British public finances - Tax and mend

Dec 9th 2009From Economist.com

Taxes rise in Britain, as the government struggles to get public finances in order
SINCE Alistair Darling took over as Britain's chancellor of the exchequer (finance minister) in June 2007, he has presented three big end-of-year fiscal statements. They go by the snappy name of a “pre-budget report” and are in effect mini-budgets. The previous two were showstoppers. The one he presented on Wednesday December 9th mattered for what it revealed about Labour’s priorities in dealing with Britain’s huge budget deficit.
The first statement, delivered shortly after Mr Brown had abandoned a plan to hold a snap general election, was notable for some flagrant clothes-pinching from the Conservative opposition, with an effective doubling in the tax-free limit on inheritance tax and a levy on people living in Britain but claiming “non-domiciled” tax status. The second, in 2008, was more momentous, for it owned up to the startling deterioration in the public finances, even though its forecasts were soon overtaken by even worse ones in the full budget in April this year.
Thankfully this time, Mr Darling did not have to announce another big downward revision to growth or an upward revision to public borrowing. The Treasury expects the economy to shrink by 4.75% this year (which nonetheless compares badly with its forecast for a contraction of 3.5% in April). But it still expects the economy to expand by 1.25% in 2010, and indeed to emerge from recession in the final quarter of this year. And the chancellor is sticking to his prediction of 3.5% GDP growth in 2011, which was heavily criticised as over-optimistic this spring. He expects the economy to carry on growing at this pace in 2012.
Nor did Mr Darling have to own up to yet another deterioration in the borrowing numbers, which was just as well given how terrible they are. A year ago he said that the deficit expected in 2009-10 would soar from £38 billion ($62 billion) to £118 billion. That was revised up again in the April budget to an even more breathtaking £175 billion. But on Wednesday the chancellor raised that just to £178 billion, equal to 12.6% of GDP.
Mr Darling has also stuck broadly to his plan to bring the public finances back into balance, first set out a year ago and then made tougher in the budget. That plan will build up to a fiscal consolidation worth around 3% of GDP in 2013-14. As before he expects the deficit to fall to 5.5% of GDP by then.
Despite this broad continuity, Mr Darling has used the pre-budget report to draw sharp political dividing lines ahead of the general election, which must be held by early June. As expected, he announced a windfall tax on bank bonuses, which may reap £550m this year. He will also freeze the threshold at which taxpayers become liable to pay income tax at 40% in 2012-13. But most important, changes to national-insurance contributions will raise an extra £3 billion in 2011-12.
With the help of these tax increases (and aided by some smallish improvements in expected deficits), Mr Darling will find an extra £7.7 billion for spending in 2011 and almost £7 billion in 2012-13 without changing his overall forecasts for borrowing. That enabled him to pledge that in real terms almost all the NHS budget would be shielded from cuts in 2011-12 and 2012-13 while spending on schools would rise. He backed that up with a tough sounding commitment to cap pay increases in the public sector in those two years at 1%.
The pre-budget report–which was dubbed the pre-election report by George Osborne, the chancellor’s opposite number–aims to depict Labour as the defender of public services and prepared to biff banks which pay big bonuses. But it also shows a government unwilling to reduce the deficit as fast as the markets would like. Even before his statement, the government had been criticised for failing to set out a big enough fiscal consolidation. Mr Darling may succeed in appealing to Labour’s core voters but the government risks exhausting the tolerance of the investors who are financing Britain’s big deficit.