Budget 2015 Q&A: How George Osborne eased the great Whitehall spending squeeze

After criticising Labour for planning to borrow more than the Tories, George Osborne has done precisely that

As widely expected, George Osborne has taken an axe to the welfare budget (AFP/Getty Images)

So has the Chancellor slashed again?

Yes and no. As widely expected, George Osborne has taken an axe to the welfare budget. But the big surprise was that the Office for Budget Responsibility said the planned squeeze on day-to-day spending by Whitehall departments over the coming three years will be significantly eased relative to the plans the Chancellor put forward at the pre-election budget in March. That was the time, readers may recall, when there were widespread fears that departmental spending was going to fall to its lowest level share of GDP since the 1930s. Spending was due to fall £41bn in inflation-adjusted terms by 2018-19. Now it will only decline by £17bn. The cuts will take place over a longer period too.

The Treasury has been calling in Cabinet ministers to put together a Spending Review which will be published in the autumn – laying out where these economies will be found and what public services will be cut or reduced. The Office for Budget Responsibility said that finding these savings should now be “a lot less challenging” than before. It looks as though the Chancellor has listened to those critics who said his planned cuts to public spending were too large and damaging.

How did the Chancellor manage to ease the squeeze?

Three routes. First, he has specified the welfare cuts. They were not factored into the March budget calculations by the OBR because the Chancellor had failed to say where the axe would fall, meaning that all the cuts needed to hit his overall target of running a current budget surplus by 2017-18 were assumed to come out of Whitehall spending. But the package of restrictions on access to working tax credits and other benefits is estimated to bring in £12bn of savings by 2018-19.

Second, the Chancellor has increased taxes. He has kept his promise not to touch the big sources of revenue such as income tax, VAT or national insurance. Instead, the new revenue comes from a host of smaller levies, including dividends tax, an insurance premium tax and by raising more from Vehicle Excise Duty. Mr Osborne has repeated the pattern of many Chancellors before of hiking taxes after an election – when the backlash is likely to be less dangerous.

Budget 2015: Budget 2015: The winners and losers
What George Osborne said... and what he really meant
Osborne promises £8bn more annual funding for NHS

And what else?

Finally, the Chancellor has simply decided to borrow more than he planned in March. In March the budget was projected to go into a £5bn surplus in 2018-19. Now, there will still be a £6.4bn deficit in that year and there will not be a surplus until 2019-20.

Overall Mr Osborne is planning to borrow around £17bn more over the five years to 2010-20 than he did in March – which is rather hypocritical given that he slammed Labour as irresponsible in the election campaign for planning to borrow more than him. Yet the Chancellor has hardly ditched his “austerity” posture.

The Budget document confirms his plan to run a budget surplus in “normal times”. And for the first time the Treasury specifies what these “normal times” are. It will be when quarterly year-on-year real GDP growth is higher than 1 per cent. That translates into a rather high bar for shelving the surplus rule.

So how is the rest of the economy looking?

Not much has changed since March. Growth has been downgraded a little this year. But there are upward revisions in 2017 and 2018. However, some economists still worry that the front-loaded spending cuts could impede growth, just as the Chancellor’s fiscal consolidation did in the last Parliament. The OBR is also still very pessimistic about the prospects for the UK export sector. Once again it doesn’t expect net trade to make any contribution to growth over the next five years.

The dominant driver of growth is expected to be household consumption. To finance this consumption the OBR expects household debt to income ratios to continue rising back to pre-2008 levels. This is despite the Chancellor’s claims that he wants to move away from an economy “built on debt”.

Budget 2015: Universities can now raise fees beyond £9,000
Students react to maintenance grants being scrapped
Osborne’s living wage 'will leave 60,000 people without jobs'

What about the new National Living Wage?

The Chancellor presented the move – which, in fact, is really a hefty increase in the national minimum wage to £9 an hour by 2020, as a way of compensating people for the loss of income they will inevitably experience from the reduction in their tax credits. But economists are sceptical. Research by the Resolution Foundation think tank suggests pushing up the minimum wage does little to compensate for tax credit reductions.

“The preponderance of the economic evidence is that any negative impacts on employment will be small, and there may be some positive impact on productivity, but it is misleading to suggest that it will outweigh tax credit reductions for low income families,” said Jonathan Portes, of the National institute for Economic and Social Research.