IHS Global Insight Perspective | |
Significance | Above all, this was a highly political budget, which was hardly a surprise with a general election potentially just six weeks away. Darling played a difficult hand as well as he probably could, but despite its hugely political nature the budget is unlikely to go down as an election decider. |
Implications | Essentially, the budget is a holding operation until the general election is out of the way and essential, extended deficit reduction can be tackled more openly by whichever party is in government. |
Outlook | More tax rises and spending cuts are coming, but they will not really bite hard until 2011/12. |
U.K. chancellor (finance minister) Alistair Darling yesterday presented his budget for fiscal year (FY) 2010/11. Above all, it was a highly political budget, which was hardly a surprise with the general election likely to be just six weeks away. The chancellor claimed that the government's fiscal stimulus measures enacted in November 2008 and in FY 2009/10 had prevented the recession from being deeper, and he looked to make political capital by warning the electorate that tightening fiscal policy sooner than the government intends (as favoured by the opposition Conservative Party) would risk throttling a still fragile recovery in its infancy.
Dire Public Finances Preclude Major Pre-Election Giveaways
The dire state of the public finances meant that major pre-election giveaways were a non-starter. In fact, the budget was essentially fiscally neutral. However, the chancellor announced a few limited sweeteners to help the unemployed, first-time house buyers, the least well-off, and businesses (especially small businesses). Prominent among these measures was a stamp duty holiday for the next two years for first-time buyers on all properties costing up to £250,000 (US$374,000). In addition, Darling announced a £2.5-billion "one-off" growth package to "help small business, promote innovation, and invest in national infrastructure and key skills".
These measures are essentially being paid for by better-than-expected recent tax revenues (including from the bank bonus tax) and lower unemployment claims than anticipated, as well as by some further targeted tax measures on the well-off. In particular, the stamp duty holiday for first-time buyers is being financed by the raising of stamp duty from 4% to 5% on purchases of properties costing over £1 million from April 2011. There is also some switching around of spending from within existing allocations.
The budget contained no major developments on taxes that had not already been announced in last December's Pre-Budget Report (PBR). The major development in the PBR was that all employer, employee, and self-employed national insurance contributions will rise by a further 0.5 percentage point from April 2011, on top of the 0.5-percentage-point increase that had already been announced for then. However, nobody earning under £20,000 will pay more. Income tax rates were left unchanged, although the chancellor confirmed that the threshold at which the higher rate 40% tax rate kicks in will not be raised in line with inflation for the 2012/13 tax year. He also confirmed that those earning more than £150,000 will face a 50% tax rate from April 2010 (up from the current level of 40%). In addition, pension tax relief will be restricted for people earning over £150,000. The chancellor also froze the inheritance tax threshold at £325,000 until 2014/15. The PBR had also made some modest tax concessions to help businesses. Most notably, the rise in the corporation tax rate for smaller companies from 21% to 22% is being deferred by a year until April 2011.
As usual, the chancellor announced modest above-inflation rises in duty on alcohol and tobacco in the budget. However, he announced that the 3p fuel duty rise that was due on 1 April will now be phased in with 1p increases in April and September 2010 and January 2011. No further changes were announced to value-added tax (VAT), which rose back up from 15.0% to 17.5% at the start of January, having been reduced for 13 months from December 2008 as the key fiscal measure to try to stimulate economic activity.
The chancellor indicated that government spending will rise by 2.2% in real terms in FY 2010/11, in line with previous plans. He stressed that cutting spending in the near term would weigh down on recovery prospects.
Public Sector Borrowing Requirement Seen Falling at Modestly Increased Rate
Meanwhile, the chancellor modestly lowered the anticipated public finance deficit forecasts up until 2014/15, which seems largely due to the assumption that the recent trends that have resulted in the deficit coming in lower than expected in 2009/10 will be extended.
Specifically, Darling now expects the Public Sector Net Borrowing Requirement (PSNBR) to fall from £167 billion in 2009/10 (11.8% of GDP) to £163 billion in 2010/11 (11.1% of GDP), £89 billion (5.2% of GDP) in 2013/14, and £74 billion (4.4% of GDP) in 2014/15. In last December's PBR, the PSNBR had been projected to fall from £178 billion (12.6% of GDP) in 2009/10 to £176 billion (12.0% of GDP) in 2010/11, £96 billion (5.5% of GDP) in 2013/14, and £82 billion (4.4% of GDP) in 2014/15.
At first glance at least, Darling seems to have put little more meat on the public sector deficit-cutting bones from 2011/12. Although the chancellor acknowledged that the next public spending round (to be held after the general election) will be the "toughest for decades", we are not really any the wiser as to where exactly the axe will fall, although more efficiency gains were identified and spelt out. It is apparent that the government is reluctant to reveal where the major spending cuts will occur given that they will not be popular with the electorate.
Furthermore, the public sector finance reduction targets are still based on very optimistic-looking growth forecasts. The Treasury's GDP growth forecast of 1.0–1.5% in 2010 is realistic, but projected expansion of 3.0–3.5% in 2011 seems very hopeful even though this has actually been trimmed from the 3.25–3.75% rate expected in last December's PBR. Furthermore, IHS Global Insight has serious doubts that the economy can grow by 3.25–3.75% in 2012 and thereafter, as forecast by the Treasury. It really is hard to see where growth of this magnitude will come from, particularly given the fiscal squeeze that is coming. Even though the Treasury bases its public finance forecasts on the lowest levels of these growth ranges, the fact remains that the plan for bringing down the PSNBR to a modestly lower-than-projected £89 billion in 2013/14 depends heavily on highly questionable robust economic activity both in 2012 and the following three years.
Outlook and Implications
Darling played a difficult hand as well as he probably could, but despite its hugely political nature the budget is unlikely to go down as an election decider. Nevertheless, the chancellor will probably be relieved to see that the markets have initially reacted to it fairly calmly. In addition, both the Fitch and Standard & Poor's (S&P) credit rating agencies have indicated that the budget will have no major impact on the United Kingdom's AAA rating. However, the clear impression is that the credit rating agencies and the markets see the budget as a holding operation until the general election is out of the way and deficit reduction can be tackled more openly by whoever is in government.