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Fiscal Squeeze in the 1990s. Tales of the Unexpected

Background: The Period in Perspective

The politics of the fiscal squeeze episode of the 1990s is distinctive and perhaps surprising in at least three ways. First, a Conservative Government not expecting to be re-elected (following the downfall of Margaret Thatcher, who was deposed as Conservative leader in 1990) turned out to be just as effective as the government of the 'Iron Lady' in the previous decade, if not more so, in restraining government spending in general and spending on administration costs in particular. Second, a split and fractious Conservative Party, which after re-election in 1992 proceeded to tear itself apart over the UK's membership of the European Union before going down to one of its biggest ever general election defeats in 1997, somehow managed to apply a surprisingly collective approach to containing the growth of public spending. And third, the squeeze was prolonged at the end of the period by a Labour Government elected by a landslide (bigger than what the Party had achieved in 1945) that had politically committed itself before the 1997 election to stick to its Conservative predecessor's plans for spending restraint for two years.

The economic background to this squeeze episode (in contrast to those of the 1920s, 1930s, and 1970s) resembled the second Thatcher episode discussed in Chapter Eight, in that it comprised a period of steady economic growth coming after a severe recession that began in 1990 and was exacerbated by the first Gulf War in 1990-91. That recession was shallower than that of the early 1980s in terms of fall in GDP, but produced similar levels of unemployment and lasted longer, confounding successive Treasury forecasts of early recovery that proved politically embarrassing to the incumbents. In the later 1980s the Thatcher Government congratulated itself on having permanently recast the public finances in a new balanced-budget mode, with public debt reduced to levels not seen since before World War I. But the early 1990s, recession, combined with a public spending blowout in the runup to the 1992 general election, caused the budget deficit to leap from just over 1 per cent of GDP in 1990/91 to over 7 per cent in 1993/94—back to the 1970s levels that the Conservatives claimed their 'rolling back the state' policies had left behind.

However, when the economic recovery finally began, a mix of continuing growth and falling inflation made it possible for that unexpectedly re-elected Conservative Government to follow a tactic similar to that developed by Chancellor Nigel Lawson in the mid-to-late 1980s episode, cutting public spending relative to GDP (but not in constant prices) over successive years, broadly by uprating social welfare and other spending in line with the price index but by less than the increase in real GDP. At the same time, the unexpected collapse of the Soviet Union in 1991 reduced the perceived need for extra military and security spending (in contrast, say, to the late 1940s and the early 1950s discussed in earlier chapters, when the advent of the Cold War and the Korean War meant sharp upward pressures on military spending).

On the tax side, the pattern was again in some ways redolent of the second 1980s squeeze described in Chapter Eight. Revenue presented the mirror image of what happened to public spending, rising over the period as a whole in real terms but not relative to GDP as the economy grew. Within that overall pattern, there were 'hard' revenue spikes in the mid-1990s and again in 1997/98, in the first case reflecting swingeing post-1992 election VAT increases combined with a freeze on direct tax thresholds and allowances for two successive years, and in the second case reflecting post-1997 election tax changes by the newly elected Blair Labour Government, including a one-off utilities windfall tax. Taxes on road fuel also rose sharply over the period as a whole, eventually producing a dramatic fuel tax revolt by oil tanker drivers blockading refineries in 2000 which thereafter made governments more wary of imposing extra taxes on fuel. And both the Major and Blair Governments introduced new taxes over the period, many of which were dubbed 'stealth taxes' by their political opponents.

As before, this chapter aims to look behind the numbers we set out in Chapter Two and the data appendix. But since official archives for this period were not open at the time of writing, the account is based on public sources (speeches, media reports, politicians' memoirs), supplemented by a few interviews with some of those involved in the Treasury at that time. We begin in 1992/23, when the Conservatives, re-elected but then seriously weakened by a major currency crisis that fatally damaged the then Chancellor's career, moved from pre-election tax giveaways funded by borrowing to a soft spending squeeze linked to a revenue squeeze that was 'hard' for two successive years in the mid-1990s before being relaxed for the 1997 election. Finally, we turn to the continuation, indeed intensification of that squeeze for a time after 1997 under the subsequent New Labour Government headed by Tony Blair.

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