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It could have been much worse
Samuel Brittan: Financial Times 09/11/00

Oh what a tangled web we weave, when first we practise to deceive - Walter Scott

When a British government is under intense populist pressure to undertake irrational and imprudent policies, when an election is looming and its popularity is only just recovering from an unexpected dive, one does not expect huge enlightenment from any package of fiscal measures. The test on such occasions is: how much harm has been done?

The government has given in to the petrol duty protesters more than it should have done. But for all the hype, the freeze on petrol duties, even with the associated so-called green measures thrown in, costs about £600m a year, half the cost of the 3p a litre cut in duty demanded by the Tories. This excludes consultative measures that can still be stopped.

One aspect of a medium-term financial strategy is that individual packages will not contain anything particularly startling in macro terms. The chancellor’s package is worth £2.6bn in the next fiscal year and almost £4bn in 2002-03. His borrowing projections are almost the same as those in his last Budget. What he has not done is to use the unexpected strength of the public finances to lock in a faster rate of debt repayment. If you take seriously the Treasury’s own estimates of the amount by which output is above capacity and the trend rate of growth, output is rising at a rate that threatens overheating and there should have been no package at all, or one that on balance took something out of the economy. But if you believe that all these “gap” estimates are highly dubious and that fiscal policy as a sensitive economic regulator is a dead duck, the chan-cellor’s measures remain prudent.

Unfortunately, however, we cannot get away from the low politics of petrol. When world oil supplies are in-secure, it makes sense to discourage consumption. Of course, a coherent environmental policy would encompass a much wider range of measures, including taxes on other pollutants and congestion charges on the roads, not to speak of taxes on domestic consumption.

Indeed, the root of the government’s troubles came with Labour’s opportunist pledge - alas fulfilled - to reverse the Tory imposition of VAT on domestic fuel. It then became difficult tojustify the remaining energy taxes on environmental grounds. This government is quite good at playing with short-term gimmicks, such as pensioners’ heating allowances. But, far from being a past master of spin doctoring, it is bad at putting over its basic strategy.

Similar remarks apply to the moves on pensions. When attacked last year for its supposedly mean decision to raise the basic pension by only 75p, the government could have presented it as a triumph for its low inflation policy. The belief that every benefit must increase every year is a hangover from times of high inflation.

David Willetts, the opposition social security spokesman, has a good case for wanting to consolidate the many specific and trivial pensioners’ benefits into an overall package. The fact remains that by far the best way in which pensioners can benefit from national prosperity is by a minimum income guarantee, which can indeed be indexed against earnings as Mr Brown proposed. He resisted the clamour to restore the link between the basic pension and earnings, which would have meant less for the poorest pensioners. The government’s spending plans, both current and capital, amount to an average increase of 3½ per cent a year in managed expenditure in real terms, with the lion’s share coming in the first year, 2001-02. This is of course higher than any of the Treasury’s growth estimates of 2½ per cent for the whole economy. The difference between these two figures seems to be accounted for by items such as a smaller rate of increase in national debt interest arising from lower inflation and debt repayment, the sale of mobile telephone licences and other non-tax revenue.

But these savings cannot go on for ever. National debt interest cannot fall year after year. A key question is whether the relatively high planned rate of increase in government spending over the next three years is a temporary catch-up after years of austerity, or if it is the beginning of a new trend that will take the tax and spending ratios to new highs reminiscent of Old Labour. The answer depends on what will happen after 2003-04, about which your guess is as good as mine - or Tony Blair’s or Gordon Brown’s.

We are left with the honestly meant “prudence” of the government’s fiscal estimates. Although the 1988 Tory Budget has been criticised with hindsight for being a reckless giveaway, according to estimates at the time by the Organisation for Economic Co-operation and Development, UK fiscal policy was strongly tightened that year even on an adjusted basis. According to other respected estimates by Goldman Sachs, the tightening was even greater.

The moral is that however prudent governments try to be, they are always in danger of underestimating the influence of the business cycle and other random events and shocks on the budget balance in both directions. Plan for the medium term but be prepared for shocks that go way beyond the Treasury’s “cautious” alternative growth rates.