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UK OUTLOOK

Budget effect

Paul Guest of Economy.com examines the implications of what is likely to be Gordon Brown’s final Budget as Chancellor

Gordon Brown presented in the middle of March, what is likely to be his swan song Budget as the Chancellor. This Treasury has presided over a remarkable economic period, in effect the longest uninterrupted expansion in modern history. The main thrust of the Budget, however, is cosmetic, with the main assumptions on growth and debt unchanged from last year. Furthermore, the magnanimous-sounding tax cuts are reclaimed elsewhere in the Budget through the closure of loopholes and other measures. As with any Budget, there are winners and losers.

Basic assumptions

The projections for the economy and for the public finances were basically unchanged from the Pre-Budget Report in December. Real GDP growth will stay in line with trend through 2009 and the projected surplus in the current budget (ie net of investment expenditure) has been pushed out – yet again – by a year. It is now 2008-09 instead of 2007-08. Furthermore, although public sector net borrowing turned out to be lower than expected in 2006-07, the total needed has been – yet again – revised up for each year through 2011-12. The steady declining trend in borrowing has, however, been preserved, implying tighter fiscal conditions once the current spending glut is over and, presumably, once a new Chancellor has implemented the requisite measures.

Implications for businesses

The corporation tax was cut, by two percentage points to 28% from April 2008. The cost, however, will be recouped by recalibrating depreciation allowances, offsetting the benefit for big firms. In fact, the depreciation rate for short-life assets was cut to 20% and even though the rate for long-life assets was increased (from 6% to 10%) the overall change in the tax burden will be adverse for some companies. The tax rate on small companies will be raised in three stages from 20% today to 22% by 2009, though this will also be offset by a big jump in the depreciation allowance for these firms.

In sum, Britain’s headline corporation tax is now the lowest in the G7 and eighth (down from 15th) in the OECD. This makes for good headlines and good advertising for UK plc; however, tinkering with depreciation allowances and an as-yet only partially addressed burden of bureaucratic red tape means that the overall cost of doing business in the UK remains high relative to some of its peers. Furthermore, the total tax take from business as a share of national income will, by 2009, have risen yet again.

Implications for private consumption

Brown’s supposed coup de grâce was a reduction in the basic rate of income tax to 20% from 22%, effective April 2008. Although it sounds like a vote winner, the £4.5 billion net cut (over three years) is not entirely pain-free. The lost revenues will be offset in large part by the elimination of the first tier (10% rate) of income tax, a bracket introduced earlier in Labour’s tenure. A complex reorganization of national insurance contributions will also take effect from 2009. The net effect is a simpler tax system with two brackets and an alignment of income tax and social security contributions.

The results for most private taxpayers will be small, implying an effect on consumption at the margin. Nonetheless, it constitutes a net drop in income tax in 2008, just before Brown could face an election. Politically, the move is astute and gives away little in terms of fiscal probity. Furthermore, the rise in the child tax and the working tax credits, puts a further £2 billion into the hands of needier households. Low to middle-income families with no children will probably see an increase in their tax burden.

Implications for the public finances

The effect of these latest adjustments on the public finances is broadly neutral. There was a big increase in health spending in the near-term, a move aimed at aiding hospitals to overcome their current deficits. Added to the fact that this takes effect at the same time as the proposed tax cuts, and prior to the envisioned tightening measures, it creates added downside risk in the event that the economy disappoints. Furthermore, the health system deficits are partly structural and throwing more money at the problem does not guarantee that they will be eliminated.

In all, it is estimated that the Treasury will take a further £7 billion out of the economy over the next several years, most of it in measures announced in the interim period between Budgets. These are listed as a memo item in the notes, which carefully avoids the political hassle of having to point out that the government’s share of the economy is actually rising. Under current projections, public borrowing still stands at 1.6% of GDP in 2010-11. The biggest worry is that a negative growth shock along the lines of a further surge in oil prices or a collapse in housing market confidence would have severe consequences for the public coffers. The margin of manoeuvre for a future Chancellor has been much reduced if the current, benign economic trend does not endure. Despite its headlines, this Budget is broadly neutral although, as ever, the devil is in the details.

In this case, projections of strong growth in the coming years should get us over the expansionary period, but further out spending risks like the Olympics, not to mention Brown’s brief championing of a future World Cup bid, mean that the public coffers could remain in the red for a lot longer than is currently foreseen.

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