UK budget deficit could be £40bn in 2020, academics warn

George Osborne could be forced to borrow billions of pounds more than forecast by 2020 if he sticks with spending cuts that will hit economic growth, according to a report by City University.

With only days to go before the chancellor’s autumn statement, the report says the Treasury has underestimated the impact of welfare and departmental spending cuts on the broader economy and especially cuts to public sector investment.

Without a boost to public infrastructure, private sector businesses will limit their own investment plans, leading to lower productivity and depressed GDP growth over the next four years.

By 2020, the government will be forced to report a £40bn deficit instead of the planned £10bn surplus, the report concludes, undermining Osborne’s fiscal charter, which dictates that governments borrow only in times of distress.

The study by two academics from City University comes only days before the chancellor is expected to tell parliament that he plans to achieve a budget surplus by 2020 from a mixture of cuts to departmental spending and welfare and from higher tax receipts, especially income tax and national insurance.

But he is already off track in 2015-16 after a run of poor figures for the public finances. Last week, the Office for National Statistics reported that higher government spending and lower corporation tax receipts than expected in October had sent borrowing to its highest for that month since 2009.

Richard Murphy, an academic at City University who has advised the Labour leader, Jeremy Corbyn, said the £50bn gap in borrowing was likely because the Treasury would repeat the same mistakes it made between 2010 and 2015, when the coalition government borrowed £160bn more than predicted.

He said the government planned to ignore a study by the International Monetary Fund (IMF) that showed cuts to public expenditure during the recovery from a financial crash can result in lower growth, depressed tax receipts and the need for higher borrowing.

The analysis of the multiplier effect from spending cuts shows that far from allowing private consumption and investment to accelerate, it remains modest at best, limiting growth and tax receipts.

Murphy said: “The very low multiplier the Treasury uses assumes that cuts in government spending will stimulate growth. That’s an assumption, and not a fact.

“It is one the IMF now disagree with. And the result of basing policy on that multiplier is we have more cuts than we need, lower growth in the UK economy as a result, lower earnings for most households and so lower tax revenues – which actually makes balancing the government’s books harder,” he added.

The Treasury and the Office for Budget Responsibility (OBR), which makes forecasts based on Treasury spending plans, assume that the multiplier for every £1 of public spending cuts is less than 70p for the economy as a whole. But the IMF study showed it could be as much as £1.70 as private businesses recoiled from making long-term investment decisions while the government retrenched.

Murphy pointed a report by the credit ratings agency Standard & Poor’s, which argued that every extra increase in public investment spending of 1% of GDP in one year would lead to a multiplier effect of two-and-a-half times over three years.

“We also project that such investment would add more than 300,000 jobs in the same year as the increase occurred,” said S&P.

Murphy said: “The fact that Osborne looks certain to already miss his 2015-16 forecast by some way just makes it clear that neither the Treasury or OBR seem to have learned the error of their ways and continue to impose austerity on the UK for wholly inappropriate reasons as a consequence.”