RSS feedsIt’s that time of year again. Accountants arrange conferences to talk about it, the airwaves are crowded with economists speculating about it and opinion pollsters test the public responses to it. Another March means another Budget, but the reality is that the attention it attracts is inversely related to its importance. Much of what the Chancellor announced was well trailed in the pre-Budget report before Christmas while, as a tool for managing the economy, interest rates and the MPC matter more than taxation and Gordon Brown. It is, however, a parliamentary occasion when the Chancellor tops the bill and can remind us how well the economy has been doing under his astute guidance.
That’s where he always starts, but he will be hoping to be more accurate with his forecasts this year than he was last. He originally thought the increase in GDP in 2005 would be in the 3% to 3.5% range, but, by the end of the year, he had to acknowledge that problems in the consumer sector led to growth slowing to less than 2%, the slowest rate since 1992. He has a more realistic view of 2006 (2% to 2.5%), although even this might be a bit on the high side. Much still depends on the consumer, and the debt overhang and the fact that unemployment is now edging up mean the risks are all on the downside.
But perhaps more important than his economic forecasts was the Chancellor’s assessment of the fiscal framework, because, in many ways, the medium-term outlook for spending, taxation and borrowing will define this third New Labour government. And for Brown personally, he was setting the future agenda of public finances for himself, not only as Chancellor, but also, in all probability, as prime minister.
This government’s record should be judged in terms of Brown’s own benchmarks, the Golden Rule (government borrowing should only be for investment) and the Sustainable Investment Rule (public sector net debt should not exceed 40% of GDP), and the elections of 2001 and 2005 seem to offer turning points. In the 1997-2001 parliament, Brown demonstrated his prudence. Rigorous controls on public spending and a rise in revenues helped to turn a budget deficit of 2.8% of national income at the start into a healthy surplus four years later. Both rules were comfortably met.
From 2001, the government’s ambitious programme to improve public services led to a rise in spending (3.8% of national income) at a time when tax revenues weakened unexpectedly (by 1.3% of national income). The first fiscal year of this parliament, therefore, opened with the government spending 42.4% of GDP and with a current budget deficit of £10.6bn, or 0.9% of national income.
While the Sustainable Investment Rule has been met consistently (assuming, of course, it is reasonable to exclude future liabilities for state pensions and PFI/PPP contracts), the Golden Rule has required some very imaginative statistical massaging to maintain the fiction that borrowing has only been for investment. But credibility in the rule has been steadily undermined by the Treasury’s redefinition of the cumulative balance and the backdating and then extending of the cycle needed to make the facts fit with the rules.
Still reluctant to change his two fiscal objectives, Brown’s latest Budget has mapped out a path by which both will be met by 2010/11. The Chancellor plans to turn the 0.9% current deficit into a surplus of 0.8% in five years (and so meet the Golden Rule) by a combination of revenue growth and spending controls. By then, current spending as a share of GDP would be where it was when Labour came to office in 1997, although the tax burden will have increased by 3.7% of national income.
For this to happen implies a sharp break with the recent past and will present a big challenge to government, especially one having to seek re-election during the period. In the next Comprehensive Spending Review, for example, growth will be slower than the economy and thus current spending will fall as a share of GDP. This would be the least generous spending review since Labour won office in 1997. On the revenue side, much of the increase is expected to come from the growth of the economy, the financial sector, North Sea oil revenues and fiscal ‘drag’. It is a very ambitious medium-term target.
A robust recovery in corporation tax receipts at the turn of the year and the additional taxes on North Sea oil companies already announced reduce the need for higher taxes in the short term. But to meet the Golden Rule the Chancellor must, on his own figures, take a tough stance on public spending and any slippage will mean revenue will have to rise. And slippage is almost inevitable.
Since the balance between spending and receipts is the difference between two very large numbers, small forecasting errors in the wrong direction can, themselves, be large numbers. Tax increases may be on the back burner for the moment, but they are certainly not off the agenda altogether.
