Darling's spending rise

In his Pre-Budget Report, Alistair Darling promised to cut borrowing after 2010 by finding £5bn a year of “efficiency savings.“ These account for all the fiscal tightening in 2010-11 and three-quarters of it in 2011-12.
But there’s a good chance that, at least in 2010, these spending cuts will be largely offset by a spending rise - on pensions and social security benefits.
The problem is that inflation is highly likely to turn negative later next year - thanks not only to the VAT cut, but to falls in oil prices and mortgage rates, and to this spring’s price rises dropping out of the annual data. I’ve seen a couple of forecasts that RPI inflation will be minus 2% next September.
This matters, because state pensions and social security benefits are usually changed in line with September’s inflation.
If the Chancellor were to do this next year, though, he’d have to cut benefits in  nominal terms. In a rational world, this might or might not be feasible, But in our world, it is almost certainly politically unacceptable.
So he’ll have to announce a real rise in benefits. Memories of the 75p pension rise disaster would mean this would have to be more than just a token.
Perhaps the least he could get away with would be a 2% rise in nominal terms - equivalent to £1.90 on the state pension.
But this would add £940m to spending on pensions alone, and £2.5bn to spending on all benefits.
Half of Darling’s “efficiency savings” are therefore offset.
Now, in one sense, this doesn’t much matter. £2.5bn is a tiny fraction of the margin of error in borrowing forecasts.
But it might matter in another sense. This rise would add to scepticism about whether Darling really has the stomach to cut spending. Which in turn might increase the pressure upon him to raise taxes.

Comments

[Marcus Hunt]

Does the Old Lady still have to send the
Chancellor a letter if the rate is below target? Hohoho: the badger will have to re-write the current letter to give to the(hmm-hmm)"independent" BOE to send back to...the badger.

[Tom Freeman]

The VAT cut will (artificially and temporarily) reduce inflation over the next year. Maybe Darling could say that, in light of this, it's justifiable to make a one-off exception by basing benefit changes on (I think) RPI-Y, which strips tax changes out and so should be higher?

[Matthew]

Doesn't the pre-budget report contain an estimate of likely benefit rises already, or do you assume they have assumed zero rise? The inflation forecast is 0.5% for Q4 09, but I think that is CPI not RPI.

[cityunslicker]

With current Government plans we will be on the steps of the IMF before long anyway and the Govt will have no say in expenditure next year.

Sad, but true.

[Matthew]

You don't actually know anything about the IMF, do you?

[Tom Freeman]

Ah. I think the PBR projections may already be taking this into account. p86 of the report, chapter 5 box 5.1:

"The Government’s economic projections show RPI inflation as negative in September 2009. This means general prices using this measure of inflation are expected to fall. RPI inflation for that month is used to index income tax, tax credits and national insurance allowances, thresholds and limits for 2010-11. September measures of inflation are also used to index social security benefits.
"With projected negative RPI inflation, the Government would maintain the cash value of tax allowances and thresholds, and the RPI-indexed social security benefits, consistent with statute. Holding these constant with lower prices means that in 2010-11, their real terms value would rise in relation to RPI, and that people would be better off in real terms. ...
"The basic State Pension is indexed by RPI inflation or 2.5 per cent, whichever is greater. This means that there will be an even larger real terms benefit for pensioners in 2010-11."

[Ren]

This whole idea is O.K for the short term but it has long term side effects which will be detramental to the market without doubt. Not the way to go in my view.

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[dearieme]

I've been told that index-linking of occupational pensions (those that have it) applies only if RPI is positive - if it goes negative, those pensions stay unchanged in nominal terms. Does anyone know whether this is true?

[jameshigham]

We knew it would come and here it is.

[Tom Freeman]

Dearieme,

"Does anyone know whether this is true?"

Ish. See the PBR extract a couple of comments back.

[jameshigham]

Chris, are you following the PFI story? Will you post on it?