Strategy & Operations » Governance » Economics: Smash ‘n’ grab

Dennis Turner

If imitation is the sincerest form of flattery, the new Chancellor Alistair
Darling paid the major opposition parties a huge compliment when he incorporated
some of their ideas in his tax proposals in the pre-Budget report. This was his
first major set piece since he succeeded Gordon Brown at the Treasury and,
because of the earlier election speculation, the PBR was combined with the
comprehensive spending review, to the detriment of both. In a much more
truncated presentation than was usual with his predecessor, Darling skated over
some of the important economic assumptions underlying his tax proposals and
spending plans.

Predictably, the next day’s headlines were dominated by the Chancellor’s
inheritance tax proposals, his plans to tax non-doms and changes to airline and
capital gains taxes, the first three of which owed a lot to Conservative and
Liberal Democrat policies. Although all these have economic implications, the
public comments focused primarily on the politics of Darling’s speech. The
Treasury’s views on the economic outlook for the next two or three years were
spared detailed scrutiny. If, however, these were to prove optimistic, the
government’s tax and spending plans could be derailed.

It now seems clear that the economy is at something of a crossroads. After 60
consecutive quarters of robust growth, there is a squeeze on private and public
sector consumption, the two primary drivers of activity in recent years. Darling
acknowledged as much in his speech, and so scaled back the Treasury’s forecast
of GDP growth in 2008 from 2.5% to 3.0% to 2.0% to 2.5%. But even this might not
be enough. The consensus in a recent survey of independent forecasts was at the
bottom end of Darling’s range, and some expect growth to be even slower.

Evidence is now mounting of problems in the personal sector. Activity in the
housing market is easing, in terms of price increases and transactions, and the
credit crunch is likely to have a negative effect on the number of mortgage ap
provals. At the same time, those who took out fixed-rate mortgages several years
ago are facing much higher interest charges once the initial deals expire. If
above-average price rises in council taxes and utility bills are factored in,
the personal sector’s discretionary income is coming under pressure. There has
been no corresponding increase in earnings, while the ability or willingness of
households to resort to additional borrowing to maintain spending has waned.

The public sector is in no position to fill the gap left by consumer
spending, as was apparent from Darling’s speech. After several years of generous
rises in spending on public services, the Chancellor signalled more restraint in
the coming years. After annual increases averaging 4% in real terms since 1999,
departmental spending will grow by a little under 2% a year between 2008 and
2011. This is really making a virtue out of necessity because even with this
more prudent approach, government borrowing this year will overshoot the levels
projected in the Budget just six months ago.

This is a familiar pattern. In fact, the sixth time in the past seven years
in which borrowing estimates have had to be revised upwards. Darling has added a
further £16bn to public borrowing plans over the next five years. The UK’s
public sector finances which, at the end of the government’s first term in 2001
were the most robust in the EU, now look more fragile than most of the major
continental economies.

Although there was enough in the Treasury kitty to give a little extra help
to the health service, the Chancellor could not disguise the slowdown elsewhere.
Taxpayers may welcome this new attitude (the tax burden is now at its highest
level since the mid-1980s), but there are several regions of the UK that are
very dependant on the public sector to sustain economic growth and any cutbacks
could have serious consequences for local activity.

As ever with these statements, everything seems to work out well in the
medium term and Darling, like many of his predecessors, has all the bad news in
the first year or so of the forecast period, after which there is a recovery
which gets the strategy back on track. But there are many questionable
assumptions underpinning his calculations about consumer spending, investment,
exports, tax revenues and so on. It is not difficult to envisage him coming back
to parliament at Budget time with yet more revisions.

Darling had the unenviable job of getting the government’s income to fit its
expenditure without putting a further strain on the taxpayer or pushing
borrowing too high, a task made all the harder because he is following a
big-spending Chancellor. What he presented to parliament was a series of
proposals which raised a further £1.8bn to taxes over four years and £16bn to
borrowing over five. On total government receipts this year of around £550bn, it
hardly amounts to a hill of beans. Perhaps the political implications are more