Whatever happened to Plan A?

In June 2010, just after the election and before the George Osborne’s ‘emergency’ Budget, government borrowing for this financial year (2014-15) was forecast to be £70 billion.

The chancellor’s plan was to reduce that 2014-15 borrowing figure to £37 billion and to eliminate the structural deficit (that’s the bit of the deficit which doesn’t go away after a recession) by May 2015 – just in time for the next election. ‘Jam Tomorrow’ was going to be the Tory offer at the election.

Four years on, and Osborne’s deficit-reduction plan is way off track. On current trends, government borrowing in 2014-15 will come in at around £100bn. The shortfall in the first five months of this financial year is actually higher than it was in the same period in 2013-14.

Clearly, this all leaves the Chancellor with a bit of serious explaining to do. On current trends, in the Autumn Statement, Osborne will either have to say that his plan is even further behind schedule or he will have to announce yet more spending cuts or tax increases to fill the fiscal gap.

Just before the 2015 General Election, that’s not exactly a great place for him to be in, and nowhere near where he had hoped to be. Of course, there may still be bumper tax receipts later in the fiscal year, notably in January when the self-assessment returns pile in, which could help Osborne hit his (heavily revised) targets for 2014-15.

There will certainly be a hefty New-Year tax take for Osborne, especially as more people have been caught in in self-assessment under this government. Nevertheless, even if there is a big tax-take in January, Osborne would still be way off-track compared to Plan A.

Remember that he said back in 2010 that the deficit would be down to £37bn 2014-15. Even with bumper New Year self-assessment returns piling in, the deficit will be at least double Osborne’s Plan A figure.

Why is this?

Firstly, over the life of this Parliament, Osborne hasn’t delivered enough growth. The UK economy may be in a sweet spot right now, but remember that it flat-lined over 2011 and 2012 (in part probably because of Osborne’s mis-guided austerity measures), and that lack of growth in turn damaged Osborne’s own deficit reduction plan.

Realising he was in a pickle, Osborne at least had the good sense to scrap his own targets and instead of unveiling yet more tax increases or spending cuts to stick to the original Plan A, he kept putting back the targets so that austerity now stretches well into the next parliament.

Secondly, the recovery has been good at creating jobs but not very well paid jobs, as the warning from the head of the Office for Budget Responsibility that income tax receipts will probably fall short of the government's target for 2014-15 indicates.

A combination of growth in low-paid jobs and a steady rise in the amount of income people can earn before paying income tax meant the shortfall was likely, said Robert Chote, OBR Chief, in comments to the BBC: “We've been getting fewer pence of revenue coming in for every pound of wages and salaries that's generated. From the perspective of the public finances that's not particularly good news."

What this suggests is that low paid workers are not earning enough to take them above the £10,000 threshold at which income tax starts to be levied.

One other relevant point made by the OBR back in August is that tougher financial ‘health checks’ on those applying for mortgages (as part of the Bank of England’s attempts to stop a house price boom) seem to have slowed down demand for mortgage loans, with some knock-on effect on the amount of money raised by the government through stamp duty.

So where does this leave Osborne’s Plan?

Firstly, let’s recognise that Plan A has been effectively scrapped, even if Osborne doesn’t admit it publicly. Deficit reduction will take two parliaments not one. Jam tomorrow seems a long way away.

Secondly, as economists know well, the deficit is very sensitive to the state of the economy. If there is no growth, then the deficit doesn’t come down very easily. Osborne should have been more sensitive to that in the first place.

Thirdly, growth on its own isn’t enough. Its distribution, matters. Having lots of people on zero-hour contracts and self-employed workers scratching around for a living doesn’t make for healthy state finances.

Overall, what this all reinforces is what many of us have been saying since 2010: a very sharp tightening of fiscal policy in the context of strong economic headwinds weighs heavily on growth, in turn actually making it harder for the government to meet its own fiscal targets.

And so it is turning out.

* Professor David Bailey works at the Aston Business School