Pre-Budget Report 2008: tax cuts, tax rises

27 November 2008

In what was billed as the most significant Treasury statement in decades, the Chancellor, Alistair Darling introduced his pre-Budget Report to the Commons against what he described as a “background of uncertainty not seen for generations” and at a time of “extraordinary” challenge for the global economy.

He went on to say that he wished to take steps to “protect and support businesses and people now” while putting public finances on “the right path for the future”.

The government has made little secret that it sees a package of fiscal measures as essential to reversing the slowdown in the economy.

So it was no surprise that Mr Darling announced £20 billion of tax cuts and funding measures – 1 per cent of GDP – to stimulate economic and business activity.

The economy

Before getting into the detail of his plans, Mr Darling conceded that recession is on its way. The economy would expand by just 0.75 per cent this year and would shrink by 1 per cent next year. Only in 2010 would growth resume, the Chancellor said, predicting an expansion of between 1.5 per cent and 2 per cent.

With the government committed to borrow in order to fund both tax cuts and to boost public expenditure, the Chancellor forecast that the budget deficit would climb to £78 billion this year and £118 billion next (equivalent to 8 per cent GDP and a record for the post-war years), scaling back to £54 billion by 2014. Nevertheless, the UK’s national debt, which at the moment is a little below 40 per cent of GDP, will inflate to a massive 57 per cent.

The UK, the Chancellor claimed, would only be borrowing to invest again by 2015/16. The government’s golden rules – that current spending, save capital expenditure, should balance out over the economic cycle and that total public sector debt should not rise above 40 per cent of the whole economy – have been abandoned as a result of the financial crisis.

The level of borrowing, and the time span over which it will last, mean that the Treasury will be running significant deficits of national income until 2013, a shortfall caused by both the anticipated drop in the tax take – unemployment is set to rise and company profits will be squeezed tighter by the economic downturn – and the tax cuts.

Spending

Public spending is one of the twin pillars of the government’s approach, and some £3 billion of capital expenditure scheduled for 2010/11 were brought forward to this year; the funds are to go on investment in roads, schools, social housing and new energy measures.

The construction industry, which has been flat on its back since the housing market fell apart, should receive a welcome boost from the news.

Tax cuts

The second pillar is the much-heralded series of tax cuts, the intention of which is to encourage consumers to loosen household purse strings. In the most eye-catching, VAT is to be cut temporarily as from 1 December by 2.5 per cent to 15 per cent.

The increase in the income tax personal allowance of £120 a year for basic rate taxpayers is to be made permanent and to be raised to £145 in April, a move which has effectively reversed the decision to abolish the 10 pence tax rate.

Small businesses also received some welcome news. The planned increase in the small companies’ rate of corporation tax, from 21 per cent to 22 per cent, has been put back and will stay at 21 per cent during 2009/10.

The threshold at which an empty property becomes liable for business rates is increasing temporarily. For the financial year 2009/10, empty premises with a rateable value of less than £15,000 will be exempt from rates.

Businesses that find themselves struggling to pay VAT, corporation tax, PAYE, income tax and NICs will be able to make use of a new HM Revenue and Customs service. The Business Payment Support Service means that firms facing temporary financial problems can negotiate spreading the payment of tax bills over a period of time they can afford.

Business

The Chancellor also proposed a package of measures to improve the levels of funding available to cash-starved firms.

Early next year, the government is to set up a Small Business Finance Scheme, a temporary programme that will guarantee £1 billion of public money to encourage banks to lend to businesses. Another £1 billion will go to provide smaller exporters with easier access to short-term working capital.

Tax rises

Just as the Chancellor’s tax cuts came as no surprise, so too his announcement of plans to raise taxes in the future to help reduce extra levels of government borrowing were not unexpected, not least in the reassurance they offer the City that he is still in command of public finances.

As from April 2011, Class1 and Class 4 NICs are to be increased by 0.5 per cent.

Also as from April 2011, taxpayers earning more than £150,000 a year will pay an increased tax rate of 45 per cent. Personal allowances for high earners are also to be cut.

Public finances

Efforts to fill the hole that is to be created in public finances will additionally include substantial reductions in investment expenditure by the government. Once the current spending round is complete, government expenditure will represent 44 per cent of GDP. The last Budget forecast that total public spending would grow by 1.8 per cent in the years 2011/12 and 2012/13. The pre-Budget Report shaved this to 1.2 per cent for the next spending round, a reduction in the three years from 2011 by £37 billion. Even though public expenditure will continue to expand, it will be at a scaled down rate.

Debate has raged over whether the increases will be sufficient to reduce the borrowing on which the government is set. And over whether the cut in VAT, estimated to represent a pump-priming £3.8 billion this year and £8.6 billion next, will actually encourage consumers to return to the shops.

The worry is that household budgets are already over-stretched and that people will continue to react by reining in spending. While economic rationalism dictates that consumers should pay off debts when the financial sun is shining and borrow and spend when the clouds are gathering, the instinctive response is to do the opposite.

Although some of the extra public finance deficit will be self-amending –VAT will resume its old level of 17.5 per cent at the end of next year – balancing the government’s books will depend on the accuracy of future growth forecasts. The Chancellor believes the economy will expand by about 1.75 per cent in 2010 before sailing into happier waters of 3 per cent growth in the next year. If, however, growth targets go awry, then the government’s tax take will suffer.

Perhaps the real gamble for the Chancellor is what the rest of the world does. Should other economies not opt to boost domestic purchasing power with a fiscal loosening, then UK consumers, were they to decide to spend, may simply end up splashing their money on imports. What is needed is for all other major countries to expand at the same time so that each buys the products of the others.

It will be left to time, and global politics, to tell whether the fiscal push and the additional borrowing will help to revive the economy.