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UK’s Osborne will have to sacrifice some sacred cows

Friday, 12 Jul 2013 | 7:16 AM ET
George Osborne, U.K. chancellor of the exchequer, leaves 11 Downing Street to testify at a Parliamentary Treasury Select Committee hearing
Simon Dawson | Bloomberg via Getty Images
George Osborne, U.K. chancellor of the exchequer, leaves 11 Downing Street to testify at a Parliamentary Treasury Select Committee hearing

The U.K. government will be forced to slash spending in education, the National Health Service (NHS) and international aid, areas previously ring-fenced from government cuts, according to economists, after the finance minister said he would not raise taxes if his party wins the next election.

Economists at ING, Berenberg bank and the Institute of Economic Affairs told CNBC that new cuts would be required in order for the Chancellor of the Exchequer George Osborne to keep his latest tax promise and still meet his budget targets.

"The government has not addressed those areas of spending that grew most rapidly in the early twenty-first century - schools, health and welfare," Professor Philip Booth, editorial director at the Institute of Economic Affairs, said. "These areas should undergo radical reform as well as spending cuts."

No more tax hikes

The Conservative Party – the leading party in Britain's coalition government – pledged on Thursday to not introduce any tax increases if it won the election in 2015.

Chancellor George Osborne made the remarks to members of parliament (MPs) at a Treasury select committee hearing on government spending. It was a clear indication of how the Conservatives will fight the next election, with the other major parties – Labour and the Liberal Democrats – not yet ruling out tax increases.

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"The further consolidation after 2015/16 is built into the tables as a spending reduction," Osborne told MPs. "I am clear that tax increases are not required to achieve this. It can be achieved with spending reductions."

Osborne's comments follow remarks last month by Paul Johnson, the director of the Institute for Fiscal Studies who argued that the government may have to raise £6 billion ($9 billion) from tax increases because spending cuts had run their course.

"At some point we are going to have to have a serious debate about whether all of the rest of the fiscal consolidation is really going to happen through spending cuts alone," Johnson said. "We are on course not for sharing the consolidation 80 percent on spending and 20 percent on tax as the government originally planned but for an 85:15 split."

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"Returning to an 80:20 split for the consolidation as a whole would mean a £6 billion tax increase in the next parliament."

Johnson said that with £25 billion (37.5 billion) planned in further spending reductions after 2016, the protection of the National Health Service (NHS), schools and pensions from future cuts would have to be reviewed, especially if taxes aren't raised.

Speaking to MPs on Thursday, Osborne said, "I'm not going to spell out today where we go next with welfare reform but it is not over. We have got substantial reforms coming in but I think there is still a question of where this country spends its scarce resources and I think the benefit bill is still too high. I think that is what the country thinks as well."

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End the ring-fencing?

In the government's recent spending review, nearly all government department budgets were cut, with local government funding being slashed by 60 percent. The government has protected education, the NHS and overseas aid from the austerity measures, while Cameron has said that free TV licences and winter fuel allowances for pensioners will also be safe.

Robert Wood, chief economist at Berenberg, said that this ring-fencing was dictated by political rather than economic concerns, and that would have to change.

"The ring-fence is a political rather than an economic constraint. The Tories need to ensure that they are seen as responsible guardians of the NHS," he said referring to the popular name for the Conservative party. "Older voters are an increasingly important political force."

"So protecting the NHS and pensioner benefits from the pain is key for re-election.But from an economic point of view the ring-fence makes the cuts required elsewhere implausibly large."

Rob Carnell, chief international economist at ING Commercial Banking, said cuts to spending on the elderly would also have to be made.

"About the only sector of the population not to see cuts is the aged - though there are of course plans in train to reduce entitlements to pensioners and introduce more means testing - so this may be made more concrete," Carnell said.

Carnell also said there was no obvious reason why international aid needed to be ring-fenced, and said that further tightening of loopholes on corporates who avoid taxes would be likely after the efforts of Prime Minister David Cameron at the G-8.

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