CLARKE’S CONJURING TRICK

New Statesman & Society, 5 December 1993


Is Kenneth Clarke really so clever? Paul Anderson examines the tax-and-cut budget and assesses its likely impact on Britain’s economic prospects
It is easy to see why Kenneth Clarke’s Tory colleagues and the markets hailed him as a magician after he delivered Britain’s first unified budget on Tuesday.
Somehow or other, Clarke managed to pro­duce a package of measures to attack the public sector borrowing requirement, raising taxes and cutting public spending – and yet he did it apparently without either hitting the most sensitive parts of the welfare state or increasing the most noticeable taxes.
On tax, Clarke confirmed the imposition of VAT on fuel, announced by Norman Lament in March, and cut the tax relief on mortgage interest payments even more than Lamont planned (which will bring in an extra £1 bil­lion a year by 1996-97). He put up duties on petrol and cigarettes (worth a total of £2.4 billion a year by 1996-97), promised to raise another £2 billion over three years by clamping down on loopholes (just as shadow chancellor Gordon Brown had been suggest­ing) and introduced new taxes on air travel and on insurance policies (worth another £1 billion a year from 1995-96). And he brought in changes in income tax that will yield just under £2 billion in 1996-97.
But the Chancellor softened the blow of VAT on fuel by announcing a compensation package for pensioners and others on benefits – an inadequate one, perhaps, as the poverty lobby and environmentalists were quick to point out, but enough to take at least some of the sting out of criticism of Lament’s original plan.
In similar vein, the reduction in tax relief on mortgage interest (very much in line with Labour thinking, as it happens) will cause little pain at a time when interest rates are as low as they are today; while the increased petrol and tobacco taxes (also very much part of Labour’s approach to taxation) can be jus­tified on green and health grounds respec­tively. Clarke’s new taxes on air travel and insurance are very cleverly levied on items of once-a-year consumer expenditure (who can remember what last year’s holiday cost?).
More important, the income tax hike was done not by increasing rates but by freezing allowances and thresholds, allowing inflation to increase the revenue, a trick learned from Lamont. And, most important of all, Clarke did not extend the base of VAT as almost everyone had expected. Much as the opposi­tion parties fulminate about Clarke’s swin­geing tax increases, there is widespread recognition among their members that it could have been an awful lot worse – and that many of Clarke’s proposals are very similar to the ones that they would have had to put forward if they were in government.
The story is much the same with the bud­get’s spending cuts. The cuts are there all right: in real terms, the “control total” of non-cyclical government spending is set to fall by more than 1 per cent from 1993-94 to 1994-95, with next year’s levels reached again only in 1996-97.
Public-sector pay is to be frozen, and there will be major cuts in social security entitle­ments as, first, sickness and invalidity benefits are merged into a new incapacity benefit, and then income support and unem­ployment benefit become job seekers’ allow­ance. Defence spending will be cut by more than 10 per cent in real terms by 1996-97, taking it to below 3 per cent of gross domestic product for the first time since 1945; there will be a further move away from student grants to loans; transport spending will be slashed.
But once again the pain is not quite what was expected. The biggest cut is in the con­tingency reserve – down £4 billion on pre­vious projections in the next financial year and only a little less in 1994-95 and 1995-96. In real terms, local authority and health spending are shown unchanged – and educa­tion gets a 5 per cent increase, while the social security budget increases by 2 per cent. Pen­sions, unemployment benefit, income sup­port and child benefit will continue to be inflation-proofed. Clarke even found the cash to introduce a childcare allowance for low-paid working single mothers and to bring in a high-interest savings bond for pensioners.
The upshot is that most of the public spend­ing element of the budget will almost cer­tainly prove difficult for the opposition to attack with conviction. Apart from what ap­pear to be draconian changes in invalidity and unemployment benefits – on which much detail is still missing – there is little for Clarke’s opponents to get their teeth into. No one outside the military and the Tory right really believes that defence spending should not be slashed, and Clarke has easy populist arguments for public-sector efficiency to answer the unions’ howls of protest on pub­lic-sector pay. On student loans, his point during the budget speech that bus-drivers should not be made to subsidise the education of future lawyers is a taste of things to come. Already, the main refrain of opposition pol­iticians on the spending plans is that more should have been ploughed into education and training and infrastructural projects –  hardly the stuff to set the voters’ pulses racing.
Enough, though, of the political cunning of the budget: will it actually work? Clarke said that its purpose was to put public finances in order once and for all, and the key projection in the Red Book that outlines the effects of the budget is the one showing public-sector borrowing steadily falling to zero by 1997-98 (conveniently enough allowing Britain to meet the convergence criteria on public bor­rowing laid down in the sections of the Maas­tricht treaty on European monetary union).
The credibility of this PSBR projection de­pends on what happens to growth: tax revenue will be inadequate to cut into PSBR if growth is low, while social security spend­ing will be difficult to keep under control. The assumption behind Clarke’s figures is that the British economy achieves a sustained growth rateof3.5 per cent from 1995 until the end of the century. But such growth rates are, to say the least, highly unlikely, not least because Europe, Britain’s largest export market, is deep in recession and unlikely to revive for a couple of years. With more realistic assump­tions of growth at 2.5 per cent, as the Red Book itself admits, the possibilities of reduc­ing the PSBR to zero fade away.
“What the Chancellor needed in this budget was to convince the markets that he had a credible path towards the reduction of the PSBR to zero,” says Meghnad Desai, profes­sor of economics at the London School of Economics and a former member of the La­bour front bench Treasury team in the House of Lords. “He has done it quite cleverly. He has disguised the tax increases needed to get the PSBR down, he has made optimistic pro­jections on growth, and he has looted the reserves to balance the books. Clarke has hidden the problems that will come to the fore, he hopes, only after the next election. Watch out for a rush to the polls in 1995 or early 1996!”
Nevertheless, to judge from the reaction of the markets, the scam seems to have worked in the short term at least. The consensus is now that the way is open for the further reductions in interest rates necessary for recovery.
Whether they will be enough on their own is, however, a moot point among left econo­mists. On one hand, there is the traditional Keynesian argument that the problem with the budget is that its mix of spending cuts and tax increases will dampen the overall level of demand in the economy to such an extent that the recovery will inevitably be stillborn.
According to Bryan Gould, writing in New Statesman and Society last week, the PSBR is simply the product of the recession and no particular cause for concern. In similar vein, Jonathan Michie, a fellow of Robinson Col­lege, Cambridge, and the author of several books arguing for a revival of a version of the Alternative Economic Strategy that formed the basis for Labour policy in the 1970s and early 1980s, says: “Cutting expenditure and increasing taxes is the opposite of what is needed to bring the country out of recession. The major worry now is what happens if it does all go wrong. If it does, the running down of the contingency reserves means that the cuts will be even more savage than those already announced.”
On the other hand, there is widespread sup­port for the idea that the central focus of the government’s economic policy efforts should be a programme for European recovery  –  which was not mentioned by Clarke in his speech. Stuart Holland, one of the architects of the AES in the 1970s who has recently been advising Jacques Delors on his European re­covery programme, argues that Clarke simply missed the point.
“No national recovery is feasible if Europe stays in recession,” he says. “In today’s inter­nationalised economy, macro-economic pol­icy has to be internationalised. For us, that means that macro-policy has to be European. The only way out is to increase the macro-economic instruments of the European Union, such as the European Investment Fund. The political space is opening up in Europe for European macro-economic policy instruments.”
The government’s hope is that exports to the US and to booming economies in the developing world – China, Indonesia, the Phillipines,  Mexico – will more than com­pensate for the sluggishness of the European economy until such time as lower German interest rates have laid the basis for European recovery without recourse to an expensive full-blown European recovery programme. It is a big gamble – but it might, just might, come off.
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