Tuesday, 25 November 2008

Key questions about the Budget - 2

(Source: www.ft.com)

How does the Treasury plan to restore prudence?

In the short-term, Mr Darling believes profligacy is the new prudence. But after two years – quite possibly when another government is in charge – the watchword in Whitehall and the country will be austerity.

With the government borrowing 8 per cent of GDP in 2009-10, or £118bn, Mr Darling expects to get back to only what he defines as prudence by 2015-16. This is when public sector net borrowing falls below the level of net investment and the Treasury expects the deficit to be about £14bn in that year.

The total reduction needed to restore prudence is, therefore, a £104bn clawback over six years.

The austerity years are split between the effects of rapid economic growth, tax rises, fiscal drag – the process by which revenues grow faster than the economy – and spending restraint.

About a fifth of the explosion in borrowing will be clawed back by rapid economic growth, the Treasury believes. This is, of course, limited by the assumption that the economy was permanently scarred by the credit crunch.

But the rest of the recovery comes from deliberate government action. The government is counting predominantly on three forces: tax increases, fiscal drag and severe public expenditure restraint to reduce the cyclically adjusted budget deficit from 7.2 per cent in 2010-11 to 3.5 per cent in 2013-14.

Tax rises come to about £20bn – a fifth of the total – and comprise the withdrawal of the value added tax reduction, rises in national insurance contributions, higher income tax for rich people and higher excise duties.

The real growth rate of public spending falls to 1 per cent a year – lower than the 1.2 per cent announced by the chancellor because he is freezing capital spending in 2010-11 and all subsequent years, giving the lie to the government’s claims of always protecting infrastructure spending.

Government revenues are forecast to rise very sharply as a share of GDP even though no specific tax increases have been announced. This is because the Treasury is assuming the damage to revenues over the next few years is not permanent. This is a very bold assumption.

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