Sunday, March 25, 2007
Look into my eyes, not at my hands
Posted by David Smith at 11:00 AM
Category: David Smith's other articles

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Even I struggle to remember the details of past budgets. Five days after the event it is hard to say with certainty whether Brown’s 11th will stick in the memory. It is easy to forget that this chancellor cut the basic rate of income tax once before, in 1999, when he reduced it from 23% to 22%. Unlike last week, that one was almost sneaked out.

Brown’s 11th budget should be remembered for longer. With less room for manoeuvre than a fat lady in a mini-skirt, and more legerdemain than a street magician, he conjured something memorable out of nothing.

When the dust settles, this will be remembered as the budget that cut the basic rate of income tax from 22% to 20%. Some may also recall that corporation tax was reduced from 30% to 28%. Will we remember that the budget implies a tax rise of a net £280m after indexation in 2008-9 and £125m in 2009-10?

We should, but maybe we will not. That is Brown’s plan. Headlines are important. People remember them.

The genesis of the income-tax and National Insurance changes in last week’s budget was in late 2005 when officials were put to work on the reform under conditions of great secrecy. The Treasury was paranoid about any details leaking out.

I can understand why. Had word of a 2p cut in the basic rate of income tax emerged early, the “con” charge would have been even louder when it turned out that it was paid for with tax rises elsewhere, including abolishing the 10% starting rate of tax Brown himself introduced. The package had to be viewed in its entirety.

The decision to cut corporation tax, again paid for by higher taxes elsewhere, came later. Before Christmas, Brown hosted a business advisory summit at the Treasury and was made aware of the concern of big companies over Britain’s declining tax competitiveness.

When this was followed up by the budget submissions of the CBI, Institute of Directors, British Chambers of Commerce and others, they were pushing at an open door. The battle is not over. Even a 28% corporation tax rate may look high in a couple of years. But it was a step in the right direction.

What else did we learn? The economy is in pretty good shape, with this year’s growth forecast of 2.75%-3.25% fairly mainstream, and 2.5%-3% in both 2008 and 2009 reasonable.

Within this, some rebalancing of economic activity is occurring. Business investment is strong, up 7% last year and expected to rise at a similar rate this year. Brown brushed aside the recent rise in inflation. As is customary, the Treasury expects consumer price inflation to be back to the 2% target soon. Most independent economists agree.

Much of the flak for Brown since Wednesday was because, despite the 2p headlines, this was no giveaway. Both Brown and the Treasury were upfront about this; given the state of the public finances, they had no choice. The Treasury expects to borrow more over the next few years than it did last year, because of lower projected North Sea oil revenues. There was a purist argument for a bigger overall tax hike.

Were the tax changes sensible? Simplifying the personal tax system, with now only two rates — 20% and 40% — and aligning tax and National Insurance makes a huge amount of sense. The question is why it has taken Brown — the great complicator — 10 years and 11 budgets to see it.

But we should not celebrate too much. The only way Brown could compensate low earners for the abolition of the 10% starting rate of tax was through a further expansion of tax credits. We are still light years away from a simple personal tax system.

That is also true of corporate taxation. While the cut in the main rate was welcome, and on the face of it echoed Lawson’s 1984 reform of business taxes (cutting rates by abolishing reliefs), the reality is that Brown also introduced new and complex allowances. Businesses still need a small army of tax accountants to negotiate their way through the system.

And why, if all this cutting is going on, is the small companies’ corporation rate going up from 19% to 22%? The Treasury has a sorry history on this. It once introduced a starting rate of 0%, rising to 10%, and was surprised when there was a rush of self-employed people turning themselves into companies.

Now the Treasury says it needs a rate even higher than the new basic rate of 20% to prevent abuse. It makes no sense. Nor does the Treasury’s claim that many businesses will benefit from enhanced allowances. That goes in the opposite direction from the changes for big companies. Small firms are right to moan.

Was the budget green? Using higher green taxes to fund cuts in direct taxation has become the next big thing. Both the Liberal Democrats and Conservatives advocate it. But this was another case of dipping a toe in the green pool, following the hammering Brown got from doubling air-passenger duty in his December pre-budget report.

Short of smoking — cigarettes went up 11p a packet — driving a large car is the easiest way to become a pariah these days. Road tax will rise on big-engined brutes from £210 to £400. But Brown has also quietly introduced the fuel-duty escalator — raising it by more than inflation — which got him into so much trouble with the fuel protests seven years ago.

The big picture of the budget was, of course, that the tax burden will continue to rise, at least for a couple of years, and that public spending will start to fall as a share of national income. That is also true of education, according to the Institute for Fiscal Studies, in direct contradiction of Brown’s claim that its share will rise.

The education settlement was tougher than expected, suggesting the NHS will be the main winner when the comprehensive spending review is published in the autumn.

We are moving from feast to something like famine on spending — from nearly 5% annual real growth to 2%. But some of this is being achieved through efficiency savings, which we should be suspicious of, and asset sales were doubled from £18 billion to £36 billion to keep government debt below the 40% ceiling.

Will a Brown-led government be genuinely tough on spending? I’m not so sure. Before the budget the Treasury was hinting that the spending outcome would be even tougher. But the slowdown, if delivered, will be genuinely felt.

How will all this play politically? The immediate Tory reaction was that their ball had been taken away. It was a good budget for Brown, not least because he had appeared to be on the back foot. He needs plenty more such days.

I feel sorry for the next Labour chancellor, whether Alistair Darling, Jack Straw or somebody else. Brown set out tax and spending changes for the next few years — most tax changes will be in April 2008 — in effect taking the job away. The new chancellor will have time to get to know the ducks in St James’s Park.

PS: While all eyes were on the budget, the Bank of England’s monetary policy committee (MPC) voted 8-1 to hold interest rates at 5.25%, its minutes showed, and the one vote, David Blanchflower, was for a cut. Coming after poor inflation figures, with retail price inflation at 4.6%, the minutes were intriguing.

Had MPC members known in advance about the inflation data, would more of them have voted to raise rates? Was the turbulence in financial markets, which has passed, the only reason for delaying? It was certainly a reason.

Not only have the markets stabilised but most of the recent data have been stronger than a month earlier. That could trigger an April hike to 5.5%, though May still looks more likely.

Kate Barker, an MPC member, asked last week whether the Bank changed rates too little or too often. In 119 meetings since independence, it has moved 34 times, 29% of the time. Barker said she would be studying closely information on firms’ pricing power and inflation expectations in general. Interest rates could change more frequently, she suggested. Can’t wait.

From The Sunday Times, March 25 2007

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