The fiscal stranglehold is killing New Labour

It is astonishing how quickly UK fiscal policy turned into a nightmare. During the first half of the last fiscal year, tax revenues were performing reasonably well. However, the deterioration in the second half was dramatic.

The chart above illustrates the sudden reversal of fortunes. It compares central government monthly revenue collection between April 2008 to March 2009 with the previous year. The change is expressed in percentage terms.

As the chart suggests, revenue collection after September last year fell off a cliff. Compared to 2008, central government revenues are down about 3.5 percent. But as I've already said, the decline is back end loaded. In March 2009, revenues were down 12 percent compared to March 2008.

A large part of explanation lies with last year's ill conceived VAT rate reduction. This was possibly the most shortsighted and ineffectual policy decision that New Labour ever introduced. It did nothing to boost consumer expenditure. All high street stores were offering significant discounts anyway. The decline in economic growth continued unabated. The reduction did however put a massive hole in the public finances.

On the expenditure side, the government continues to spend as if the economy was booming. During the last fiscal year, expenditures were up 5.4 percent. That's the kind of number that a government can get away with when the economy is growing at three percent a year. It is also the sort of number that spells disaster when the economy is contracting at the speed that we now see here in the UK.

Recent fiscal performance is in many respects a mirror of the political crisis that now faces New Labour. For the last decade or so, it sold itself as the party that could prudently increase public expenditures while maintaining macroeconomic stability. This required limited fiscal deficits and a rising tax to GDP ratio.

However, with revenues declining, the sales pitch is no longer credible. At some point, drastic public expenditure cuts are inevitable. Anyone who bothers to look at the public accounts knows this, and that includes the New Labour leadership.