This is why George Osborne misses his deficit targets over and over again — and why he might keep missing them

Mike Bird

George Osborne is settling into a job that not everyone expected he would have before May's general election.

He's not only still Chancellor of the Exchequer, but is now backed by a Conservative majority in parliament, not the Tory-Lib Dem Coalition that he previously relied on. Even the Tories didn't expect an outright victory.

But because of this Osborne now has to keep to government spending plans that the Conservatives didn't expect to have to keep. Osborne wants a budget surplus by 2018, something that might have been diluted in coalition negotiations — or completely scrapped under a Labour-led administration.

It's easy to take the new budget forecasts with a pinch of salt — after all, the government deficit targets laid out in 2010 were way off the mark by the 2015 election. The government'sJune 2010 projections forecast that the budget would be balanced by 2014/15, the fiscal year just gone. TheMarch 2015 outlook put the 2014-15 deficit at 3.3% of GDP.

So there's no doubt the targets have been missed. But why they've been missed is an important element of the puzzle. And that offers some insights into how likely the new targets are to be reached.

HSBC economist Liz Martins has a great graph showing just what happened to both spending and receipts under the last administration:

Since 2012-13 the figures for total managed expenditure (the figure for both departmental budgets and less easily controllable spending, like welfare) has pretty much exactly matched what was expected — spending was overestimated a bit in the earlier period, but Osborne has ended up pretty much exactly where he said he would in 2010, albeit by a different route.

It's receipts (largely from taxes) that have registered a growing shortfall over the period. The difference between collecting 35.8% of GDP and 38.8% might not sound like too much, but that's more than £50 billion. That's the equivalent of the whole of the UK defence budget, with many billions to spare.

Martins explains:

In part, this reflects the weaker-than-expected economic performance. Back in 2010 when the government was elected, the economy was projected to have grown 22% by the end of 2014. In fact, it was just 15% higher. Yet this is not the only reason. Revenues as a percentage of GDP stand 3% below their 2010 target (35.8%, compared with 38.8%).

That slower growth also means that in sterling terms total managed expenditure (spending) is actually lower than it was in Osborne's original plan — the Treasury is spending what it expected when measured as a proportion of the economy, but the government expected that the economy would actually be larger.

A big part is down to wage growth too — the Coalition government prioritised repeated increases to the person allowance, which equated to an income tax cut for most people. That effect combined with extremely sluggish wages have meant poor income tax receipts.

It's going to be difficult to close that gap — the new government has already ruled out tax hikes for income tax, VAT and national insurance, which Martins notes are worth 65% of receipts.

And there's not much obvious low-hanging fruit left in departmental budgets without a change of approach. For example, the commitment to protecting the NHS budget could be scrapped, but not without political pain. Some departments were cut by over half in real terms during the last parliament:

Martins' conclusion is that the deficit may be higher for longer than the current plans suggest, given the optimistic set of assumptions and pretty severe tightening that would be needed for the current projections to be accurate:

If the government’s core scenario is to be borne out, it may need to cut as many as 640,000 public sector jobs and slash unprotected departmental and welfare spending by 18% and 10%, respectively, in four years, while leaving all of the major tax rates unchanged. Yet, even with this extensive tightening in this scenario, it still relies on the benign assumption of uninterrupted growth, robust private sector job creation, improving productivity and wage growth, low rates and inflation, and continued buoyant private consumption. One or more of these assumptions may very well prove over-optimistic, as did so many of the assumptions made back in 2010.

That fits nicely with an International Monetary Fund (IMF) report that was released last week, suggesting that in much of the western world it would be healthier if governments didn't fret so much about their public debt, and rather allowed deficits to close organically, through economic growth.

This analysis is based on the idea that the government's plans are laid out in entirely good faith. But Osborne ma not even be that committed to hitting his deficit target. It's no slur on Osborne to admit that this might not be the case — politicians have political motives, which isn't a surprise or a secret. 

Mark Pack picked out a fascinating section of George Osborne's biography by Janan Ganesh a few months ago with an alternative analysis. Osborne learned at the 2005 election that the government's fiscal projections become the baseline — the forecast to which any other suggestions will inevitably be compared.

If other parties don't agree to them, they can be painted as either Scrooge-like right-wingers (in the case of the Conservatives in 2005), or spending-happy leftists (in the case of Labour now). Since it's a political manoeuvre, it won't matter too much if the targets are quietly relaxed after the election.

After all, Osborne missed his targets by quite a distance from 2010 to 2015, and was returned to office (with an even greater number of Conservative MPs). What incentive does he have to try and stick to them this time?

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