The first cut

In May, the new coalition Government announced a £6.2 billion headline cut to public spending in the current year. Since £500 million is being recycled into additional spending or tax cuts, and the £704 million earmarked for devolved administrations does not have to be found until next year, the likely reduction in borrowing in 2010-11 is around £5 billion. This is less than a tenth of the fiscal repair job that Alistair Darling's March 2010 Budget forecast suggested will be needed over the next few years.

Of the £5 billion reduction in borrowing £4.8 billion is to come from reduced spending by central government on public services and their administration (Departmental Expenditure Limits, DELs). The rest is from cuts to the Child Trust Fund, offset by a small cut in business rates. This is a fall in these budgets of 1.2% relative to the level departments were told they could budget for under the previous Labour Government's plans. Labour had planned to cut these budgets by 0.5% after economy-wide inflation between 2009-10 and 2010-11: the 1.2% cut in plans for 2010-11 announced today increases this cut to 1.7%.

As promised, the new coalition Government is keeping to Labour's planned increases in spending in the NHS, MoD and overseas aid. In addition they have decided not to cut spending on schools, Sure Start and education for 16-19 year olds. Our calculations – largely based on spending figures made available from the Treasury – suggest that on average the areas of spending that have not been protected from cuts in May’s announcement will see their budgets fall by an extra 3.7%. This brings the total cut in these areas relative those planned for last year up from 4.7% to 8.2%. (An earlier version of this observation contained slightly different numbers as it was produced before any figures were made available from the Treasury).

The Table below shows our estimate of the cuts to each department as a share of the previous Labour Government's plans, and the change in budget compared to last year.

	% change relative to Labour's plans for 2010-11	% real change relative to spending in 2009-10
Total DEL	-1.2	-1.7
Total protected DEL	0.0	+1.7
Total unprotected DEL	-3.7	-8.2
Of which
Education (not schools, Sure Start and 16-19 education)	-6.0	-6.4
CLG Communities	-5.8	-27.4
Work and Pensions	-5.7	-5.6
Environment, Food and Rural Affairs	-5.6	-12.3
Transport	-5.1	-10.8
Culture, Media and Sport	-4.3	-5.4
Home Office	-3.5	-5.4
Justice	-3.4	-8.5
Cabinet Office	-3.3	-3.7
Chancellor's Departments	-3.1	-13.2
Business, Innovation and Skills	-2.9	-6.5
Energy and Climate Change	-2.7	-2.2
Law Officers' Departments	-2.6	-6.8
Foreign and Commonwealth Office	-2.5	-7.9
CLG Local Government	-1.5	-1.2

Note: Figures take account of increases in spending in the CLG Communities and the Business, Innovation and Skills departments. Chancellor's Departments ignores the cut to the Child Trust Fund.


Carl Emmerson and Robert Chote


Carl Emmerson is deputy director of the Institute for Fiscal Studies and programme director of their work on pensions, saving and public finances. He is an editor of the annual IFS Green Budget. His recent research includes analysis of the UK public finances and public spending, and also the effect of UK pension reform on inequality, retirement behaviour, labour market mobility and incentives to save. He is also a specialist advisor to the House of Commons Work and Pensions Select Committee.

Robert Chote has been Director of the Institute for Fiscal Studies since October 2002. Robert is also a member of the Finance Committee of the University of Cambridge and the Advisory Board of the UK Centre for the Measurement of Government Activity at the Office for National Statistics. He is a Governor of the National Institute for Economic and Social Research.

Pensions and retirement policy

This IFS election briefing note reviews the policies that the three main UK political parties have announced in their manifestos that relate to state pensions, private pension saving, public sector pensions, and employment at older ages.

Summary

• All three main UK parties have promised to increase the Basic State Pension (BSP) at least in line with earnings. The Liberal Democrats have said they would do this from April 2011, Labour from April 2012 and the Conservatives at some point in the next Parliament.
• Labour and the Liberal Democrats plan to start increasing the State Pension Age (SPA) to 66 for men and women from 2024. The Conservatives have said they might bring this forward to 2016 for men and 2020 for women. If implemented, this would adversely affect men born between 1951 and 1959 and women born between 1955 and 1959.
• All would restrict the tax relief received by some on their pension contributions. Labour and the Conservatives would do this for 300,000 individuals with incomes above £130,000, while the Liberal Democrats propose doing this for all 3.1 million higher rate taxpayers. It is unfair to restrict tax relief on pension contributions without similarly restricting the tax paid on pension income. Such policies introduce considerable complexity and compliance costs.
• The Conservatives and the Liberal Democrats have both pledged to get rid of the requirement to annuitise all private pension pots before the age of 75. This reform risks worsening the operation of the annuities market and higher prices for some. The current system does not actually force individuals to annuitise retirement savings, as they are free to save for retirement in non-pension products.
• The Conservatives and the Liberal Democrats have both said they would review the current pension arrangements for public sector workers. Public sector pensions are more generous on average than private sector ones, but this is not itself a justification for cuts. Any future review should consider whether the remuneration packages being offered provide the appropriate incentives to recruit and retain staff at the lowest cost to taxpayers. The Conservative proposal to cap public sector pensions at £50,000 a year would not be a sensible reform.
• All three parties want to remove employers' right to make individuals retire at age 65. Employment legislation should contain provisions for employers to be able to assess their employees' abilities to carry out their roles and terminate their employment if they cannot perform their duties even with reasonable adjustments. But allowing age as a proxy for physical and mental capability does not seem desirable.

This is the last IFS election briefing note in this series. A summary of all election briefing notes can be found here.



Carl Emmerson is deputy director of the Institute for Fiscal Studies and programme director of their work on pensions, saving and public finances. He is an editor of the annual IFS Green Budget. His recent research includes analysis of the UK public finances and public spending, and also the effect of UK pension reform on inequality, retirement behaviour, labour market mobility and incentives to save. He is also a specialist advisor to the House of Commons Work and Pensions Select Committee.

No new taxes?

The Conservative manifesto did not tell us anything about their tax and spending plans we did not already know. In particular, it was no more explicit about how much more ambitious the Conservatives would be than the Government in reducing the budget deficit over the medium term. The Conservatives promised only "to eliminate the bulk of the structural deficit over the Parliament", a vague goal that the Government would argue that it is on course to achieve already.

The best clue to the Conservatives' fiscal ambition is their earlier commitment to balance the structural current budget deficit (i.e. that part of Government borrowing which is neither used to fund investment nor is the result of the temporary weakness of the economy) by the end of the forecasting horizon. Unfortunately, they refuse to say yet what their forecasting horizon would be, but it seems reasonable to assume that it would remain five years as under Labour now.

A five-year horizon implies that in 2015-16 the Conservatives would need to deliver the spending cuts and tax increases of 4.1% of national income (£60 billion in today's terms) that Labour is already intending for that year, plus an additional 0.6% of national income (£9 billion). (Labour would make that additional tightening too (plus an extra 0.1% of national income or £1 billion), but not until the following year.) This acceleration of the tightening timetable would be consistent with David Cameron's comment at the manifesto launch that the Conservatives want to go further than Labour in dealing with the deficit, and not just start earlier.

The Conservatives have also signalled that they would prefer to see deficit reduction measures split 4:1 between spending cuts and tax increases, rather than the 2:1 split implied by the Government's plans. If they aim for the same overall tightening of 4.8% of national income or £70 billion in today's terms as the Government, then a 4:1 split would imply an eventual spending cut of around 3.8% of national income (£56 billion) and a tax increase of around 1.0% of national income (£14 billion). If the Government was to stick with a 2:1 ratio throughout its planned tightening, it would be looking for eventual spending cuts of 3.2% of national income (£47 billion) and tax increases of 1.6% of national income (£23 billion).

The tax increases that the Government has already announced will deliver about 1.2% of national income (£17 billion) in the medium term, suggesting that they might need to announce further tax increases worth around 0.4% of national income (£6 billion). Of the 3.2% of national income spending cut (£47 billion) they need, their plans to 'protect' (but shrink as a share of national income) non-investment spending on the NHS and part of the education budget, offset by a rise in the share of national income spent on overseas aid, would get them only a small part of the way there. We would have to wait for a Labour Spending Review to see where much of the rest fell.

Under their desired 4:1 ratio, the Conservatives would need a tax increase of 1% of national income, smaller than the 1.2% of national income that the Government has already announced. But their National Insurance cut, marriage tax break and freezing of council tax in England (minus the proceeds of their bank bonus tax) would more than exhaust this cushion and so the Conservatives too would likely need to announce further tax raising measures to get the job done. We will address this issue more definitively when we compare the deficit reduction plans of all three parties in a few days' time.

All these calculations are based on the Treasury's latest forecasts in the Budget. And, of course, there are huge uncertainties surrounding them, especially over a period of five or six years. The necessary fiscal repair job could yet turn out be much larger or smaller than we now think.

Given the current forecasts, let alone the uncertainties surrounding them, the Conservatives were wise not to make a "read my lips, no new taxes" pledge in their manifesto. William Hague only went so far yesterday as to say: "We are not looking for tax rises", which does not rule anything out. The Conservatives also eschewed Labour's manifesto promise not to increase income tax rates or extend VAT, a pledge that leaves the door open to many other tax increases - just as similar pledges in Labour's last three manifestos left the door open to the substantial tax increases they have implemented since 1997.

Of course, the Conservatives are left having to identify an even bigger spending cut overall than Labour in the next Spending Review and beyond. And, like Labour, they have only identified where a small proportion of the cuts will come from.

An obvious question is whether it is really realistic to expect spending cuts to bear as much of the burden of the fiscal tightening as the Conservatives intend, given the likely consequences for public services and the generosity of the welfare system. Bear in mind that the ratio of discretionary spending cuts to tax increases in the last big fiscal tightening undertaken by a Conservative government, under Norman Lamont and Kenneth Clarke in the early 1990s, looks to us to have been around 1:1.

Whoever forms the next Government, it is hard to escape the conclusion that there are likely to be more tax increases to come.


Carl Emmerson is deputy director of the Institute for Fiscal Studies and programme director of their work on pensions, saving and public finances. He is an editor of the annual IFS Green Budget. His recent research includes analysis of the UK public finances and public spending, and also the effect of UK pension reform on inequality, retirement behaviour, labour market mobility and incentives to save. He is also a specialist advisor to the House of Commons Work and Pensions Select Committee.

Taxes and elections: are they by any chance related?

Prior to the 2010 Budget, Chancellor Alistair Darling warned us not to expect a giveaway, while his Chief Secretary to the Treasury, Liam Byrne, reassured us that the Government could halve the deficit by 2013-14 without announcing any further tax increases. If both statements are read as correct – no pre-election tax giveaway and no new post-election tax takeaway – then this would break the pattern of the last four general elections.

The figure below shows the net long-run fiscal impact of tax measures announced in each Budget and Pre-Budget Report (PBR) since spring 1985. The shaded areas denote different Parliaments.

The clearest example of pre-election tax cuts followed by post-election tax rises was around the April 1992 general election. In the pre-election Spring 1992 Budget, the Conservative Government announced net tax cuts worth £5½ billion a year in today's terms. The then Chancellor Norman Lamont has conceded that this was "not a very good budget. But it did help us to win the 1992 election". In contrast, the Spring 1993 Budget delivered a net tax rise of £23 billion a year. Lord Lamont described this as having "helped to lose the 1997 election for the Conservatives, but it was definitely my best budget". The November 1993 Budget – delivered by the now Shadow Business Secretary Ken Clarke – delivered a further £16 billion of tax raising measures.

Under Labour the pre-election Budget of Spring 2001 did contain a net tax cut, but the pre-election Budget of Spring 2005 did not. This difference reflects the apparent strength of the public finances at the time: in 2001 a pre-election giveaway appeared consistent with then Chancellor Gordon Brown's fiscal rules, whereas by 2005 the strength of the public finances had deteriorated and a breach of those rules seemed increasingly likely. Given the current far worse state of the public finances, a significant permanent pre-election giveaway would be tantamount to poking gilt investors with a sharp stick. And voters might well think it too good to be true.

That suspicion would certainly be justified by the experience of recent post-election tax decisions. Like the Conservatives after 1992, Labour has tended to announce relatively big net tax increases in the months following its general election victories. This can be seen in the Budgets of July 1997, March 1998, April 2002 and the PBR of 2005. We have also seen relatively large tax increases announced since the outbreak of the recent financial crisis (PBR 2008, Budget 2009 and PBR 2009). But with the exception of the increases in income tax from April 2010, which will only directly affect one adult in 50 (those fortunate enough to have an income above £100,000 a year), most of the pain will not be felt until after the 2010 general election. For example the forthcoming 1ppt rise in all rates of National Insurance Contributions is not scheduled to come into force until April 2011.

It is possible that we won't see further net tax rises after the 2010 general election. But recent history suggests we will. And so too does the need to reduce the deficit from its current post second World War high without eye-watering cuts in many areas of public spending. Whatever Mr Byrne may say now, most likely we will see a Chancellor – or Chancellors – announcing fresh net tax increases in 2010 and 2011, once the forthcoming general election is safely out of the way.


Figure. Net estimated long-run fiscal impact of tax changes by statement since Spring 1985.




Carl Emmerson is deputy director of the Institute for Fiscal Studies and programme director of their work on pensions, saving and public finances. He is an editor of the annual IFS Green Budget. His recent research includes analysis of the UK public finances and public spending, and also the effect of UK pension reform on inequality, retirement behaviour, labour market mobility and incentives to save. He is also a specialist advisor to the House of Commons Work and Pensions Select Committee.