Economics: Budget that tackles the core problems

THE MOTIVE for unifying the Government's public spending and tax decisions in a single Budget each year was to let the Cabinet realise the full tax implications of its spending decisions. This was to be another giant stride towards enlightened and open government. Spending ministers would no longer measure their prowess by the increase in their budget, but by the collective good. Rational choices would prevail.

The truth is more murky. The Treasury's success in the public spending round - and it is an enormous success, in Treasury terms, to squeeze pounds 3.5bn from planned levels - was due not to open discussion but to old-fashioned subterfuge. Several spending ministers had no inkling of the extent to which Michael Portillo, the Chief Secretary, was undershooting his plans.

The underhand manner in which the Chancellor and his deputy manoeuvred their colleagues into a tight settlement has been seized on by some City people to suggest that the tough spending targets will not be met. Spending ministers will not be rolled over again. I suspect, though, that the Treasury team will come up with new skulduggery to keep their plans on course.

The real secret of the Treasury's success lies in the standing of the Chancellor and his deputy. Not only are they considerable political figures in their own right, but they are also the respective leaders of the left and right wings of their party. I can think of no previous period when the Treasury packed so much political clout.

Mr Portillo also has the technical means to help him hit his targets. The presumption among spending ministers is that they must meet overshoots from within their budget, and they now have greater flexibility to use tendering and contracting out to improve efficiency and avoid having to raid the contingency reserve.

The change in the system of decision-making has clearly helped. Under the old system, ministers had an incentive to wait until the last moment before settling with the Chief Secretary. They could always go to the star chamber to appeal.

During this round, the clear understanding that any increase in one programme would be met at the expense of another - the so- called top-down rule - meant that spending ministers would often accept an early offer from the EDX (spending) Cabinet committee rather than risk a clash with other spending colleagues for a share of a shrinking pot.

The system is not, of course, perfect. As usual, Whitehall has pushed some spending cuts as far away from those taking the decision as it can. The grant to local councils suffered particularly badly, and this will lead to sharp rises in council tax. The Treasury has also been legged over by the Ministry of Defence, whose extra cuts are so small that Malcolm Rifkind is confident he can meet them from cutting administrators rather than rearranging the armed forces.

Mr Rifkind actually announced an order for another 259 Challenger II tanks the day after the Budget. This is potty. We are in a world where we need more mobile armed forces to tackle situations such as Bosnia or Somalia. The maximum deployment of tank forces by Britain outside the Nato area in the post-war period was the three regiments sent to the Gulf, but we are still planning to have eight - a force more suitable for use in Germany against an adversary that has vanished.

The Treasury's abject surrender is revealed most starkly by the fact that the Ministry of Defence is the only big spending department that will not have to suffer the inconvenience of a 'fundamental review' - the exercise that looks at objectives as well as means of attaining them. This is on the spurious grounds that Options for Change was a recent review, even though it was completed in 1990 before the collapse of the Soviet empire, the scission of its armed forces, and the application of eastern European states to join Nato.

We are, though, likely to go on spending far more of our national income on defence than Germany or France. The Government is evidently too weak to carry defence cuts through the House of Commons, and Michael Portillo does not want to tarnish his right-wing credentials by restructuring a declining industry that happens to be a sacred cow of his own supporters. Nor will he be lambasted by the official Opposition, which was so discredited by its desire to slash defence when we really did need our armed forces in the 1980s that it is now petrified of arguing the case for cuts even though circumstances have changed.

Looking at the overall spending picture, my hunch is that the Government may even undershoot its plans. This is partly because Mr Portillo has made no allowance for the success of 'fundamental reviews' in reshaping programmes, and partly because the Government's inflation assumptions look high, particularly for next year. If I am right, the Government's medium-term re-election strategy is in place. We are heading for tax cuts before a 1996 or 1997 election.

True, this does not look much like a medium-term, tax-cutting strategy. It is more like the progress of the grand old Duke of York, who marched his troops to the top of the hill and marched them down again. On current plans for new and higher taxes, the non-oil tax take will actually rise from the present 34.25 per cent of national income to 38.5 per cent by 1998/9, all to reduce the budget deficit to just 0.25 per cent of GDP. But it is quite possible, with some spending undershoot and a little more buoyancy on tax revenues, to see substantial income tax cuts worth 1 to 2 per cent of GDP - enough to deliver a 20p basic rate - in the run-up to the general election. Taxes will go up, but they will then come down.

Will such a cynical old trick work yet again? I suspect it will. The electorate is much less interested than the chattering classes in policy and is likely to succumb to collective amnesia about past tax increases when faced with new tax cuts. For those with better memories, there is always the additional thought that Labour is unlikely to levy lower taxes than the Tories.

The Budget was also interesting because it was the work of a left-wing Tory rather than the succession of right-wing ones who have held Treasury office since 1979.

According to the Institute of Fiscal Studies, the increased burden of taxation will weigh rather more heavily on the middle classes and the well-off than on the poor. The education programme fared particularly well, and so did health. As I predicted, overseas aid emerged unscathed. Mr Clarke has a genuine interest in development, and his wife, Gillian, was a trustee of Oxfam for many years.

Mr Clarke's Europeanism was also in evidence. One of the unstated reasons for cutting the deficit so sharply is to ensure that Britain meets the convergence criteria laid down in the Maastricht treaty, which sets a limit for budget deficits of 3 per cent of national income if countries are to participate in a single currency in 1997 or 1999. Mr Clarke is aiming for 2.75 per cent in 1996/7.

This does not mean that Mr Clarke wants to adopt a single currency in Britain, but it does mean that he is keeping his options open. If Germany and France go ahead with a single currency later in this decade - a big if - the Chancellor wants to be able to participate.

For the rest, Mr Clarke deserves his plaudits. We have sound finance delivered by a brave Budget, which cut public spending and raised taxes and which will do much to tackle our core macro- economic problems. It will rightly damp down consumers' spending and ensure that swelling imports and a burgeoning trade deficit do not spark a sterling crisis and derail the recovery.

Those who are worried that the budget is so severe that it will stall growth next year underestimate the impact of falling interest rates combined with the slow-burn rise in taxes: the insurance tax does not come in until October, and the freeze in income tax allowances implies only a gradual tightening through the year. Providing that the Chancellor cuts interest rates again before the annual review mortgages are fixed between January and March, his tough budget should lay the foundation for a long period of sustained growth and falling unemployment.