School of Business and Economics

News

22 Nov 2022

Autumn statement is highly political compared to research on ‘best’ ways to fix public finances

Palace of Westminster.

The UK faces some significant belt-tightening following Chancellor Jeremy Hunt’s autumn statement, which announced spending reductions and tax rises of around £55 billion. Much research has been done into the best ways to do fiscal austerity in terms of reducing debt, avoiding economic damage and not exacerbating inequality. So how does this attempt measure up?

That £55 billion retrenchment includes over £30 billion of reduced annual government spending by 2027/28. Over the next couple of years, the government is actually going stick to previous spending plans and even increase them for core departments like health and social care. But from 2025-28 there will be a crackdown, with maximum 1% real-terms increases for day-to-day (current) spending, and infrastructure (capital) spending only being maintained in cash terms.

Our research, which looked at the US finances between 1985 and 2016 but is applicable to many countries, has found that austerity based on public spending cuts often costs the overall economy less than tax rises. Spending cuts are usually followed by reduced interest rates, which can spur consumption and business investment.

Previous findings based on data around the world dating back as far back as the 1960s have reached similar conclusions. In contrast, tax rises disincentivise consumption and investment by whoever is on the receiving end of them.

Having said that, cuts to capital spending weaken the overall economy longer term by making a country less productive. Unfortunately, governments tend to see this as more appealing than immediately unpopular cuts to current spending. Nearly half of Hunt’s spending cuts fall into this category.

Even if the government had cut spending in the 'right' way, there’s still an ugly trade off. Our research suggests that spending cuts are associated with greater income inequality than tax rises, disproportionately affecting those on lower incomes.

The most obvious example is the UK’s early 2010s fiscal austerity, which caused a clear rise in both absolute and relative poverty. The government may again be calculating that it takes a while for people to see the effects, thereby minimising the political cost in the short term.

Dr Dawid Trzeciakiewicz, Lecturer in Economics, discusses why the “Autumn statement is highly political compared to research on ‘best’ ways to fix public finances" in a new Conversation article with Professor Gulcin Ozkan and Professor Richard McManus.