Fix the roof when the sun is shining...unless there are elections!

Michael Hatcher, University of Southampton

Alessandro Mennuni, University of Southampton

Chancellor George Osborne. Source: Financial Times.

In 2014 GDP growth in the UK was 2.6%, the highest among the G7 countries. GDP growth is expected to reach 3% in 2015 (IFS Green Budget). However, lower than expected growth between 2010 and 2014 has led to a higher than planned budget deficit. What is the right stance for fiscal policy in these circumstances, and how does this Budget - the Chancellor's fifth - stack up?

There is consensus amongst economists that fiscal policy should be countercyclical, stimulating the economy during recessions, but financing the borrowing through higher taxes or lower spending during booms. In this way, governments can keep public debt under control, thereby avoiding higher future taxes. Current events in the south of Europe are a vivid reminder of the need for fiscal discipline when the sun shines to avoid extreme economic pain in the bad times. The case for fiscal consolidation is all the stronger given the inevitable future increases in NHS and state pension spending that will be necessary to support an ageing population. Indeed, independent estimates put the UK's ‘fiscal imbalance’ at 510% of GDP -- much higher than other leading nations within Europe.

Given the positive economic outlook, countercyclical policy calls for a fiscal consolidation during the next year. But that is not what this Budget is about, with numerous tax cuts (such as the increase in the personal allowance to £11,000; decreases in duty on beer and spirits; tax breaks for North Sea operators; and a cut in corporation tax) and spending increases in several areas. All this is financed mostly by lower welfare benefits due to the lower unemployment rate and by higher tax revenues from rising income levels. In our view, this is a missed opportunity to save for future investments in infrastructure, education, healthcare, pensions, and bringing down government debt to lower future taxes. Contrary to his promises, Mr. Osborne is not `fixing the roof when the sun is shining’.

Of course, at times of elections governments are under immense pressure to please the electorate. And historically the way to do this is to give short-lived gifts to the public, but leave them no better off later on. Either people do not care about their future selves, or they do not understand the benefits of a fiscal policy with a time horizon longer than a few quarters. Whatever the reason, as long as this is how people vote, governments are bound to play this electoral cycle; those virtuous governments that resisted this temptation would probably not be elected, inducing a Darwinian extinction of such virtuous governments.

With the pending election, it is not surprising that Mr. Osborne has postponed countercyclical fiscal policy until a later date; indeed the Chancellor plans savings of £30 billion from the period after the General Election up until 2017-18. The challenge will be to sell this Budget as part of the government's long-term economic plan to balance the books.

Meanwhile, the Opposition can argue that the government has failed to reach its targets for fiscal consolidation despite improving economic conditions. But the tricky part for the Labour Party is to do this while promoting policies which increase spending and thus fail to address the UK’s long-term fiscal challenges. It will be interesting to follow the policy debate in the coming months. With attentive voters, they would all be walking on eggshells.

Michael Hatcher, University of Southampton

Alessandro Mennuni, University of Southampton