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Analysis
Faultlines in UK economy remain

Faultlines in UK economy remain

Budget giveaways may be lost in post-election tax hikes 

by Bronwyn Curtis

Thu 19 Mar 2015

Giveaways in the UK Budget presented by Chancellor of the Exchequer George Osborne may be lost in post-election tax hikes, whoever wins the election on 7 May.

The script for the Budget in the run up to the election could not have been better for Osborne, but he may have overplayed his hand in declaring that the end of austerity was in sight. His gamble to keep austerity in place over the last five years had already paid off with stronger growth performance than the rest of the G-7. The recent fall in the oil price and its effects added an extra kick so public finances and the economy are in better shape than the Office for Budget Responsibility was forecasting just three months ago.

Inflation forecasts were lowered from 1.2% to just 0.2% this year and 1.2% in 2016. Lower inflation translates into better public finances as payments on index-linked bonds and benefits are lower, creating the opportunity for giveaways while still allowing occupation of the high ground on austerity.

To achieve ‘the end of austerity’ though, the deep real cuts in day-to-day spending on public services and administration are brought forward to 2016-18, then the brakes come off and spending accelerates in 2017-18. As the cuts in public services and administration still account for 70% of the improvement in the budget balance this means massive reductions in departments that are not ring-fenced.

We know that what is promised before an election and what happens afterwards are usually different and all the parties face the same dilemma. The sheer magnitude of the spending cuts still required to achieve a balanced budget, let alone a surplus, mean that tax hikes will be needed after the election, whoever wins.

Going forward, consumers will still be the main driver of the economy. Even if nominal wages stayed flat, real wages are rising and lower energy prices are an unexpected windfall. The upward growth revisions to 2.5% and 2.3% in 2015 and 2016 are lower than private sector forecasts as the OBR takes a more pessimistic view on the contribution of exports and oil production and investment in the North Sea.

Many of the old fault lines visible before the financial crisis are still there too. The dependence on consumer spending, the failure of businesses to invest and the fact that labour is cheaper and can be laid off more easily, keeps the structural issues like weak productivity and the widening current account deficit hovering in the background to trip up the next government.

Bronwyn Curtis is Chief Economic Adviser, OMFIF.

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