Memorandum submitted by Tenon Economics
Three thoughts on the budget tax increases:
1. They were probably not strictly speaking
necessary, and certainly not on the scale set out.
2. The tax increases could have been structured
so as to improve the chances of the Treasury carrying out a positive
assessment of our convergence with Euroland early next year, but
they were not.
3. Some 80 per cent of the net increase in
taxes by 2004-05 falls on business.
The object of this briefing note is to explain
the above statements.
1. The Treasury uses two rules with regard
to the public finances.
(a) The "golden rule" to the effect
that borrowing is only permissible to finance net public investment
(NPI), and not to fund current spending;
(b) The "sustainable debt rule"
which states that the net debt owed by the Government at any one
time (ie the Government's total overdraft) must not exceed 40
per cent of GDP.
When borrowing is less than NPI, there is said
to be golden rule surplus; where by contrast borrowing is more
than NPI, there is said to be a golden rule deficit.
2. According to the public finances forecasts
set out in the Budget Red Book, the effect of the tax rises is
more or less equivalent to the forecast "golden rule surpluses",
as projected over the years, as follows:
|Year||Golden Rule Surplus
||Projected effect of tax increases announced in Budget 2002
3. Thus even without the projected tax increases, the
golden rule would more or less have been met during the forecast
period. The sustainable debt rule would also have been met (without
the tax increases, sustainable debt as a proportion of GDP by
2006-07 would be no higher than c 33 per cent). It should be noted
that throughout this period the economy is forecast to be broadly
on trend in terms of growth.
4. The inescapable conclusion is that taxes have been
raised under cover of the required NHS spending increases, but
that the real motivation behind tax increases is to provide Chancellor
Brown with room to manoeuvre in the run up to the next Election:
don't be surprised to see a cut of 1p in the basic rate of income
tax in (say) 2004 financed out of the "Budget 2002 War Chest".
5. In early 2004, the Treasury is expected to carry out
an assessment as to whether the Chancellor's five tests for joining
the Euro have been met. One of the five tests is that we need
to have achieved economic convergence with Euroland.
6. The three key elements to economic convergence between
any two economies are a comparison of the following indicators
as between the two economies:
(a) inflation rate;
(b) short interest rate;
(c) output gap (the output gap is the difference between
an economy's actual output at any one time, and it is estimated
sustainable long term capacity at any one time). When an economy
is producing at above its estimated sustainable long term capacity
at any one time it is said to have a "positive output gap"
(and might colloquially be described as "over heating";
by contrast, where an economy's actual output is below its sustainable
long term capacity at any one time it is said to have a negative
output gap, and colloquially might be described as "in recession".
7. Currently our interest rate is 0.75 per cent above
that of Euroland, our inflation rate is 0.9 per cent below that
of Euroland, and our output gap is around -0.5 per cent, whilst
Euroland's output gap is around -2.5 per cent.
8. A Budget strategy to minimise the divergence between
the UK and Euroland by early 2003 in respect of the first two
indicators (a) and (b) above would have been as follows:
(a) raise VAT in this financial year in order to close
the gap between our inflation rate and Euroland's inflation rate;
(b) raise taxes on consumers this year, in order to ward
off any danger of the Bank of England having to raise UK interest
rates this year in order to rein in consumer spending thus in
turn increasing the divergence between the UK's interest rate
and Euroland's interest rate (which is broadly expected to remain
static, and certainly is not anticipated to go up anything like
the amount that UK's interest rate might go up by this year) in
9. Significantly, the Budget did neither of the above.
This was not a Budget prepared by a Chancellor who is straining
at the bit to join the Euro.
10. It is instructive to review the make up of the total
net tax increases announced in Budget 2002 for (say) the 2004-05
tax year, totalling £7.6 billion. Of this £6 billion
will fall on business, some 80 per cent. This was a Budget to
hit business, and not the consumer.