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PM has left himself with no choice but to spend
Robert Chote, Director, Institute for Fiscal Studies28 Oct 2008
James Callaghan, near the start of his prime ministerial term in 1976, famously told the Labour Party: "We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists." We will soon discover if Gordon Brown agrees.
The recession will certainly see tax receipts fall and government spending rise as shares of national income. There will be less earnings, spending and profits for the Exchequer to tax, while the Government will have to pay more in social security benefits as unemployment rises. So the Government will have to borrow more and accumulate more debt.
Unfortunately, seven years of over-optimistic Budget forecasts have left the Government almost no room to take on extra debt without breaching Mr Brown's famous fiscal rules. But it makes much more sense to allow borrowing to rise and to breach the rules in the short-term than to increase taxes and cut public spending plans now. This would take spending power out of an already weakening economy.
Most economists agree that the automatic rise in borrowing as the economy weakens should be accommodated. More controversial is whether the Government should announce additional tax and spending measures to give a further temporary boost to the economy. For example, Mr Brown hinted yesterday that the Government may bring forward public sector investment projects from future years.
One argument for doing so is that relying entirely on the Bank of England to stimulate the economy through interest rate cuts may be complacent if banks are less willing and able than normal to pass them on to consumers and businesses.
On the other hand, it is worth remembering why using public spending and tax changes to stabilise the economy went out of fashion in the first place. One problem is that capital spending projects take time to get up and running. Labour planned to increase public investment when it first took office, but found that it took much longer than expected.
Tax cuts and benefit increases are more flexible but it would still be a challenge to ensure they were timely, temporary and targeted. As former chancellor Nigel Lawson once observed, efforts to stabilise the economy often fall into one of two categories: too much too late or too little too late.
However actively Mr Brown uses fiscal policy in the short term, he or his successor will need to use it actively once the economy has stabilised. We are likely to be left with an unsustainable structural budget deficit, which will require a combination of big tax-raising measures and cuts in public spending as a share of national income to reduce. The bigger the giveaway in the short term, the bigger the takeaway to follow.
Reader views (1)
The UK must learn how to become self-supporting agriculturally and commercially, and stop subsidising the European pipe dream and 3rd World indebtedness. Furthermore there are a number of very critical projects which could be dealt with by a Government workforce such as the strengthening of our coastal defences and the many inland areas where the population is because of climate change under threat from annual flooding.
- Robert El-Cid,, Hull, East Yorks.,, 28/10/2008 16:38
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