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The Coalition's Plans for Fiscal Squeeze

The coalition formed in 2010 under the Conservative leader David Cameron presented itself from the outset as something of an emergency government centrally concerned with correcting the public finances. Its programme, following five days of post-election bargaining, heavily stressed the need for debt and deficit reduction to restore economic credibility:'... the most urgent task facing this coalition is to tackle our record debts...' Later in the document, the government announced it would 'significantly accelerate the reduction of the structural deficit over the course of a Parliament, with the main burden of deficit reduction borne by reduced spending rather than increased taxes'.[1]

A month after the election the new Chancellor (George Osborne) presented an 'emergency budget' that had been promised in the Conservative manifesto and foreshadowed in the coalition programme. Two-thirds of a five-year plan for fiscal squeeze announced in this budget followed what had been signalled in the pre-election Labour budget, as described earlier. But the coalition plan added roughly one-third to what Labour had proposed, in the form of an extra fiscal squeeze over 2010/11-2014/15 of about ?40bn (about an extra 1.2 per cent of GDP on top of the Labour plan). It was intended to produce a fall in debt relative to GDP by 2015/16, and eliminate the structural deficit by the end of the Parliament in 2014/15, rather than cutting it by more than half by then, as Labour had planned to do (Emmerson Johnson and Joyce 2015).

That budget apparently reflected the overall plans announced by the Conservatives before the 2010 election and represented a notable change of stance by the Liberal Democrats from their previously announced opposition to early spending cuts. But (as with Alasdair Darling's plans), Osborne's plan for reducing debt and deficit rested on assumptions of above-average economic growth after the recession, to enable public spending to fall relative to GDP without falling substantially in constant-money terms (i.e. a 'soft' squeeze, in our language) and to boost revenue by some ?175bn more than was raised in the last year of the Labour Government. The budget speech declared that the extra ?40bn of fiscal squeeze should follow an 80:20 rule of thumb as between expenditure reductions and revenue increases, in contrast to the 70:30 split applying to the squeeze measures inherited from the Labour plan: 'The country has overspent; it has not been under-taxed.'[2] As already noted, the justification for an earlier, shorter, and deeper squeeze than Labour had planned stressed the need to reassure the financial markets, and thereby to reduce interest on UK borrowing to levels more likely to stimulate economic growth.[3]

On the revenue side, that post-election budget raised VAT from 17.5 per cent to 20 per cent—a change not mentioned by any of the major parties in the election campaign, but now claimed to be unavoidable, and expected to generate ?13bn a year of extra revenue by the end of the Parliament. Also— recalling the bank windfall tax introduced by the Conservatives in 1981, discussed in Chapter Eight—the budget imposed a new tax on the balance sheets of UK banks and building societies, which differed from the 1981 tax and the previous Labour Government's bank bonus tax in that it was intended to be permanent. The move was coordinated with the French and German Governments (which announced plans for similar taxes on the same day) and justified by blaming the banks for causing the 2008 financial crisis.

In addition, the tax threshold for higher rates of income tax was frozen for three years up to 2013/14, and indeed remained frozen until the eve of the following general election in 2015, with the effect that 1.5 million extra people became liable for higher rate tax (and consequently ineligible for some welfare payments) between 2010 and 2015. Inheritance tax thresholds, already frozen for four years by the previous government, remained frozen, and higher rate income taxpayers were also excluded in 2010/11 from an increased personal allowance for lower-rate taxpayers as well as being subjected to increased rates of capital gains tax. Several business tax offsets or allowances were reduced or removed, but the Corporation Tax rate was cut by 1 per cent, and it was announced that there would be four successive reductions to make the UK's Corporation Tax rate one of the lowest among the developed countries at 24 per cent in 2014/15. Income tax thresholds were also raised sharply for taxpayers at the lower end of the income scale, following the plan in the coalition agreement (itself reflecting one of the Liberal Democrats' major election promises) to raise the income tax threshold to ?10,000 by the end of the Parliament.

The 2010 emergency budget also announced plans for an extra spending squeeze. Again reflecting 'red lines' in the coalition agreement, some spending domains, namely the National Health Service and overseas aid, were protected altogether from reductions in planned spending, but departments in nonprotected areas faced an average real cut in their planned spending of about 25 per cent over four years (as against the 20 per cent implied in Labour's plans). The coalition government broadly followed its Labour predecessor's plans for big cuts in planned capital spending, but it chose not to impose further capital spending cutbacks (in contrast to what had happened in previous spending squeezes), such that the extra spending cutbacks imposed by the coalition mostly fell on current rather than capital spending.

Retirement pensioners—an electoral group especially important for the Conservatives but also to other parties given their higher-than-average voting turnout—were protected by a 'triple lock' on state retirement pensions (to be uprated annually in relation to inflation, earnings, or 2.5 per cent, whichever was the highest) that had been promised in the Liberal Democrats' manifesto. But other welfare spending figured prominently in the spending-squeeze plans, with extra cuts in welfare planned to comprise roughly one-third of the reductions in current spending. The post-election budget therefore announced cuts in welfare designed to save ?11bn a year by 2014/15, including reductions of tax credits for higher income earners, stricter medical assessment for those claiming disability benefits, a cap on the level of benefit payable to support housing rental costs, a requirement that to be eligible for benefits, lone parents should look for work when their youngest child started school, and a three year freeze in child benefit payments, payable to mothers. The small print of the budget also announced a change in the inflation index (from the Retail Prices Index to the Consumer Prices Index) to be used from the following year in uprating retirement pensions and welfare benefits, which was expected to save over ?6bn a year by the end of the Parliament.

Labour's pre-election budget had announced a two-year 1 per cent pay cap for public employees, but the coalition's post-election budget replaced that with a two-year pay freeze on all but the lowest incomes. Freezes or cuts in public sector pay were commonly applied in earlier spending squeezes, but this episode also saw an assault on public service pensions, in the form of a review of public service pensions chaired by a former Labour cabinet minister (Lord Hutton), that recommended raising the age of pension eligibility for public servants, raising employee contributions by several percentage points of their salary, and moving from pensions based on final salary to payments based on average pay over a career (Independent Public Service Pension Commission 2011). These recommendations were broadly enacted to take effect from 2015, subject to a 'grandfather' provision, that no public servants within ten years of their earlier pension age would be affected by the changes. So, as with the 1995 increase in the state pension age, these changes had little immediate effect on public spending, but were expected to limit the rise in spending on pensions by public service employers a decade or more into the future.

Arguably, the spending change representing the greatest political cost to the Liberal Democrats early in the government's life, not mentioned in the 2010 emergency budget, was a raising of the top-up tuition fees that universities were permitted to charge their students. It will be recalled that in the 1990s squeeze discussed in Chapter Nine, New Labour had scrapped the previous system of student maintenance grants. During its long post-election honeymoon it had replaced those grants entirely by loans and enabled universities to charge their students tuition fees of ?1000 a year. Although as we saw in Chapter Nine, that move provoked New Labour's biggest backbench rebellion in its first term (and the fees were later abandoned for Scotland as a result of Liberal Democrat pressure in the Edinburgh Parliament), Labour had again later raised the fees to ?3000 a year after the 2005 general election while promising no further increases before the next election. The fees were means-tested (and numbers of means-tested places were not capped) so the change did not directly bear on the poorest students, but the change affected aspirations even for those on low incomes and bore directly on those on middle and higher incomes.

The Liberal Democrats held parliamentary seats in several constituencies where student votes were important, and their 2010 manifesto promised to phase out tuition fees for all first-degree university students and immediately scrap fees for final-year undergraduates. But instead the 2010 coalition government followed a course similar to that charted by Labour in 1998 by accepting the recommendations of an independent report on university financing commissioned by their predecessor. It consequently legislated to triple tuition fees from their previous cap of ?3000 per year, to be collected retrospectively from students through the tax system after they had graduated and their earnings were above a specified level. The legislation provoked a major parliamentary revolt by Liberal Democrat MPs (thirty-five of the Party's fifty-seven MPs either voted against or abstained) but the votes of the others sufficed to pass the legislation.

That violation of a central manifesto pledge—a key marker for high political effort or cost in our qualitative scale of fiscal squeeze in Chapter One—was repeatedly used by their political opponents to attack the Liberal Democrats, whose poll ratings never returned to their mid-2010 level over the rest of the Parliament. In part, that tuition fees hike seems comparable to the 'Geddes Axe' cuts in secondary education imposed by the Lloyd George coalition in 1922 (as discussed in Chapter Three), in that it struck at the aspirations of families who saw higher education as the route to social advancement. It was different in that no fees were payable upfront and the number of free places was not rationed, but its negative impact on electoral support for the Liberal Democrats seems to have been marked and lasting.

These policy changes early in the life of the coalition government were accompanied by changes in structures and procedures. Going well beyond the independent forecasters that Conservative Chancellor Norman Lamont had introduced into the Treasury in the early 1990s, the government 'outsourced' economic forecasting from the Treasury to a new semi-independent public body, the Office for Budget Responsibility, which had been promised in the Conservatives' election manifesto and was intended to offer greater credibility to official economic forecasting (and no doubt also to absorb some of the blame for forecasting errors as the OBR greatly over-estimated economic growth in the early 2010s). But the Liberal Democrats' manifesto proposal for a 'Council on Financial Stability' (comprising representatives of all political parties and other experts, such as the Governor of the Bank of England), did not see the light of day. The proposal—a probably unconscious echo of the 1931 May Committee, discussed in Chapter Four—was for this Council to recommend a deficit reduction framework for a comprehensive spending review—and presumably also spread the blame for unpopular tax increases and spending cutbacks.[4]

Instead of that sharing-the-blame proposal, ministers made fiscal squeeze decisions directly, as had applied to every fiscal squeeze since 1931. But blame was shared among the parties in the coalition, with a Conservative Chancellor paired with a Liberal Democrat Chief Secretary in the Treasury and all major policy decisions going through a 'quartet' comprising the two party leaders and the two Treasury Cabinet ministers. A variant of the 'EDX' cabinet committee procedure described for the 1990s in Chapter Nine was adopted for spending-round decisions, with a similar rule that spending ministers could not join the committee to judge their fellow-ministers' claims until they had themselves agreed spending plans with the Treasury. But some interviewees reported that this arrangement proved less effective in deterring 'holdout' behaviour by spending ministers than in the early 1990s, perhaps because of different political conditions (such as coalition rather than single-party government and a smaller pool of long-serving, highly experienced ministers than two decades before).

  • [1] The Coalition: Our Programme for Government (2010) London: HMSO, p. 7 and p. 15.
  • [2] HC Deb 22 June 2010, c.168.
  • [3] HC Deb 23 March 2011, c.951: 'We have a higher deficit than Portugal, Greece and Spain,but... virtually the same interest rate as Germany. This is our powerful monetary stimulus to ourrecovering economy.'
  • [4] Liberal Democrat Manifesto 2010: Change that Works for You, London: Chris Fox, p. 98,
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