Sunday, March 21, 2004
Chancellor experiments with an economy drive
Posted by David Smith at 09:01 AM
Category: David Smith's other articles

Britain’s business lobbyists have got used to a well-worn ritual in the run-up to Gordon Brown’s budgets. Early in March they troop into the Treasury’s Whitehall headquarters, plead with the chancellor to cut government waste, bureaucracy and red tape. He smiles sympathetically.

A couple of years ago the surroundings changed. Instead of the chancellor’s oak-panelled office with a table the size of the average lawn, Brown started holding his meetings in the new, airy, ultra-modern offices designed by Sir Norman Foster as part of the Treasury’s refurbishment.

The message, however, did not change. While Brown listened to industry’s pleas that they were being squeezed to the bone while the public sector was enjoying the good life, courtesy of their tax revenues and his largesse, he did nothing about it.

Far from cutting civil service numbers and pruning the number of public-sector workers, he was happy to increase them. Jobs in health and social work are up 300,000 since 1997, education by nearly 400,000 and public administration by 110,000. Extra public servants were needed to deliver the government’s objectives for public services.

Two years ago, when the Conservative party promised to release resources for front-line public services by cutting backroom and administrative staff, Tony Blair was dismissive. At that time the Tories were promising to cut 20 billion from the cost of government.

But according to the prime minister then, that was pie in the sky. “Nobody believes you can cut a few civil servants and get this money,” he said. “You would have to take it out of the schools and hospitals programme.” That, it seems, was the government’s line.

So when the chancellor announced last week that he intended to cut more than 40,000 civil service jobs from just two departments — the work and pensions department and the new tax agency formed out of the Inland Revenue and Customs and Excise — the business reaction was one of surprise and delight.

“I really did nearly fall off my chair,” said one business leader. “If the chancellor wanted to do anything to get a good reaction from us, this was it.”

Others agreed. “Business welcomes this much-needed action to improve efficiency in the public sector and curb the rate of growth in public spending,” said Martin Temple, director-general of the EEF, the manufacturers’ body.

Digby Jones, director-general of the CBI, pledged the full support of business for Brown’s efficiency drive. “I am delighted that the chancellor has committed himself to increasing productivity from taxpayers’ money,” he said.

“At last we are seeing a real attempt to tackle outdated ways of working that have often resulted in the inefficient use of public money. Our message to the government is: you will need sustained political courage to achieve genuine reform — failure is not an option.”

Analysts argue, however, that a note of caution is in order. Peter Spencer, economic adviser to the Item club, which uses the Treasury’s own model of the economy, points out that 40,000 job cuts over three to four years should be set against a rise of 172,000 in public- sector employment in the past year alone.

“Even the Treasury would concede that this is a rebalancing of jobs away from the backroom and towards the frontline,” he said. “It won’t make much difference to the overall numbers.”

Experts point out, in addition, that cutting civil service numbers will get the chancellor only a small way towards his targeted efficiency savings of 20 billion a year. John Hawksworth, an economist at Price Waterhouse Coopers, estimates that cutting 40,000 jobs will save “only” 1.2 billion. Other estimates suggest at most 2 billion of savings.

Even 80,000 job reductions, the number said to have been identified by Sir Peter Gershon’s review of government efficiency, would leave the Treasury well short.

“I would view the 20 billion of savings as an aspiration,” said Hawksworth. “Most businesses would recognise, in addition, that you have to spend to save this kind of money — by re-engineering processes and so on.”

Although the Treasury concedes that its planned efficiency savings are ambitious, and has refused to quantify the amount it expects to save from civil service job cuts, it also insists that its overall fiscal projections are not reliant on reducing waste.

The efficiency savings, officials point out, have the scope to head off a slowdown in the funding for public services. Growth in government spending is projected to slow to 3.2% a year in real terms from 2005-6. The recent rate has been above 4%.

But if government departments are successful in cutting waste, the amount going into “front-line” services will actually rise by 4.5% a year, faster than in recent years. By the same token, if the savings are not achieved, some services will be squeezed.

It may be a difficult circle to square. Geoffrey Dicks, chief UK economist at Royal Bank of Scotland, points out that while the private sector has been able to achieve such gains, dealing with the civil service unions may make the process harder.

The unions, battered by the prospect not only of job cuts but the shift of 20,000 posts out of London and southeast England, have made it clear they will fight.

Not only that, but if the savings are not achieved, the government could come under pressure for failing to achieve its promises on the public services.

“The chancellor is budgeting for significant real increases in spending to be obtained from efficiency gains,” said Dicks. “In the past the chancellor did not take credit for similar gains, for example on privatisation, until they had been achieved.”

Mark Cliffe of ING Financial Markets also questioned Brown’s ability to turn round weak public-sector productivity. The government, he predicted, was likely to be troubled by a continuing overshoot in spending, with the planned total for next year, 2004-5, likely to be overshot by more than 5 billion. “Public spending is a bigger threat to borrowing than tax shortfalls,” he said.

BEYOND trying to get the public sector to embark on an efficiency drive, Brown’s other big budget idea was a clampdown on tax avoidance.

The chancellor is aiming to bring in extra tax amounting to 925m a year within three years, by closing tax loopholes. He hopes to achieve this even after giving the taxmen extra resources for compliance work.

Brown did not introduce, as had been feared, a general anti-avoidance rule, of the kind used in Australia and Canada.

But in future, to their chagrin, accountants and tax advisers will be required to notify the authorities of schemes they are advising their clients to use to minimise the amount of tax they pay.

The aim, according to the official briefing notes, is “to provide the Inland Revenue with information about potential tax avoidance schemes and arrangements much earlier than at present to enable swifter and more effective investigation and, where appropriate, counteraction”.

In other words, any adviser who is planning to market a tax-avoidance scheme is required to tip off the taxman so that it can be killed at birth. America uses a similar system. Accountants warn, however, that the plan could backfire.

“The danger is that if you put into the minds of companies that you cannot plan tax in the UK, they will look to shift to tax regimes that are more favourable,” said Stephen Herring, a tax partner at BDO Stoy Hayward.

On Thursday, 25 representatives from the big accountants, legal firms and banks were summoned to a meeting at 11 Downing Street with Gus O’Donnell, the Treasury’s permanent secretary.

O’Donnell, mastermind of the planned merger between the Inland Revenue and Customs and Excise, made clear he was interested in co-operation rather than confrontation with the industry over tax avoidance.

But the Treasury has also shown its readiness to act, pointing out that partners in some top accountancy firms have been taking action to minimise their tax in ways that the Inland Revenue finds unacceptable.

The Treasury has also signalled that it will go ahead with a clampdown on schemes designed to avoid inheritance tax, by changing the treatment of so-called pre-owned assets. People who put their houses in trust for their children but continue to live in them will have to pay income tax on the “benefit in kind” they obtain. Accountants said that, by introducing tax on arrangements that have already been entered into, Brown is engaging in retrospective taxation.

The Inland Revenue, responding to criticism of its proposals, said it was targeting “contrived” arrangements rather than those entered into, for example, by husbands and wives. Even so, accountants predict widespread confusion over both this and the new disclosure requirements.

“The big question remains: how do you distinguish between a ‘scheme’ and normal tax advice?” said Mike Warburton, a partner at Grant Thornton, the accountants. “What’s the dividing line here? It appears that even some bespoke arrangements will get caught up in this.”

Warburton predicted that much of the tax-planning advice currently carried out in Britain would go offshore, and beyond the reach of the authorities. “The banks already have offshore operations, and so do many other people in the industry,” he said. “The big loophole in this, I predict, is that it will shift offshore.”

Even in the budget, however, Brown introduced firm measures aimed at “protecting tax revenues” — raising money by changing the tax rules.

Small firms face a new, 19% tax on distributed profits, designed to stop them taking advantage of the 0% tax on the first 10,000 of profits, a measure designed to bring in 490m a year by 2006-7.

Closing loopholes on finance leasing is intended to bring in 110m, while acting on so-called red-diesel fraud will give the government an extra 190m. Car dealers will no longer be able to reclaim Vat on the demonstrator cars they allow their sales staff to use for private journeys.

THE Treasury insists that, despite the clampdown on what it sees as tax avoidance, the budget was business-friendly. After being attacked for adding a cumulative 30 billion of red tape on business since Labour came to power, Brown responded. One of the bugbears of companies, particularly smaller firms, has been the burden of having to administer the chancellor’s tax credits. He announced that he would be phasing out the payment of the working tax credit through employers. The move was welcomed by the British Chambers of Commerce (BCC), the government’s leading red-tape critic.

Isabella Moore, the BCC president, said the budget was “a good step in the right direction”. “The fact that Gordon Brown will remove the burden of paying tax credits away from businesses shows the chancellor is responding to the views of our members,” she added, while calling for further moves to simplify the business tax regime.

Brown also announced a new commitment to cutting the red-tape burden, with Tony Blair to chair a government panel aimed at reducing regulations.

There were other signs that the Treasury had taken on board some of the criticism it had received since December’s pre-budget report.

The new and controversial lifetime pension cap had been expected in April 2005 and set at 1.4m. In the budget it was delayed for a year and raised to 1.5m, with a pledge, not only that it would be increased to 1.8m by 2010, but that its operation would be reviewed at that time.

BROWN’s strategy for last week’s budget — cutting waste, closing tax loopholes and nodding in the direction of business concerns about red tape — all conveyed an impression of a hyperactive chancellor taking action on all fronts.

In terms of its overall economic impact, however, this chancellor’s eighth budget was a non-event. Most of the big numbers were similar to those set out in December, when he bit the bullet on borrowing.

This year’s borrowing is now estimated at 37.5 billion, up marginally on the previous estimate, while next year the total is predicted to subside to 33 billion, before trending gradually lower.

Brown’s new economic forecasts present something like a “golden scenario” for next year’s general election, with 3% to 3.5% growth this year and next, and no post-election hangover.

“It’s boom-boom, not boom-bust,” said Andrew Smith, KPMG’s chief economist.

“The public finances always deteriorate more rapidly than people expect during a downturn. But they can also improve more quickly during the upturn, and that is what the chancellor will be hoping for.”

There is even a predicted re-balancing of the economy, with business investment expected to recover strongly after a three-year squeeze, growing by 3.5% to 4% this year and 5.5% to 6.25% in 2005, according to the Treasury.

Inflation remains firmly under control, rising gradually to the new target of 2%. Tax revenues, particularly from companies, are predicted to jump sharply. Corporation tax receipts are projected to rise to 34.7 billion in 2004-5, from 28.7 billion in 2003-4.

Is it all too good to be true? “The chancellor said that stability is the issue, but in my view it is sustainability,” said Gerard Lyons, head of research at Standard Chartered. “There’s always an assumption that this is as bad as it gets. The Treasury always predicts that growth will become more balanced and that government borrowing will fall.”

Any number of things could go wrong. The Treasury is predicting a current-account deficit of 33 billion this year — a record. If sterling took fright from the figures, as it has responded badly to recent trade data, the Bank of England could be forced to put up interest rates more rapidly than it wants to.

“The worry is not just the speed the economy is travelling but the fuel that is being used — high-octane household spending,” said Richard Jeffrey, head of research at Bridgewell Securities. “We can already see one manifestation of this in the burgeoning trade deficit.”

Other factors, such as further terrorists attacks or the American recovery running out of steam after the November presidential election, could also upset the rosy outlook.

The point, said analysts, is not just that Brown has set out an optimistic scenario, but that his projections for the public finances depend on it.

“High public spending is being bought on tick,” said David Smith, chief economist at Williams de Broe, the stockbroker. He points to the likely need for huge tax rises to correct a budget deficit he predicts will top 60 billion in three years. The “day of reckoning”, he said, will come soon after the general election in May next year.

Brown had a good day last week. But whether he can continue to put off that day of reckoning remains in doubt.

THE MAIN POINTS OF THE BUDGET

-- Public-sector efficiency savings of 2.5% a year from 2005-6, including cuts of 54,000 (gross) 40,500 (net) civil service jobs, mainly from the Department for Work and Pensions, Inland Revenue and Customs and Excise.

-- The planned merger of Inland Revenue and Customs and Excise, following a review by Gus O’Donnell, Treasury permanent secretary.

-- Tax advisers to be required to notify avoidance schemes to the Inland Revenue before marketing them.

-- A 10-year strategy for science, to be given priority in the 2004 comprehensive spending review.

-- Small firms to pay a new tax of 19% on their distributed profits, to clamp down on avoidance through the 0% corporation-tax rate.

-- New pension tax regime to be introduced in 2006, a year later than originally planned. Lifetime pensions cap to be 1.5m rather than 1.4m, rising to 1.8m by 2010.

-- No re-opening of the euro assessment. The position will be re-examined in a year’s time, in the 2005 budget.

-- Government borrowing 37 billion this year (2003-4), falling to 33 billion in 2004-5. Current budget deficit — excluding investment — predicted to be back in balance by 2006-7.

-- Growth forecast to be 3%-3.5% in both 2004 and 2005.

-- Education budget to rise 4.4% a year in real terms from 2005-6, an increase of 8.5 billion to 77 billion.

-- Real estate investment trusts (Reits) to go ahead and planning to be streamlined. A new tax on development land to be considered after the Barker review of the housing market

-- Additional 100 annual payment for pensioners over 70, to offset council-tax increases.

-- Tax relief on venture-capital trusts raised to 200,000. Capital allowances for small firms raised from 40% to 50%.

From The Sunday Times, March 21 2004

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