Time for Plan B? IMF tells George Osborne to ease pace of spending cuts

George Osborne has been urged to put his austerity programme on hold by the International Monetary Fund in order to support the anaemic economy.

The IMF’s recommendations, made at the culmination of its annual health check of the UK, effectively amount to a call for the Government to adopt an economic “Plan B”.

In an embarrassment to the Chancellor, whose fiscal policy was once strongly supported by the Washington-based organisation, the IMF said that Mr Osborne should ease the pace of his planned spending cuts. It advised that the £10bn fiscal consolidation the Coalition is due to make over 2013/14 should be “offset” by a package of infrastructure spending and tax cuts.

This would mean there would be no net deficit reduction in the present financial year. Public borrowing for 2013/13 is projected to be £120bn. If the Government were to act on the IMF’s advice the deficit would rise to £130bn.

The Chancellor has long resisted calls to slow the pace of cuts, arguing that to do so could result in a disastrous loss of investor confidence in British government debt and send interest rates soaring across the economy. But the IMF said that the greater risk was that unemployment would remain higher than necessary, economic resources would lie idle, and that growth would continue to disappoint.

“In a range of policy areas, the government should be more supportive of growth” said the IMF deputy managing director, David Lipton, at a news conference held at the Treasury. He also warned against interpreting a run of improved economic data and forecasts in recent weeks as a sign that a firm recovery is taking hold. “What is important now is not to make a mistake today and presume that all will be well with the economy some years from now” Mr Lipton said.

Labour said that the IMF’s advice echoed its own longstanding call for Mr Osborne to ease up on his cuts. “A sensible Chancellor would listen to the IMF’s advice and take action” said the shadow Chancellor Ed Balls. “Only a reckless Chancellor would try to plough on regardless.”

The IMF stated that bringing forward state capital investment in road infrastructure and school building would “cataylze private investment and spur much-needed growth”. It added that the Coalition should look into reducing the level of taxes paid by businesses.

Introducing the IMF report Mr Osborne said he welcomed the Fund’s advice, but Treasury officials would not be drawn on whether the Coalition would act on it. The Chancellor insisted to a conference of business leaders last week that he would not be changing course. “Now is not the time to lose our nerve. Let’s not listen to those who would take us back to square one” he told the Confederation of British Industry.

Under Mr Osborne’s plans the Government’s structural deficit is due to be wiped out 2016-17. The IMF said that the Government was still right to aim to eradicate the deficit over the medium term but, in another blow to the Chancellor, Mr Lipton said that this judgement might need to be revisited if the economy did not recover strongly. “One has to evaluate the impact on policies on the economy as you go so whether the present medium-term framework turns out to be an appropriate one when measured next year or the year after remains to be seen” he said.

In his March Budget the Chancellor outlined £9bn of capital expenditure projects. But work is not due to start on them until after the present Parliament ends in 2015.

The economy grew by 0.3 per cent in the first three months of 2013, meaning that the UK avoided a triple dip recession. And the Bank of England last week revised up its 2013 growth forecasts to 1.2 per cent. But the IMF said yesterday that the UK is “still a long way from a strong and sustainable recovery”.

Health check: The IMF’s recommendations

Austerity

Current policy

A discretionary fiscal consolidation (spending cuts and tax rises) in 2013/14 of £10bn, or around 0.75 per cent of GDP.

What the IMF wants

Offset that £10bn consolidation with government spending on infrastructure projects (such as roads, school buildings) and also tax cuts for businesses.

What it means

The IMF wants the Chancellor to press the pause button on his structural deficit reduction programme in order to keep demand in the economy. Such calls have always been rejected in the past by George Osborne.

Banks

Current policy

Sell the Government’s equity stakes in the Royal Bank of Scotland and Lloyds before the next election in 2015.

What the IMF wants

Selling the stakes is a sound goal but the Government should be prepared to provide a “sovereign backstop” to the banks if necessary.

What it means

The IMF doubts that the banks are yet sufficiently healthy to return to the private sector. It thinks further public guarantees might be needed even after a sale. Unlikely to be welcomed by Mr Osborne, who is highly resistant to giving the bailed-out banks more public money.

Housing

Current policy

Give first-time buyers state equity loans to help them get on the housing ladder and also offer state guarantees of mortgages to persuade banks to lend.

What the IMF wants

Introduce a land tax to encourage owners to put land on the market for residential development.

What it means

The IMF fears Mr Osborne’s “Help to Buy” scheme will not result in more house building but instead inflate a new property bubble. In the medium term, this would make homes even more unaffordable to first-time-buyers.

Value Added Tax

Current policy

In the March 2012 Budget, the Chancellor announced plans to impose VAT on all hot takeaway foods. But he backed down after a barrage of complaints that this would penalise those who buy hot pasties from bakeries.

What the IMF wants

Broaden the VAT tax base to raise revenue and eliminate loopholes.

What it means

The IMF thinks the Coalition should have held firm over the “pasty tax”. It also thinks other VAT exemptions for sales of books, magazines, food and children’s clothes should be scrapped.

Property taxes

Current policy

The Lib Dems have been pushing for an annual “mansion tax” on houses worth more than £2m to help reduce the deficit. But this has been vetoed by the PM.

What the IMF wants

Reform property taxes as part of a broader shake-up of tax in order to encourage growth.

What it means

The IMF thinks property is undertaxed and that higher levies on this source of static wealth are a more growth-friendly way of reducing the deficit than taxes imposed on company profits and investment.