Global Insight Perspective | |
Significance | At first glance, the chancellor appears to be leaving the Treasury with a "big bang" with his 11th budget, the reduction of the basic rate of income tax from 22% to 20% and the trimming of corporation tax from 30% to 28% from April 2008 being the most eye-catching measures. |
Implications | Overall though, our impression is that there is less here than meets the eye, with there being many examples of the chancellor giving with one hand and taking back with the other. For example, the cut to corporation tax is largely offset by other measures, such as a reduction in capital allowances and a rise in small company corporation tax from 20% to 22% by 2009. |
Outlook | Although the budget is largely neutral fiscally, the chancellor has nonetheless been forced yet again to raise his borrowing projections, thanks in part to falling North Sea oil revenues. Politically, the budget has managed to steal some of the Conservatives' thunder on tax cuts, but Brown needs to do more to convince the electorate that he can make a convincing prime minister. |
Seeking Attention
Gordon Brown has served as Chancellor of the Exchequer since 1997 and has aspirations to figure among the "greats" who have occupied that post over the centuries. He has probably done enough to do so—whether by luck or design, the economy has seen exceptionally stable growth throughout the period, public finances have remained robust, and there have been plenty of bold spending and tax initiatives thrown into the mix. Yesterday's budget will almost certainly have been Brown's last as he prepares to slip into the role of prime minister when it is vacated by Tony Blair this summer. Brown may have impressed as chancellor over the years, but he is still having trouble convincing voters that he is right for the top job. The 2007 budget was one of his key opportunities to boost his popularity and to eat into the strong poll lead enjoyed by Conservative leader David Cameron.
The budget measures certainly succeeded in grabbing the limelight, as well as some positive newspaper headlines. Brown was expected to make some gestures on tax, but the cuts in the main personal income tax rate and the corporation rate came as a surprise. The changes are described in detail below. The budget also contained a number of significant “green” initiatives, again an area where Brown is competing keenly with Cameron. The chancellor did not forget the disadvantaged either—there were more measures to help the poorest and the elderly. It is nonetheless obvious that in order to guard fiscal neutrality, Brown has had to make up the difference—something the Conservatives wasted no time in highlighting.
Key Measures
- Personal Taxation: The basic rate of income tax for individuals will fall from 22% to 20% from April 2008, the lowest level in 75 years. However, the lower 10% band (which Brown himself introduced) will be scrapped from April 2009. The bands will meanwhile be widened—the top 40% rate now applying to earnings over £43,000 rather than £38,000, although an equivalent rise in the National Insurance ceiling will reduce the benefit. The capital gains tax allowance will be raised from £8,800 to £9,200 this year. Poorer individuals will benefit from an increase in the working tax credit—the earnings level at which a family with two children starts to pay tax is now set at £22,500, and will rise to £24,250 by 2009. Child benefit for the first child will rise by 15% by 2010, while the tax-free limits for pensioners are to rise annually through to 2011. Recognising the surge in house prices, the budget hikes the inheritance tax allowance from £285,000 to £350,000 by 2010. Taxes on cigarettes will rise sharply, and more gently on alcohol. The annual allowance for tax-free cash ISAs will rise to £3,600 from April 2008.
- Corporate Taxation: As with personal taxation, there is a “give and take” picture for corporate taxes too.The standard corporation tax rate will fall from 30% to 28% from April 2008, although the rate applied to small businesses will rise from 20% to 22% by 2009. This is ostensibly designed to discourage contractors from setting themselves up as companies and lowering their tax bill. Small firms will benefit from a change that allows them to claim 100% tax relief for new capital investment up to £50,000, but relief intended for industrial buildings will be phased out at the same time (a major blow to many property firms). Annual relief for long-life assets will be raised from 6% to 10%. Some businesses will benefit from a hike in the research tax credit by an extra £100 million, as well as some changes to corporation tax rules to enhance research and development (R&D) allowances.
- Public Spending: In line with past investment pledges, the total education budget will reach £74 billion by 2010, and the National Health Service (NHS) will receive an additional £10 billion this year. The 2008-11 investment levels will be decided in the next spending review. The defence budget will be boosted by £86 million this year, lifting the security and intelligence spend to a total of £2.25 billion. The armed forces will receive an additional £400 million.
- The Environment: There are several eye-catching “green” moves in the budget, although environmental groups were quick to argue that they do not go nearly far enough. The tax on the highest-polluting vehicles or 4x4s rises by £300 immediately and by £400 in 2008. The tax on low-emission vehicles meanwhile falls from £50 to £35. Value-added tax (VAT) is to be cut from 17.5% to 5% on environmental products for the home, while landfill tax will rise by £8 a year from next year until 2011. Tax relief on empty business property will be restricted to six months, and to three months on empty retail space, in a bid to maximise usage of existing premises. New "zero carbon" homes worth up to £500,000 will be exempt from stamp duty until 2012, and for other buildings insulation grants of up to £4,000 are on offer. The environment overseas is helped by a £50 million fund to protect rainforests.
The Macro-Economic Picture
From an overall macro-economic point of view, the key feature is the chancellor's comment that the measures "will be broadly neutral for the public finances and overall". The tax cuts may look bold, but they are carefully balanced; Brown is not going to throw away his (rather battered) reputation for prudence at this late stage. Nevertheless, the chancellor has been forced to raise his borrowing projections, albeit modestly, although he has largely attributed this to anticipated reduced tax revenues from North Sea oil companies. The current budget deficit is now projected to be higher in both 2006/07 and 2007/08, while the expected surpluses are reduced modestly from 2008/09 through to 2011/12. Similarly, while the Public Sector Net Borrowing Requirement (PSNBR) for 2006/07 has been trimmed from the level expected in the Pre-Budget Report, it is has been raised from 2007/08 onwards. The chancellor stated that he has met the ”golden rule” over the current economic cycle, which he argues started in 1997/98 and ends in the current quarter. Indeed, he claims that there has been an £11-billion surplus. As the boundaries of the cycle have been moved so frequently in recent times, this has to be taken with a rather large pinch of salt. However, the new cycle is starting with the public finances in a weakened position, and the government will need to tightly control public spending over the coming years. Indeed, real public spending growth is set to be limited to around 2% per annum from 2008/09, although the chancellor confirmed that education would receive preferential treatment.
Having trumpeted the performance of the economy under his tenure, highlighting (admittedly with some justification) its extended strong, stable, low-inflation growth, the chancellor maintained his GDP growth forecasts of 2.75-3.25% in 2007 and 2.5-3.0% in 2008. He also forecast growth at 2.5-3.0% in 2009. The forecasts are certainly defensible and realistic, although we are modestly less optimistic. Specifically, we forecast GDP growth at 2.7% in 2007 and 2.6% in 2008. If growth does come in lower than the chancellor expects, it will increase the risk that he will miss what we believe are still optimistic-looking public finance targets.
Outlook and Implications
The 2007 budget is certainly eye-catching, but the fact that as much is taken with one hand as is given with the other means that its impact on voters is likely to be neutral. Brown was wise not to throw away his reputation for prudence and inflate the deficit after all his hard work since 1997, but he looks unlikely to claw back the poll lead enjoyed by the youthful Cameron in a hurry. Brown may be one of the United Kingdom's most impressive chancellors to date, but the jury is still out on whether he can make a good prime minister.
In terms of the business implications of the budget, there was certainly some cause for cheer. The cut to the corporation tax rate had been lobbied for heavily and some (but by no means all) of the tax-relief measures will also help. The changes have helped to simplify some parts of the code too. Companies producing “green” products will benefit from greater consumer demand as the tax cuts lower prices. However, many companies will be hit hard by other measures—notably in terms of property tax relief. In general the corporate tax changes have somewhat penalised those companies that are relatively unprofitable with large fixed assets, in favour of those that are more profitable with lower assets.