UK government urged to delay some spending cuts

George Osborne - Chancellor of the Exchequer

The government should delay some spending cuts planned for this year because of a weak economy, and balance future fiscal consolidation more towards tax rises, a leading economic think tank said on Tuesday.

The assessment by the non-partisan National Institute for Economic and Social Research comes as the coalition prepares its 2011/12 budget, and is likely to further inflame the political debate about spending cuts.

The Conservatives and their Liberal Democrat partners have insisted that the pace of fiscal consolidation and its focus on spending cuts rather than tax rises are essential to restore financial market confidence in government debt.

But NIESR said financial markets would tolerate a slower pace of deficit reduction in the short run, and that tax rises were just as credible a way to do this as spending cuts, making the latter a political rather than an economic choice.

“The reason why there is a bias towards a spending-based consolidation in the UK … is not because it’s optimal in some sense, but because some politicians have a desire for a smaller state,” NIESR’s acting director Ray Barrell told reporters.

“There is no real evidence recently that spending-based consolidations are more effective than tax-based consolidations, at least in advanced European economies,” he added.

The budget deficit was 11 percent of GDP in the 2009/10 fiscal year, the largest of any economy in the G20 group of advanced economies, and the coalition aims to reduce that to 1 percent by 2015/16.

Labour proposes a slower pace of cuts and says the coalition programme masks a long-standing Conservative aim to reduce the size of the state.

NIESR said the major tax rise brought in by the coalition, an increase in the rate of value-added tax on most goods and services, worsened Britain’s inflation problem and hurt growth more than raising the equivalent sum from direct taxation.

“A differently structured fiscal package would raise growth now, and as long as the fiscal consolidation is in place, should raise no long-run costs,” Barrell said.


Barrell’s comments came when he presented NIESR’s quarterly economic review, which included a marked downgrade to its growth forecast for 2011 to 1.5 percent from November’s 1.8 percent.

This fall is largely due to the 20 percent rise in oil prices over the past three months, and is well below the 2.1 percent growth rate assumed by the government’s independent forecasting unit in late November.

The fourth quarter’s unexpected 0.5 percent drop in output would be largely compensated by a strong rebound in the first quarter of 2011 which would then peter out, NIESR added.

NIESR said it expected inflation to average 3.8 percent over 2011 due to the increase in oil prices and VAT, and said a major reason for the government to defer spending cuts was to give the Bank of England more scope to raise interest rates.

“The current policy mix perhaps has fiscal policy too tight in the short term and monetary policy too loose,” NIESR said in its economic review.

Barrell said central bank action to keep inflation expectations in check after rises in oil prices was essential to stop a longer-term rise in inflation above the Bank’s 2 percent target level.

Bank rates have been at a record low of 0.5 percent since March 2009, and in January former NIESR director Martin Weale joined long-standing Bank hawk Andrew Sentance in a minority vote for an immediate rise in rates to 0.75 percent.

NIESR forecast that unemployment would rise further in 2011, peaking at 8.8 percent of the workforce in the third quarter. Due to lasting damage from the financial crisis, it was unlikely to fall below 6 percent in the long run compared to an underlying rate of 5 percent beforehand.

Real disposable income would also fall to a five-year low by the end of 2011 due to limited wage increases, higher taxes and inflation — the sharpest decline since 1975-79.

“As far as households are concerned, this is going to be a particularly tough year,” NIESR researcher Simon Kirby said.

Source: Reuters

Leave A Reply

Your email address will not be published.