Global Insight Perspective | |
Significance | Darling was faced with an inauspicious economic context for his first budget, delivered in front of his long-serving predecessor, and now-Prime Minister, Gordon Brown. |
Implications | The government's growth forecasts have been cut and the deficit forecasts raised, but Global Insight believes that these are still on the optimistic side. In terms of new measures, there is little for businesses to get excited about, but then they are also relieved over the absence of any nasty surprises. |
Outlook | There is a good deal of economic uncertainty facing the United Kingdom over 2008/09, much of it international, but the government cannot afford to ignore troubling domestic problems such as the over-extended housing market. |
Gloomy Prospects
In his closely watched first budget, Chancellor Alistair Darling predictably played up the economy's performance under Labour over the past decade, and attributed much of the U.K. slowdown in 2008 to a deteriorating global environment. He highlighted weaker global growth, financial-market turmoil, and tighter lending conditions, influenced markedly by the U.S. sub-prime mortgage crisis. He also argued that GDP growth in the United Kingdom is likely to be higher than in the Eurozone, United States, and Japan in 2008. However, this skates over the fact that the U.K. economy has serious problems of its own (notably including high household debt levels and an over-extended housing market), while the public finances are in poor shape despite the economy having experienced extended robust growth during Labour's time in power. This seriously limited Darling's scope for fiscal manoeuvre in this budget.
Darling cut his GDP growth forecasts for 2008 and 2009, but they still look too high. Expected GDP growth in 2008 has been trimmed to 1.75-2.25%, compared to 2.0-2.5% in last October's Pre-Budget Report. The 2009 growth projection has been cut to 2.0-2.5% from 2.5-3.0% in 2009. Growth is seen at 2.50-3.00% in 2010. The new forecasts therefore give respective growth rates of 2.0% in 2008, 2.25% in 2009, and 2.75% in 2010. Global Insight expects GDP growth to be 1.8% in both 2008 and 2009, and around 2.5% in 2010. Furthermore, we consider the risks to these forecasts to be to the downside.
Fiscal Pressures
Although the expected public deficits for 2007/08 are similar to those expected in last October's Pre-Budget Report (in fact, the Public Sector Net Borrowing Requirement is marginally lower at £36.0 billion), Darling has nevertheless had to raise the forecasts for the coming years. The expected Public Sector Net Borrowing Requirement (PSNBR) for 2008/09 has been raised to £43.0 billion from £36.0 billion, while the expected 2009/10 shortfall has been increased to £38.0 billion from £31.0 billion. Meanwhile, the current budget deficit is now predicted to be in deficit by £10.0 billion in 2008/09 and by £4.0 billion in 2009/10. It is seen returning to surplus in 2010/11, to the tune of £4.0 billion. Previously the current budget was expected to move into surplus in 2009/10 (by £3.0 billion) after a deficit of just £4.0 billion in 2008/09.
Furthermore, there is a very real danger that the PSNBR and current budget deficits will be significantly higher than the chancellor now forecasts, given that his GDP growth forecasts look optimistic. The softer consumer spending and overall growth is, the greater the likely shortfall in value-added tax (VAT) and corporation tax receipts. In addition, there is a very real risk that the housing market will remain weak for an extended period, which would exact a significant toll on stamp-duty receipts.
Main Features
This is a budget that has raised few eyebrows. As expected, Darling was unable to take major stimulative measures to support the economy due to the weakened state of the public finances, but he also held off from taking significant measures to bring the public finances back into line in the near term, given the economy's current fragile state. There are measures targeted at reducing child poverty, helping pensioners, improving the environment, and supporting small business, but these are generally limited in scope, reflecting the parlous state of the public finances.
- Taxation: The main personal and corporate tax measures for 2008/09 are those that had been pre-announced, either in last year's budget or in the Pre-Budget Report. The basic rate of income tax will be cut from 22% to 20% in April, but this is countered by the abolition of the lower 10p tax rate. Similarly, it had already been announced that the main corporation tax rate will be cut from 30% to 28% in April, but the rate for small companies will rise from 20% to 21%. A new flat-rate 18% capital gains tax charge is being introduced from April, up from 10%. Meanwhile, the chancellor confirmed that non-domiciled residents will have to pay a £30,000 charge from April, and there will be no further concessions.
- “Sin Taxes”: Many of the changes are "small beer", although an exception is the marked increases in alcohol taxes. Duties rise by 6% above inflation, with beer rising 4p a pint, cider 3p a litre, wine 14p a bottle, and spirits 55p a bottle. In addition, 11p is being added to a packet of cigarettes.
- Environment: There was a “green” tinge to the budget, although the chancellor did delay raising fuel duty by 2p from April to October. Further ahead, fuel duty is to be raised by 1/2p per litre in real terms from 2010. Owners of “gas-guzzling” cars will be hit, while low-polluting cars will pay no road tax at all. Darling also announced that a new charge on plastic bags will be introduced in 2009, if progress is not made in reducing them on a voluntary basis by then. The government is meanwhile looking into whether the country's carbon emissions reduction target can be raised to 80% by 2050. From 2009, the government will start issuing "Carbon Budgets" alongside the regular fiscal packages. Various measures are being rolled out to force new non-domestic buildings to become carbon neutral by 2019.
- Welfare: Alongside a number of measures aimed to reduce poverty among children and pensioners, the government is looking to crack down on the abuse of sickness benefits. Long-term recipients will have to attend "work capability assessments" from April 2010. Reforms are also planned to council tax and housing benefit, and there will be additional incentives for working families.
Outlook and Implications
The last few months have seen sharp tensions between the government and businesses, and the latter were awaiting yesterday's budget with some trepidation. In the event, there was little to cheer companies, but they were relieved not to be hit by more nasty surprises. The tax burden is expected to rise for most enterprises as a result of the budget, but most of the changes (such as the taxation of non-domiciles and alterations to capital gains tax) were trailed well in advance and factored in. In the event, the government decided to tone down the key changes following the backlash from businesses. The tax crackdown on non-domiciles is very unpopular in the City of London financial district, where thousands of overseas staff have benefited from the attractive regime, but the government has backed off from some of its original proposals. In terms of the capital gains tax changes, the lessened complexity is welcome, but many will see their charges jump from 10% to 18%. By contrast, second home-owners and unit trust investors benefit from a cut from the current rate of 40%.
Given the lean economic times, the government is wise to play it safe with fiscal policy. However, there is a danger that even the reduced forecasts will be undershot and the deficit could be substantially higher than forecast. The British economy is not in as bad a shape as some of its key international counterparts, but there are significant downside risks, both external and domestic.