Cutting spending is more difficult than simply cutting out the luxuries

23Apr10

Imagine you are skint.

Imagine you have also run up some debt on your credit card.

You open up a spreadsheet on your laptop, and calculate your monthly income and outgoings. You notice that you are spending more money than you receive. Clearly you can’t carry on like this.

So you decide to change your spending habits so that you are earning more than you spend. At first this involves making cuts; you forgo the pub lunches and make sandwiches, you get pissed once a week instead of twice, and you buy clothes from a charity shop instead of brand new.

In the longer term you think about how you raise your income, perhaps you look for a better paid job, and maybe you think about paying your debts down by selling some old junk you don’t need.

Of course this process is easier said than done, there will be days when you can’t be bothered to make sandwiches, and sometimes you may face unexpected costs such as repairing your car. Similarly your old junk might not raise as much money as you think.

But on the whole the process is pretty logical. You look at the areas where you are spending money, and work out what you don’t need.

Government finances are not like this. Cutting spending in one area can lead to an increase in other areas. Cutting out the pub lunches saves you money, and won’t lead you to spend more money on clothes. On the other hand, in government, cutting money that is spent on one area always has effects on the spending on other areas. Cut civil service jobs in one department, and you increase the spending of social security. Cut a programme aimed at preventing young people turning to crime, and in future years you spend more money on putting the young people in prison. Cut a programme that increases physical fitness in deprived communities and you spend the money on healthcare later on (assuming a mixed economy with some government funding of healthcare costs).

The point is that looking for cheap cuts and savings now can incur long term spending in other areas.

Another side of the debate regarding reducing the deficit is revenue raising. This is a side of the debate seldom aired because the UK electorate is not yet sufficiently mature enough to understand that government services have to be paid for in some manner. However, again, increasing the income of government isn’t the same as an individual increasing his own income – the government can hardly go and get a better paid job. It is however tempting to make a joke about the UK starting to charge the US for sexual favours.

There are two ways in which the government can raise money – taxation and selling assets. The later can be a useful way of providing one time bonuses to the exchequer, but can’t really be regarded as a sustainable way of financing services. Similarly a person spending more money than they earn can’t continually make up the difference by selling junk on ebay.

This leaves taxation. But the problem with taxation is that raising/introducing taxes in some areas also effects other areas. The laffer curve is a well documented concept that explains how raising income tax can – depending upon which side of the curve you are on – be counter-productive and actually lead to less revenue being generated. Furthermore rises in direct taxation can harm consumption and thus reduce revenue raised elsewhere (such as with VAT).  When it comes to indirect taxation, the elasticity of demand can also mean rises become counter-productive.

The point is that raising revenue is more complex than simply raising or introducing taxes.

In other words, balancing the budget is a far more difficult act than people realise. Libertarians frequently list projects they would scrap, but ignore the fact that some spending is designed to avoid the need to spend later. They also ignore the other side of the equation – balancing the budget through raising revenue. The socialists also do a similar thing when it comes to taxation (see robin hood tax….) and frequently only propose military spending as an area to cut – as if there really are no areas where the government wastes money. Outside of the blogs, commentary is even worse – with the 2 main parties pretending the finances will be magically saved via “efficiency savings”, and the tabloid newspapers acting in an even worse manner by pretending everything is the fault of immigrants.

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