How Osborne will cut the deficit

by Ed Bowsher on 08 June 2010  |  17 comments
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George Osborne's emergency budget is two weeks away. Here are a few predictions on how he will cut the deficit.

George Osborne’s emergency budget is due to be announced on June 22nd.  I’m not convinced that now is the time for major spending cuts but it’s obvious that the Chancellor sees things differently. He looks set to announce further cuts and probably some tax rises too. So where will Osborne find the cash?

Numbers

The Chancellor will probably announce his spending plans for 2011-12 and 2012-13. Last year’s deficit was £156 billion and the Chancellor has said he wants to halve that figure over the next three years. So I reckon he could announce a £15 billion spending cut for 2011/12 followed by at least a further £30 billion in 2012/3. Then perhaps a further £15 billion before 2015.

We won’t learn where all of the cuts will fall in the budget itself. That’s because Osborne will say that he’s waiting for the results of the Comprehensive Spending Review in the autumn. However, we may hear a few clues as to where the axe will fall. On top of that, we’ll almost certainly hear about some tax rises.

Cuts

Public sector headcount is an obvious area for cutbacks, especially in education. According to think tank, Reform, staff costs make up 68% of the education budget. Staff numbers have risen by nearly a quarter since 1999 while the number of teaching assistants has soared by 200%!

Staff numbers haven’t just risen in education. The public sector as a whole now employs 6.1 million people, up from 5.2 million in 1999. Osborne has already announced a freeze on civil service recruitment for this year, but that’s probably just the beginning. Compulsory redundancies will happen sooner or later.

If I were a Chancellor looking for cutbacks, I’d focus on child benefit. If child benefit was only paid to poorer mothers we could save something like £7 billion. Yes, the downside of mean testing is that some poorer people won’t claim. But £7 billion is a chunky sum and leading Liberal Democrat, Vince Cable, has called for this measure in the past. In other words, it’s a potential cut that the Liberal Democrats would find hard to oppose.

Tax

So what about tax?  I think the most likely risers are Capital Gains Tax (CGT) and VAT.

The Coalition agreement said that CGT would rise closer to the levels of Income Tax, but the right wing of the Tory party is on revolt on this. I suspect that Capital Gains Tax will rise to 40% but it will be accompanied by some form of taper relief. In other words, if you’ve held the asset for more than, say, five years, you’ll pay a lower rate of CGT. Reform says that a rise to 40% plus a cut in the annual allowance to £2000 would raise £4.1 billion. However, taper relief will reduce the size of that revenue gain.

There’s also been a lot of speculation about a VAT increase. I reckon that Osborne will want to announce as much bad news as possible now so that he can blame things on the previous government. So VAT will probably rise to 20% and that could raise something like £13 billion. It’s possible that Osborne will say that the rise won’t take effect until April 2011 or 12.

We could also see more changes to tax relief on pension savings. As things stand, people earning more than £150,000 will get reduced relief from next April. Osborne may decide to move that threshold down - perhaps to £100,000.

On a happier note, the Chancellor will probably tell us more about plans to increase the personal allowance for income tax. The Liberal Democrats hope to increase the allowance from the current level of £6,475 to £10,000. Osborne will probably announce a much smaller increase and talk about his aspiration to go further in future years.

Sadly we’re all going to be affected by the cuts and/or tax rises. In my final budget-related blog I’m going to see if there is anything we can do to lessen the pain.