Now the Conservatives and Liberal Democrats agree over the need for spending cuts this year, the question is are they also in agreement over the relationship of reduced spending to raised taxes?

While unwilling to specifically commit to his parties’ favoured 80:20 ratio of cuts to taxes rises, David Cameron was this morning fairly adamant that something along such lines was the best way to proceed.

The Claim

Speaking on the Today programme, the Prime Minister said: “If you look internationally at when countries have had to deal with horrendous budget deficits, like the one that we were left by Labour, the international evidence shows that the 80-20 split is about the right proportion ... That is if you like the gold standard that has been set internationally”.

So does the historical evidence back him up, and can the Conservatives ratio be considered the international “gold standard.”?

Analysis

The economic argument has been made that a high ratio of cuts to tax rises is the recommended way to tackle a budget deficit.

In summarising the economic literature of fiscal consolidations, David Smith from the Institute of Economic Affairs, noted two essential approaches to deficit reduction.

Type one implements government expenditure cuts, including spending on public sector wages and employment. Type two depends mainly on tax increases and cuts in public sector investment.

Mr Smith argues that type one adjustments expand output and boost competitiveness whereas type two risk leading to a worse budget deficit and reduced economic activity.

Policy Exchange released a report on tackling the budget deficit which recommended the UK Government aim to deliver an 80:20 split in spending cuts and tax rises to tackle the deficit.  

Full Fact spoke to the author of their report, Dr Andrew Lilico, who confirmed that the ratio was an established recommendation for budget reduction, citing the work of Harvard economist Alberto Alesina.

 In 1996, Alberto Alesina and Roberto Perotti published an analysis of previous fiscal tightenings which concluded that "fiscal adjustments which rely primarily on spending cuts on transfers and the government wage bill have a better chance of being successful and are expansionary. On the contrary, fiscal adjustments which rely primarily on tax increases and cuts in public investment tend not to last and are contractionary.". 

While such academic work may help back up the Prime Minister’s claim that the 80:20 ration is seen as “about right", recent examples of deficit reduction have relied on a significant amount of tax increases as well as expenditure cuts. 

 In the early 1990s Sweden suffered a deep recession and its budget deficit by 1994 stood at over 10 per cent of GDP. Government action meant that within three years the deficit fell to 2 per cent. However, despite determined action to reduce spending it still only accounted for just over half of the savings – 53 per cent, versus 47 per cent achieved through higher taxes. 

Canada and Finland During the mid  mid-1990s Canada and Finland had a similar pattern of successful fiscal consolidation. In Canada, 60 per cent of savings came through expenditure cuts with 40 per cent tax rises. In Finland the figures were 55 per cent versus 45 per cent respectively.

Research by the OECD also suggests that historically Government’s have not used spending cuts quite so readily.

Their  analysis produced in 2008 of 85 different examples of budget consolidation showed that in two thirds of cases revenue increases  accounted for a higher portion  of  deficit reduction than that achieved by spending cuts.

However their report also stresses preference for spending cuts as the means to tackle deficits.

Stephanie Guichard, who produced the research explained to us that while the evidence suggested an emphasis on spending reductions produced fiscal consolidations that were stronger, historically such options had been thwarted by political considerations.

“In reality, it’s usually politically more difficult to reduce expenditure than to raise taxes.”

“You get more people protesting in the streets if you start cutting civil servants’ salaries or if you try to change some of the social benefits than if you do things with taxes."

She added: “It also takes longer to implement durable expenditure cuts as that may require important and painful reforms. For instance to improve the efficiency of the healthcare system, you need to implement comprehensive reform of the health care sector, which make take several years to be completed. In the same way reducing durably expenditure on public wages requires important public administration reforms and cannot be achieved by emergency measures across the board on wages”.

“Such in-depth reforms of public expenditure are supposed to produce stronger consolidations, but in practice it can be easier to increase taxes if you want to get quick results”. 

“In the past some countries have relied on switching strategy where they start consolidation by raising taxes and/or cutting public investment and then move to a broader strategy involving expenditure cuts that are more politically sensitive and also take more time to implement.”

Conclusion

There appears to be theoretical backing for the kind of ratio between cuts and tax rises espoused by the Conservatives prior to the election, based on analysis of past plans to tackle deficits.

However if the Prime Minister’s comments were intended to mean that the 80:20 ratio had been  a near-universally adopted approach in the past, this is not what has happened, in recent budget deficit  events as shown in the examples above.

These cases suggest the biggest obstacle to achieving such ratios would appear to be political considerations.  Looking ahead for the UK it seems more than likely that such factors will again play a role in determining whether the 80:20 ratio is used by the Government  - particularly as it is a coalition with all  the added political tensions that arise from such a partnership.