No easy choices in budget cuts

Budgets are set to see increasing pressures in the years ahead

The cuts are coming. That much is clear. If David Cameron is right in saying it's going to affect every family in the country, what does that mean for you?

There has already been a down-payment on deficit reduction measures, with the new UK government taking nearly £6bn out of spending this year - roughly one pound in every hundred.

We learned this week how large the deficit is likely to be and what economic growth will look like, as calculated by the new Office of Budget Responsibility (OBR).

The extent of tax changes, and overall increases, will become clearer when George Osborne delivers his first Budget next Tuesday. A Comprehensive Spending Review follows some time in autumn.

In Scotland, Finance Secretary John Swinney has to set out his budget plans for the financial year starting next April - a year which looks likely to face cuts of at least 3.5%, and perhaps up to 6%.

That's a cut on a scale we've never seen before. So how does this affect you, the public services you use, and, more widely, how does it affect Scotland? The answers will become clearer as the UK and Scottish governments set out their spending plans, but here is at least some explanation of what's being faced.

Why are cuts necessary?

Britain's debt is far from being the highest in Europe, at 68% of national income, but its deficit (the annual overspend that compiles over years to form the stock of debt) is higher than almost any other, also measured as a proportion of national income.

For every £10 we make as a country, £1.11 is being borrowed by government.

That annual overspend builds up into a big debt very quickly. Last year, British government had to borrow £156bn more than it spent. This year, the OBR says it will be around £155bn.

Borrowing is healthy in moderation, but there's nothing moderate about the extent to which Britain is currently selling bonds to investors.

If it doesn't look a credible creditor, and doubt creeps in that the government may not be able to repay that debt, then its credit rating will fall, the risk of holding UK government debt would go up, meaning a higher interest rate and that would put up the cost of servicing the debt even more.

Meanwhile, even if the deficit reduces and the debt stabilises, it is already costing more to service that debt - at today's exceptionally low interest rates - than Britain is spending on defence.

How much to cut back, and how fast, are political decisions. The Conservatives in the new government reckoned during their election campaign that a £661bn budget had to be cut by around £64bn over the next five years.

While their opponents say cuts will be necessary, they argue for a delay in applying them, while helping stimulate the economy back to the private sector growth with which to bring taxation and spending back into kilter.

Why has taxation and spending become so out of kilter?

When the economy contracts, which is what happens in a recession, there is less paid in tax. People have less income on which to pay tax, they pull back on spending so VAT falls, companies make lower profits so there's less corporation tax, and there are fewer home transactions on which stamp duty is paid.

That meant last year that revenue from taxation fell by 5.3%.

Meanwhile, governments costs go up, in paying out benefit to those who are unemployed, and because a rising debt means rising debt payments.

The government also chose last year to increase spending and cut tax temporarily to help keep people and businesses spending. Last year, government spending rose by 6.8%.

When is the best time to tackle the deficit?

That's a contentious one. The international consensus has shifted in recent months. It was believed that it was too soon to rein in overspending, for fear the reduction in government spending would kill off the fragile private sector recovery.

But the crisis in Greece, where the overspend risked a sudden drying up of credit to service its debt, sparked fear of contagion, and the international consensus, particularly in Europe, rapidly shifted to the need to get deficits down quickly.

At the same time, Britain's new government could claim to have a mandate to move more swiftly with deficit reduction than Labour had planned.

That change of mood hasn't removed the risk that a sudden reduction in government spending could throw the recovery into reverse, particularly if it's applied across Europe. However the risk of debt default by governments was judged greater than the risk of another downturn.

Scotland has devolved spending powers - what difference does that make?

With few taxation powers and no borrowing powers, the Scottish Parliament and government have to work with the block grant handed to them by the Treasury.

That block grant could have taken a £322m cut in the current financial year, through applying the funding formula from which the block grant is calculated.

But as an act of goodwill, to avoid the devolved administrations having to rework their budgets, the new Chancellor, George Osborne, said that cut could be deferred. In Scotland, that means the cut of £322m will be applied from next spring, at the same time that a much steeper cut is also applied.

It is reckoned that the Scottish budget will also be reduced next year because the Holyrood administration has reached the end of a fund of unspent money that had been saved up over previous years.

With those different elements, Glasgow University economists reckon the cut could be a particularly severe 5 to 6%.

The scale of the cuts over the following two years is expected to continue at the same pace, requiring cuts of more than 3% per year.

The relatively good news for Scotland is that health, education and policing are unlikely to take the worst of the cuts across Whitehall departments, so there will be a knock-on effect in protecting Holyrood's main spending departments. That will become clearer with the Comprehensive Spending Review this year.

There's a disadvantage however. Because Scotland weathered the recession relatively well through having a cushion of higher public spending and a higher proportion of public sector jobs than in England, the downside is that cuts in that government spending will have a disproportionately larger effect.

How are we going about cuts in spending?

That's a lot less clear. The new government in Westminster has set out its £6bn spending cuts for this year. On Tuesday, the Budget should make clear the changes it will make in taxation. Some could be applied this year, and some will wait until next April.

The Comprehensive Spending Review, in autumn, will set out the plans for the 2011-2015. That will provide the figures with which John Swinney will have to work for the Scottish budget for at least 2011-12.

The finance secretary has commissioned a three-man budget review group, under the leadership of Crawford Beveridge, a businessman from the electronics sector who was chief executive of Scottish Enterprise.

It is scheduled to report next month, with suggestions for how to handle the likely squeeze on public spending.

That is the starting point for a debate on what government in Scotland has to prioritise and protect, which programmes it has to pare back or axe altogether, and how much users of public services may be required to contribute in user charges and fees.

How is taxpayer spending being spent now?

In broad terms, the £661bn of government spending in the UK is spent on:

• Health: £119bn

• Education: £84bn

• Pensions: £119bn

• Welfare: £105bn

• Others: £234bn

In making cuts, it is hard to bring welfare under control without changing the terms under which people can claim it. Likewise, public sector pensions carry legal obligations, so they're very difficult to cut, at least in the short-term. (In the long-term, they're very much in the frame.)

The new Westminster government has promised to protect NHS frontline spending, as well as international aid, and promises to older voters, including the winter fuel payment and free bus travel. That leaves fewer spending departments to share more of the pain.

In Scotland, the government at Holyrood is responsible for spending £35bn. More than £5bn of that is on programmes over which it has limited control, such as pensions.

The big spending heads are:

• Health and housing: £12.3bn

• Local government, including schools: £10.5bn

• Economy and transport: £3.2bn

• Education other than schools: £2.8bn

• Justice: £2bn

• Rural affairs: £500m

That's the starting point. Squeezing a household budget is much easier, as it includes more discretionary spend.

Squeezing a government budget is much tougher, because it's political and politicians are accountable. And the easy cuts in one area can push up costs in another: civil service job losses mean more people claiming unemployment benefit.

Or the impact could come after a few years. Save on IT systems this year, and you may find the result is that productivity falls in four years. Or cut back on nursery education, and you may pay the price for decades to come.

Nobody said it was going to be easy.