Column: Budgeting under uncertainty

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Updated: March 28, 2016 9:57:16 AM

The UK Budget was presented on March 16 amid much fanfare. The Conservatives have a majority on their own for the first time since the 1992-1997 John Major-led government.

uk-parl--l--reutersThe UK Budget was presented on March 16 amid much fanfare. The Conservatives have a majority on their own for the first time since the 1992-1997 John Major-led government. George Osborne, the chancellor, had garnered many kudos as he was seen to have got the UK economy from the high deficit/debt situation by being very tough on government spending. From near 11% in 2010, the Budget deficit was brought down to half.

The previous year, the March budget was just on the eve of the election; so, it was more like a vote-on-account. In July 2015, Osborne presented his new budget. But now, he was presenting his budget for the full financial year—his first fully Conservative budget, since previously there was a coalition in power.

Osborne had set himself the goals of eliminating the deficit completely over the five years of the new Parliament. He wanted to get the debt-GDP ratio to come down after a long climb up. Then, he also committed himself to a surplus on the Budget for the final year (2020-21) of the present UK Parliament.

More than half of the £772-billion expenditure goes to health and personal care, plus social welfare. Every political party treats the National Health Service as ring-fenced. Thus, austerity’s impact has had to be borne by the welfare expenditures—unemployment benefits, income support, tax credit for those in work, pensions, housing benefits, disability benefits and other entitlements.

Every government has been aware that welfare spending needs to be controlled but no one has found a way to do it. To simplify the payments, different benefits have been standardised and brought under a single tent. But, computerisation has been difficult. So, the cuts fall on the bits that seem to be growing out of control.

This budget saw an unusual development. There have been personal independence payments (PIPs) to enable the disabled to work. The secretary for work and pensions, Ian Duncan Smith, agreed with the chancellor that around £4.5 billion could be cut over the next few years from the PIPs. This was done, but it was perceived as an attack on the most vulnerable while tax-cuts were given for higher tax-payers. Within two days, Duncan Smith resigned claiming he was bullied into this policy. The next day, prime minister David Cameron rescinded those cuts. By Monday, a new secretary of state for work and pensions declared that there would be no more spending cuts from the welfare budget.

Never before has a budget unravelled so fast. There is an additional problem that the UK is to have a referendum on whether to quit the EU (Brexit) or to stay in it. The Conservative Party is divided. Cameron and Osborne are for staying. Duncan Smith is leading the Brexit campaign. So, his resignation became a signal to be decoded. Cameron has promised to resign as prime minister before the next election. Osborne is highly rated as his successor. But Boris Johnson, the London mayor, is also ambitious. He is also for Brexit. So, the referendum, the Tory succession and the budget have got intertwined.

When he became chancellor for the 2010-2015 coalition, Osborne established an Office of Budget Responsibility (OBR) to keep an independent check on the figures and projections used in the Budget. The OBR runs the forecasts on which the Treasury bases its budget. But there has been a problem. Despite the presence of very talented staff, the OBR has got its forecasts wrong. In 2010, it overestimated the rate of recovery from the recession. This led to Osborne swinging the axe heavily just to find that the economy was much weaker than the OBR thought. Again last November, the OBR forecast that the chancellor would have a healthy economy, nearly £30 billion better. The forecast again proved too optimistic.

Osborne found that his plan to reduce borrowing in each year could not be fulfilled. The deficit percentage could not be reduced year-on-year and the debt-GDP ratio did not come down.

There was also a shortfall in tax revenue collection. This is because the rate of inflation is down and nominal incomes have not risen as much as forecast (much like in India). This is what put the burden of cuts on welfare spending. Now, the Budget will need some revisions.

Given that uncertainty about forecasts and data revisions for income and inflation have become routine, the time may have come when budgets need to admit margins of error right at the outset. Point forecasts of GDP, inflation or targets for deficits in point estimates may be out of date. We may have to live with a range of Budget estimates with the caveat that the outcome will fall somewhere within the range forecast. Beyond that, any precision may be misleading.

It is not economists who are at fault. The economy has just got more complex.

The author is a prominent economist and Labour peer

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