Tuesday, October 09, 2007

Emergency Budget


Getting ready for Darling

It really is just like old times. A major public service crippled by strikes, more public sector strikes in the offing, no money left because it's all been flushed down the bog, the economy teetering on the brink, more taxes on the undeserving rich, and finally, the Emergency Budget.

Of course, the Pre-Budget Statement was originally brought forward two months as part of Bottler's aborted election campaign. But it has all the hallmarks of those old Wilsonian emergencies.

Binge Borrowing

In March Bottler said he'd be borrowing £34bn this year (2007-08), and a further £84bn over the next three years. But with growth now faltering, that's unachievable on unchanged policies.

In March the Treasury assumed GDP growth of 2.75% in 2007-08, and 2.5% pa thereafter. Both assumptions now look optimistic, with outside forecasters having already cut their 2008 figures to reflect the credit crunch to 2% pa or less.

Very roughly, 1% off GDP next year will mean another £10bn on borrowing (Tyler/Treasury rule of thumb- 1% off GDP cuts tax revenue and boosts social security spending by a total of about three-quarters of a percent of GDP). And the extra borrowing is cumulative for each year that GDP falls short of the assumed 2.5%.
Worse, as we blogged here, both the economy and the public finances have become increasingly dependent on the booming financial sector. The banks pay some £10bn pa in corporation taxes, and if the credit crunch really does cut their profits in half, that could mean another £5bn loss of revenue (plus the estimated £2bn loss of income tax on lower City bonuses).

Borrowing is revving up on the runway- on unchanged policies, best guess is that by 2010-11 (election year- you mark my words) it will be £60bn pa- double what Bottler forecast just six months ago.

(Angels on a pinhead technical aside: Darling will give himself Golden Rule wriggle room by declaring the economic cycle that began in 1997-98 is now ending. That means he can start the clock again on those "cyclically adjusted" (aka fudged) fiscal deficits. But unlike the first cycle, where Bottler was able to "bank" a series of surpluses in the late 90s, Darling will be starting his new economic cycle with a string of deficits. In effect, he will be saying 'trust me- I'll will pay back these deficits when the economy recovers later'. But in the real world, he'll still have to borrow real money from real lenders.)


French Letter Spending

Bottler has put on what's known as a "spending envelope" for the Comprehensive Spending Review- 2% pa real growth overall. Like its close relative the French Letter, the spending envelope is designed to persuade us that nothing too bad will happen even if he gets carried away- on the NHS, say. Higher growth in one area will be financed by lower growth elsewhere so that the total is kept in a firm and rigid manner to his prudent 2%.

Unfortunately, as the Major discovered just before being compelled to join the Foreign Legion in 1956, French Letters can't always be relied on.

In particular, although Bottler calls his c £600bn pa spending Total Managed Expenditure (or TME), implying that it's all properly under control, 40% of it isn't actually managed at all. It comprises things like social security payments and debt interest payments that depend much more on the economic environment than year to year policy decisions.

This spending is literally out of his hands, and if the economy weakens it will turn out substantially higher than he is allowing for. And according to the Treasury Select Committee (see here), he has systematically underestimated these figures for the last several years, with a cumulative understatement of £19bn over the most recent three year period.


Squeaking Pips

Taxing the undeserving rich is back in fashion. Darling will likely rip the Tory wheeze on non-doms (see this blog), and will doubtless whack those private equity guys. Actually, we agree that the rules on taxing income as capital need to be changed (eg see this blog), but we need to remember two important things.

First, it was tinkering unworldly law-of-unintended-consequences Bottler who introduced the very tax changes that fuelled those private equity fortunes. It was his egregious abolition of ACT refunds that boosted the attractions of debt financed private equity take-overs, and it was his naive decision to tweak the capital gains tax rules so as to incentivise business investment - his so-called accelerated taper relief - that gifted private equity players their 10% tax rate (eg see this blog).

For all his command of figures, when it comes to the real world, Bottler is an absolute clot.

The second thing is that in attempting to tax the super-rich and the City's finest, he's taking on the best informed and most innovative tax planners on the planet. It's not like taxing helpless widows and orphans, or all those millions of PAYE drudges. So any claims for additional tax revenue will need to be taken with a very large pinch of salt.
As we've said many times, the best taxes are low and simple, and applied to all forms of income and capital gains.


Staying Awake

This is a major concern. Bottler's speeches were bad enough. But believe me, Darling's speeches are a hundred times worse. To even attempt listening, you will need a collection of six-inch nails which you can drive into sensitive parts of your anatomy at regular intervals.

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