It’s rising prices as much as spending cuts that will give the Coalition a political headache

Published on Public Finances and the Economy

It’s rising prices as much as spending cuts that will give the Coalition a political headache.

Last Wednesday, Bank of England Governor Mervyn King forecast that inflation would remain above its 2% target until at least the end of 2011. British Gas has just announced a 7% price hike.  It all bodes ill for the Coalition.  For now, each day still starts to headlines screaming about cuts.  But come 2015, it’s unlikely that cuts will be the defining issue of the election.  Instead, the framing will be closer to that of the 1980 Presidential campaign: “ask yourself: are you better off now than you were four years ago?”, as Ronald Reagan put it to the American people.

On present trends, the Coalition will be very anxious about that framing.  Their policy agenda pays little regard to the rising costs of modern life that make people feel worse off.  Take the Spending Review. It amounts to a three-year programme to raise the running costs of a working family.  In eight weeks time, VAT will rise to 20%, pushing up household bills for a low earning family by around £400 a year.  From 2012, the cap on regulated rail fares will rise to ‘inflation plus three percent’; the cost of an annual season ticket from Reading to London will be up by as much as £1,000 by the end of the Parliament.  £300 million is to be cut from bus subsidies, to be displaced by fare rises.  Real cuts in funding for childcare will shift the burden to family budgets.

Even in a benign environment these ingredients would make for a dangerous political cocktail.  Back in early 2000, when fuel price protests and ‘Rip-off Britain’ campaigns swept the nation, RPI inflation stood at 2.3%.  Across the spectrum wages had grown year on year, in real terms, for seven years.  Today, RPI inflation is running at 4.7%, even higher for families on modest incomes.  Wages for those on low and modest incomes have flat-lined since 2003.  For these families the smallest of price hikes is keenly felt.  Combine VAT, travel and childcare, and many will be left gasping for air.

Given today’s level of economic uncertainly it is highly unlikely that the Bank will act any time soon to counter rising prices – and in any case, action would raise mortgage repayments, today’s one area of respite.  As for Whitehall, the challenge of tackling rising living costs is now an unfamiliar one.  Any change in the tax system is pored over: charts of winners and losers are forensically scrutinised, the smallest sums can cause a panic.  But when it comes to the escalating cost of a bag of shopping, or a journey to work, there is a collective shrug.

This should all trouble the Coalition deeply, because the families who will be hardest hit – young, working families on modest incomes – are a decisive electoral group.  Their political loyalties are weak and their attachment to rising living standards is strong.  In 1997, they backed Tony Blair in droves.  As living standards flattened towards the end of Labour’s rule, they moved away in ever greater numbers.

For the coalition, the sin is one of commission as well omission. Their public spending strategy promise to turn the screw on those struggling in work on modest incomes. The most under-reported aspect of the Spending Review was the deliberate decision to protect the richest generation of pensioners in history at the expense of working families with children.  In the medium-term, with modifications, the impact of the child benefit cut for the affluent move may fade away.  It will hit some families hard, but won’t eat into spending on necessities.  But cuts to tax credits – which have received no attention – are an entirely different story.  Families on incomes of £20-25,000 will lose as much as £1,500 a year in childcare support from 2012, substantially reducing their ability to meet the running costs of daily life.  Nor will the new Universal Credit help them – in fact it is likely to make matters worse. This is also the group hardest hit by cost rises.  For millions the squeeze will feel physical, and will endure until polling day.

As Labour discovered back in 2000, when the spotlight shifts to prices, things move fast.  There is an immediacy to rising living costs that quickly incites calls for populist tax cuts.  The Coalition’s vanguard policy on that front, and one that Labour will need to support, is the raising of the personal allowance.  It should be noted that the gain from this measure will be outweighed by the pain of others.  Next April’s £1,000 increase in the allowance gives a basic rate tax payer around £170 – less than half the impact of the VAT rise never mind the cuts to tax-credits.

The struggle of those on low to middle incomes to meet the running costs of modern life is not new; it is merely newly exposed.  For the past seven years in the UK, real wage stagnation has been cloaked by rising tax credits and the flood of consumer debt.  Now the latter has dried up and the former is being hacked-back the problem will be forced out in the open, just as it has long been in the US.  For now, spending cuts will continue to dominate debate, as they must.  But in the longer term, the political test for the Coalition – and for Labour leader Ed Miliband – will be the one on living standards posed so devastatingly thirty years ago by a victorious Ronald Reagan.

This post originally appeared on the Independent