What should Cameron cut?

The projections in last month’s Budget were terrifying. They suggest that net government borrowing is likely to reach unprecedented levels over the next three years: 

2009-10: £168 bn = 12.4% GDP
2010-11: £173 bn = 11.9% GDP
2011-12: £149 bn = 9.1% GDP

But even these forecasts may be too optimistic. They are based on GDP growth of -3.75% in 2009, +1% in 2010, and +3.25% in 2011.

But if the recession is deeper and longer than expected – say growth of -4.5% in 2009, -1% in 2010 and zero in 2011 – the deficit is likely to be closer to £200 billion for each of the next three years, equivalent to about 15% of GDP. Even when the recession ends, though, the structural budget deficit is still at alarming levels. This would mean almost one in three pounds spent by the government would be borrowed.

Clearly such high deficits are unsustainable and need to be addressed urgently if a funding crisis is to be avoided. Yet raising taxes above already historically high levels is likely to be counterproductive. It will yield little extra revenue in the medium term. A substantial cut in public spending will therefore be the only serious option available to the next government.

If the Conservatives win the next election, David Cameron will be forced to deal with this problem. And tackling the low-hanging fruit – cancelling ID cards, NHS computer schemes and Crossrail, for example – while worthwhile, will not be adequate when around £150 billion of annual spending reductions may be required.

It will be necessary to curtail the major areas of government spending: welfare, health and education. Indeed, emergency cuts, or at least freezes, in welfare benefits and public sector pay may be in order – the kind of measures seen recently in struggling central European countries. Indeed, we should start this year – welfare benefits, pensions and public sector pay should not rise by more than private sector pay rises. If public sector pay cannot be reined in this year it will never be reined in. If welfare benefits are not pegged to wage increases then employment incentives will be diminished.  

However, the crisis also presents opportunities for Cameron to launch positive longer-term reforms that reduce the scope of government. He could start by tackling public sector pensions (a liability of  over £1 trillion), move on to welfare reform and then health and education, promoting competition and efficiency through individual savings accounts and voucher-type schemes while getting rid of the costly bureaucrats.

How could this be done in practice? A voucher scheme could involve a voucher of a fixed money value being given for the first five years of the scheme. Its value in real terms – and certainly relative to national income – would then fall. This could be politically acceptable as it would happen at the same time as huge efficiency savings were achieved.

And let’s not forget regulation. Removing red tape – for example, the new gender pay audits  – would reduce the government payroll while lowering costs for businesses.

8 May 2009, IEA Blog

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