2010 set out a path for public spending that saw it rise from £669bn in 2009-10 to £757bn in 2015-16, an increase of 13%. Given the urgent need for fiscal consolidation, many commentators - including the TPA - thought that not nearly tough enough. However, it was justified on the basis that economic recovery would boost revenues and close the deficit, just as it had done after the recessions of the early 1980s and 1990s.

Unfortunately, that hasn't happened. Growth has been feeble, and the economy is now (2012-13) 4% smaller than it was forecast to be back in 2010. Worse, according to the OBR's latest forecasts, the shortfall is expected to go on getting bigger, reaching 7% in real terms, and 9% in cash terms, by 2015-16. Over the whole of this Parliament (2010-11 to 2015-16), the OBR now reckons the economy will grow by just 6%, compared to its June 2010 forecast of 14%.

Relative to our economy and its capacity to bear taxation, government overspending is even worse than it appeared in June 2010.

Spending still planned to increase

The following chart shows spending in cash terms (Total Managed Expenditure - TME) since the start of Labour's reckless spending surge. As we know, that surge more than doubled spending in cash terms and even in real terms increased it by one-half. From 2009-10, it compares three plans:

• Labour's final plan
• The Coalition's first plan - June 2010
• The Coalition's latest plan - March 2013 

Key points to note:

• All three plans incorporate a sharp slow-down in growth from the surge years, but there's not a huge difference between them. 
• Spending in 2013-14 is now planned to be £720bn - almost exactly in line with the £722bn "spending envelope" set out in June 2010. Which in the narrow terms of public spending control is pretty precise management, and much better than most previous governments have managed.
• However...

...because economic growth and revenue have both fallen well below what had been expected, as a percentage of GDP spending has turned out higher than planned, and revenue much lower. Spending is now running at 45% of GDP, a mere two percentage points lower than what the Coalition inherited back in 2010. Revenue will once again fall well short of spending, at 38% of GDP, leaving government borrowing an unsustainable 7%.

Spending already far too high

The following chart puts the budget spending and revenue forecasts into context, again showing the entire period from 2000-01 through to 2017-18. The gap between the two lines represents government borrowing.

Key points to note:

• Since the privatisation of Britain's big nationalised industries (which removed a large chunk of trading profits from public sector revenues), no government has managed to raise revenues of more than about 38% of GDP: that seems to be the limit on what is politically acceptable and economically sustainable. 
• The public spending envelope remains substantially oversized relative to sustainable revenue. 
• The projected convergence of spending and revenue over the next five years depends crucially on the OBR's growth forecast being realised. 

The OBR is forecasting average growth over the next five years of 2.1% pa. Given recent growth performance, the continuing problems in Europe, our broken banks, and high energy prices, that may well turn out to be optimistic. If so, the convergence of spending and revenue may not happen at all.

Return to the 70s? 

For example, if instead of 2.1% pa growth, we get a prolonged period of 0.5% pa 1970s style growth, the gap remains stuck at 7% of GDP*. All of which will have to be borrowed.

In its first three years the Coalition has already increased the official government debt (PSND) by well over £400bn. By 2017-18, even on the OBR's forecasts, their increase will be nearly £900bn - more than doubling the debt total they inherited. And the official debt is only one small part of the government's overall liabilities.

Debt piled on debt

According the Office for National Statistics, the government's overall liabilities amount to well over £7 trillion, equivalent to five times GDP. The following chart shows the main components:

Interest on the official national debt is currently running just under £50bn pa. The OBR now forecasts it will increase to over £70bn by 2017-18. 

However, all of the government's liabilities require servicing, and if we add in those public and state pensions payments, along with PFI payments, total debt servicing is already running at £170bn pa, and is set to increase to £220bn by 2017-18. 

That means that by 2017-18, over 30% of government revenues will be earmarked to service past liabilities rather than to pay for current services.

Public spending that doesn't add up

With an increasingly large chunk of public spending earmarked for debt servicing, and NHS, Schools, and Aid spending protected inside their preposterous ring-fence, only around one-third of the spending is available for cuts. Nobody has a clue how that can be done inside George's existing spending envelope, including George himself. 

If we don't get a big shot of growth soon, we are facing a massive spending crunch. Forget public sector pay and benefit freezes: we are talking Irish-style 15% across the board cuts for everything. 

*Note I have calculated the impact of lower growth on the public finances using the OBR's own ready reckoner. It's almost identical to the old Treasury rule of thumb blogged here, and it says that a one percentage point shortfall in GDP raises public sector borrowing by 0.7% of GDP after two years. That comprises 0.5 percentage points on the spending ratio, and 0.2 percentage points off the revenue ratio.