A reality check for fiscal Pollyannas

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British governments will need to make tough choices about taxes and public spending in the decade ahead. These choices are inevitably political. But they can only be well made if the information on which these choices are based is not.

The British government will on Wednesday announce the largest financial deficit in peacetime history, along with projections of how that deficit will be reduced. But these forecasts no longer have credibility.

Anticipating tax revenues is difficult, and with total receipts in excess of £500bn ($815bn, €550bn) even a small error implies a big number. A billion here, a billion there, and you are soon talking serious money, as the saying goes. In the past, both surpluses and deficits were usually underestimated, because underlying forecasts of economic growth were unreliable.

But no longer. The chart below shows the recent pattern. The fiscal outlook covers five years, with the first forecast made four years before the relevant fiscal year begins. This always shows a comfortable surplus and is always wrong. Each successive forecast is downgraded and the outcome is worse than any forecast. The underlying trend is for public finances continuously to worsen, while the forecasts predict continuous improvement.

The incompetent but committed entrepreneur always expects positive profits and cash flow a couple of years ahead and this never happens. Perpetual optimism is necessary for the entrepreneur: few people would set up small businesses without it. But excessive optimism is not a desirable characteristic in chancellors of the exchequer. Nor is it one that used to be associated with them. They were the killjoys of government, not the Panglosses.

Background documents to official statements such as the pre-Budget report were once objective, technical affairs, read only by the cognoscenti. Today, they are written in the style of the corporate PR executive. Selective in their presentation of information and suffused with self-congratulation, they are unreadable for different reasons and probably read by no one at all.

Wrong again

The politicisation of the civil service was a feature of the Thatcher years, but it gathered pace under the present government. The people who prepare the filtered data and the irritating prose are not primarily – or often at all – motivated by partisan loyalties. They are certainly not dishonest and the documents do not contain information that is untrue, although that cannot necessarily be said of the political statements that accompany them.

But loyalty is today valued more than competence. Advancement is better achieved by telling your superiors what they wish to hear than being the bearer of unwelcome news. The economic world is necessarily uncertain and there is usually a range of estimates that can be defended. But always to choose the best from that range is to create bias, and the bias may be very large. So it seems to have been with forecasts of public finances. Almost without exception, they have been proven unduly optimistic by events.

The consequences of this Pollyanna approach have been serious. The deficit that will be disclosed on Wednesday is largely caused by the financial crisis and its consequences. But the reason Britain’s fiscal problem is today so serious is that the country entered the present recession with a large structural deficit. That deficit is the direct result of the persistently unrealistic projections made since the turn of the century.

In all areas of government, processes that deprive politicians and the public of honest feedback impose large economic costs. In the field of fiscal policy, at least, there are clear steps that can be taken to improve the situation. The main requirement is to depoliticise the presentation of data. The best mechanism for this is a fiscal policy commission with independent responsibility for projections of the public finances. Such bodies exist in several other countries and the opposition Conservatives have proposed to establish one in Britain.

Such a commission would make formal recommendations on the balance between income and expenditure and spell out the future costs of current policies. It would need access to the models on which revenue estimates are based and should be involved in the processes of planning and reviewing public expenditure. As with the monetary policy committee, its members would need to have the status and independence to ensure that their futures did not depend on pleasing those currently in power.

British governments will need to make tough choices about taxes and public spending in the decade ahead. These choices are inevitably political. But they can only be well made if the information on which these choices are based is not.

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