Wednesday, April 22, 2009
Going for broke
Posted by David Smith at 03:00 PM
Category: Thoughts and responses

In the old days, the Treasury used to prepare the markets for the worst, and then unveil something rather better. This time the pre-budget guidance on the public finances understated the true horror.

After borrowing of 175 billion this year (2009-10), 12.4% of gross domestic product, borrowing declines glacially from then on, to 173 billion, 11.9% of GDP in 2010-11 and so on. Remember 118 billion? That was how much borrowing was meant to be this year. The new projections suggest we will not get down to that until 2012-13.

Much of the reaction to the new projections will be based on whether the Treasury's growth projections are plausible. In particular, for the purposes of the public finances it has assumed 3.25% GDP growth from 2011-12 onwards.

The Treasury's argument is that these numbers are in line with the recoveries from recession in the 1980s and 1990s and that this time the monetary and fiscal stimulus has been much bigger than then.

The counter argument, of course, is that the economy has been holed below the waterline by the credit crunch and that it will take years to float again, let alone grow rapidly. Add in tax rises and public spending cuts and the numbers look decidedly optimistic.

There is merit in both arguments. The 1990s' recovery occurred against the backdrop of rising taxes and a real freeze on public spending, and in the aftermath of a housing bust. What we did not have then, however, was the loss of bank lending capacity and the hangover of a credit crunch.

The real story, however, is that even with growth returning, the public finances are reckoned to remain in a very bad way. That is why the Treasury announced 26.5 billion of fiscal consolidation, split three ways between higher taxes (mainly on the rich), lower current spending and lower capital spending.

But it is also why more will be needed. Darling went for what was politically acceptable, to Labour at least. A new top rate on earnings above 150,000 will not encourage Swiss, French or German bankers to base themselves in London but many of them have gone home anyway. Combine it with restricting pension tax relief for these high earners (which officials probably thought necessary to protect revenues resulting from the tax hike from 40% to 50%) and this is a different world. Sir Fred Goodwin and his like have got a lot to answer for.

None of the detailed short-term measures in the budget were very memorable. We will, however, remember this budget for a long time, both the legacy of high government borrowing and debt - now expected to nudge 80% of GDP - and for its "thin end of the wedge" increase in taxes on the better-off.

One way or another, even higher taxes must surely come, though not until after the election. Not much jam today and plenty of pain tomorrow.