This post was written before the Tory manifesto was published. As that manifesto differed so radically from what was expected, I have decided to leave this one for comparison purposes and a new post describes the actual manifesto.
Usually people worry that politicians will break their promises: we decided to take a look, based on what they have said so far, and to see what will happen if the three main parties actually try to keep their promises.
Some of the most important promises relate to levels of taxation, Government spending and the deficit; and of course Brexit. In summary, the key pledges seem to be as follows:
Key Pledges on Tax & Spending and Brexit
|Additional investment||Up to £55 billion per annum||Up to £20 billion per annum||IFS, IFS|
|Additional spending||Up to £80 billion per annum||Around £42 billion per annum||IFS, IFS|
|Taxation||Increased taxes on corporations and higher earners to raise additional £80 billion||Raise additional £37 billion in taxes||Aim for tax reductions, but pledges withdrawn, so assume no change||IFS, IFS, Times|
|Brexit||Negotiate a soft Brexit and offer a second referendum||No Brexit||Hard, possibly no-deal, Brexit, delivered quickly||Parties|
They have also both set out their new Fiscal Rules.
Key Fiscal Rules for the next Parliament
|Current Deficit||Cease focussing on deficit as key measure. Target national net wealth instead
Nevertheless, Labour has pledged to close the deficit after 5 years
|Run a budget surplus of 1% every year||Balance the budget in 3 years||IFS, Times,|
|Debt||Will be falling after 5 years||Fiscal Credibility Rule
|Borrow only to invest||Current deficit must be approximately zero||Fiscal Credibility Rule|
|Investment||Must be less than 3% of GDP||Guardian|
|Exceptions||When interest rates are at the lower bound||If borrowing costs become too high||Fiscal Credibility Rule, Guardian|
All other things being equal, higher GDP will result in higher taxation and a lower deficit. Higher tax as a percentage of GDP will also result in higher taxation and a reduced deficit. Additional spending on the other hand will increase the deficit. So for all parties, keeping their spending and investment pledges without breaching their fiscal rules will require some care.
In principle, the Labour Party position – whether you like it or not – seems clear: they will increase both taxation as a percentage of GDP (and therefore total taxation) and spending, and they will cease treating the deficit as the key measure of economic performance, though they will bring it to zero over a five-year period. This balancing will be achieved through increased taxation.
The Lib Dems have proposed more modest spending increases, and some tax increases to off-set them. But they have also made the most aggressive fiscal pledge: to run a 1% surplus every year. (The virtues or otherwise of governments running permanent surpluses will be the subject of a separate post). This creates a challenge which they will need to address.
The Tory party position is more complicated: they are not planning to increase taxes as a percentage of GDP, and indeed GDP growth is likely to be subdued as a result of the hard Brexit, so tax revenues will be lower than for the Labour Party and the Lib Dems; they will nevertheless increase spending significantly; but in three years’ time they will balance the budget. This balancing will require cost reduction.
To make sense of these positions, we have decided to run the numbers.
For simplicity, we have assumed that all parties are able to make rapid headway and implement their investment spending plans fully from year one (2020). This is not realistic; but it highlights the differences more clearly.
The Labour party’s taxation plans will increase the percentage of GDP from its current level of around 33% to 36% in the first 4 years. To keep within its fiscal credibility rule, we have assumed that tax will need to rise to 41% in 2024 (and presumably thereafter) to create a surplus, so that debt will fall after 5 years. (For comparison, the rate for most of the 20th century was around 40%).
The Lib Dem party’s taxation plans will increase the percentage of GDP from its current level of around 33% to around 35%. To run a 1% surplus, while spending an additional £42 billion per annum will require a reduction in other Government spending of a little over £70 billion per annum.
For the Tory party, we have assumed slightly lower GDP growth, in line with the government’s own projections for the impact of Brexit. And we have assumed that they make good on their promise to balance the budget after three years without increasing taxes. This implies that they will need to make serious cuts in spending from 2023 onwards.
The results are shown below.
The conclusion of this exercise is that for any of the parties to keep their promises, there will be serious consequences. For Labour to keep its promises, we will need to see a return to taxation levels of the 20th century – for the wealthy, this will be as uncomfortable as it was then.
For the Tory Party to keep its promises, there will need to be a major programme of austerity, considerably more severe than the one imposed by Cameron and Osborne. For 99% of the population, that will be very painful.
And for the Lib Dems to run a 1% surplus in every year would mean more severe austerity than the Tories.
The reason for the austerity is, of course, the supposed need to keep Government debt:GDP under control. The chart below shows the impact of the three parties’ plans in the context of the average level of debt over the last 300 years.
The Lib Dems would immediately start to reduce the debt:GDP ratio (assuming that £70 billion of austerity had no impact on the growth of the economy); the Tories would stabilise it at slightly below the 300-year average (again assuming no adverse impact of the austerity); Labour would touch the average level and then start to reduce debt:GDP gradually (assuming no adverse impact from the increased taxation).