By Andrew Holt

The Government will need to set out £48 billion of additional cuts to annual public spending or tax rises at the next spending review in order to get the deficit reduction plans back on track, according to new analysis published today by the Social Market Foundation and the Royal Society of Arts (RSA).

Replicating models used by the independent Office for Budget Responsibility (OBR) to predict the size of structural deficit, the SMF’s economists find that the OBR’s forthcoming report on the UK economy is likely to reveal that the black hole in the public finances is significantly larger than previously thought.

In the paper, Fiscal Fallout, the RSA concludes that the government must use the forthcoming spending review to explore a radical remodelling of public service provision if the Chancellor is to stand a chance of tackling this growing hole in the public finances.

The 2010 spending review was supposed to finish the job of deficit reduction by 2014, but the next one looks set to lay out much more pain.

The small-print of the March 2012 Budget implied that £26 billion of new cuts would be required beyond this spending review.

Since then, the deteriorating economic situation means that a further £22bn of cuts will need to be found by 2018 to achieve those plans.

This will mean savings of 23% from departmental spending will needed if current spending priorities are to be protected and £10.5bn from welfare is found.

This huge hike in the extra cuts required is both because government borrowing looks set to overshoot the OBR’s forecast this year, and because OBR models suggest that the economy’s potential to bounce back from recession is substantially smaller than assumed at the time of the 2012 Budget.

This means that the structural deficit is 1.1% of GDP larger this year than was expected back in March.

Ian Mulheirn, director of the SMF and author of the economic analysis, said: “According to the OBR’s own models, the economy appears to have less room to bounce back than previously thought.

"Combined with high public borrowing since March this implies a much bigger black hole in the public finances, making the stakes for the next spending review higher than ever”

“Combined with the savings pencilled in at the last Budget, the developments since March means that the Chancellor will have to lay out some eye-watering cuts at the next spending review and will prolong austerity deep into the next parliament.

“Looking across the decade, the combined effect of the 2010 spending review, and the next one will, on current plans, mean that by 2018 spending in some departments will have been decimated."

Responding to these alarming figures, the RSA argues that currently there is little sense of coherence between the national strategy for achieving fiscal sustainability and the Government’s plans for reforming public services.

It maintains that there should be a radical re-evaluation of the way public services are delivered, focusing on localising public finances, promoting preventative services, and shifting spending towards investment in human and physical capital.

The RSA warns that the welfare budget is not a bottomless pit for cuts, and that we will incur a massive human cost if it continues to be treated as one. Neither can we keep salami-slicing government departments as they are currently configured, the report concludes.

Instead, the RSA’s 2020 Public Services Hub calls for the spending review to re-evaluate the provision of public service delivery to promote ideas like the Living Wage and localised spending on growth.

Ben Lucas, RSA chair of Public Services, said: “Faced with the unprecedented level of cuts to public spending outlined by the SMF, we can’t continue to tinker around with a model of public services that was designed in the 1940s.

"What’s needed is a radical new approach based on social productivity which moves away from Whitehall towards local-based collaboration, integration and shared services.

“I would urge the Chancellor to use the spending review as an opportunity to kick-start this debate. Without genuine reform public services will be overwhelmed by the twin pressures of growing demand and deep expenditure cuts.”

Key findings from Fiscal Fallout: the Challenge ahead for public spending and public services include:

The OBR’s forthcoming report on the UK economy is likely to show that the output gap (the gap between the economy’s performance and its potential) has narrowed to just -1.8% from 2.7% suggesting that there is around a third less room for the economy to bounce back than previously thought

According to the OBR’s models, the structural deficit is 1.1% of GDP larger this year than previously expected. In 2018’s terms, this means it is £22bn bigger than planned.

The Government is likely to miss its fiscal target to eliminate the structural deficit within five years unless deeper cuts are made in the three years to 2017/18.

This outlook means real terms cuts to departmental spending between 2015 and 2018 of 3.7% each year to achieve the plans set out in Budget 2012 – faster than the pace of cuts over the current spending review of 2.3% per year.

These extra cuts from 2015 will mean that some unprotected departments, including the Home Office and Ministry of Justice, are likely to be over 40% smaller in 2018 than they were at the start of the decade, according to the SMF’s analysis

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