It is a daring gamble for the Chancellor. He is banking on the UK economy picking up by 2005. Ian Fraser asks if the numbers add up
NOW the dust is settling on a “neutral” Budget that was comprehensively upstaged by the toppling of statues of Saddam Hussein in Baghdad, there are mounting fears that Gordon Brown’s liberation of the UK economy from the spectre of tax rises may prove to be short-lived.
The Chancellor was doing the rounds of TV and radio studios on Wednesday afternoon and Thursday — not quite in the style of Iraq’s information minister Mohammed Saeed al-Saheef, but almost. He seemed keen to persuade disbelieving viewers and listeners that, no, his forecasts for growth and the public finances are neither optimistic nor reckless.
Instead Brown wants us believe his forecasts are cautious and prudent just like everything else he has done since entering 11 Downing Street back in May 1997.
However the trouble is that the majority of independent economists and financial observers don’t believe that Brown’s sums add up. Unbowed, the Chancellor was last week keen to rebut accusations that he was gambling with the UK economy. “I don’t think people think of me as a gambler,” he told Good Morning Television.
There can be no escaping the fact, however, that the Dunfermline East MP’s forecasts for economic growth of 3%-3.5% in both 2004 and 2005, seem excessively sanguine to the vast majority of UK economists.
Brown’s estimates are founded on optimistic assumption including that household consumption will grow faster this year than was expected last November, despite the rise in national insurance which kicked in last week, and that there will be a net improvement in trade, which many see as unrealistic given the economic plight of the UK’s Continental trading partners.
Brown’s forecasts for UK growth over the next couple of years contrast with a City consensus of 2.3% and the Bank of England’s forecast of 2.25%. The International Monetary Fund is forecasting growth of 2.5% for 2004.
Yet Brown is not only predicting 3%-3.5% growth next year and the year after. He also seems convinced that an economic rebound in 2004 will be matched by an accompanying sharp rebound in corporate profits, together with a successful crackdown on tax avoidance and fraud.
It’s all too upbeat for the City’s large band of dismal scientists. John O’Sullivan, UK economist at Dresdner Kleinwort Wasserstein, was particularly taken aback by Brown’s Panglossian outlook.
O’Sullivan said: “From today’s gloomy perspective, it is hard to imagine GDP growth of 3%-3.5% any time soon. The global and UK recovery is likely to be a more drawn-out and sluggish affair than the Treasury expects or hopes.”
Andrew Milligan, head of global strategy at Standard Life Investments, also questioned whether Brown’s forecasts are credible. He said: “Looking into 2004 and 2005 the room for manoeuvre for this government is going to become more limited. If the strong economic revival that Brown is forecasting does not occur, politicians will face difficult decisions on taxes or spending albeit these may be postponed until after a 2005 election.”
And Brown is so wedded to the generous spending promises for health and education that he unveiled in his April 2002 Budget that consumer spending and the wider business world would end up bearing the brunt in the shape of increased taxation. It could be the tax hikes many had been fearing before he embarked on his 59-minute Budget speech last Wednesday have simply been postponed.
However Andrew McLaughlin, deputy chief economist of Royal Bank of Scotland, does not believe further tax rises will be necessary this parliament, even though he does think the Chancellor’s economic forecasts are unduly optimistic.
McLaughlin said: “We were surprised by the Chancellor’s continued optimism over the long-anticipated rebound in the world economy. We are agreed that he needed to downgrade his forecast for the current year but we think the consumer and business sector will be a lot more subdued than he does in 2004 and 2005. We also think the Chancellor is optimistic in his view that corporation tax receipts will bounce back to their levels of the late 1990s.
“But with his surplus of £50bn, built up in the first few years of the economic cycle, he can still meet his fiscal rules without having to raise taxes before the next election.”
The Institute for Fiscal Studies also believes Brown’s expectation of a recovery in corporate tax revenues on the back of resurgent UK economic growth in 2004-05 is built on sand. “This was a Budget in which Brown was keeping his fingers crossed,” said IFS director Robert Chote.
The IFS also doubted whether Brown can gain £1bn from crackdowns on tax avoidance and smuggling. Although the National Audit Office has given the green light to these anti-avoidance forecasts, Chote said they “raise eyebrows.” He added: “In defiance of a growing chorus of independent commentators, the Chancellor thinks he can continue to meet his fiscal rules with room to spare without raising taxes again.
“He may be right. If he’s not, future Budgets and next year’s spending review will confront him with some rather more difficult choices.”
The would mean raising taxes by a crippling £11bn — equivalent to 3p on the basic rate of income tax — to bring the UK’s books into long-term health.
Loughlin Hickey, UK head of tax at KPMG, said: “Gordon Brown is positioning for a global upturn and the confidence that he is going to be right is reflected in the lower- than-expected borrowing figures and no dramatic revenue raising measures. So he is backing his judgement.”
The Confederation of British Industry was last week grateful not to have been clobbered with the hefty tax rises that many were predicting. These could have proved crippling for many businesses when added to the previously announced rises in National Insurance. “In a difficult business climate and with little room for manoeuvre he has turned to more creative ways of improving the overall performance of the economy, especially productivity and investment,” said Iain MacMillan, director of CBI Scotland.
George Cox, director general of the Institute of Directors, said: “The problem essentially is not this year’s Budget it was last year’s. That was when the Chancellor abandoned his tight control of public finances and committed himself to a massive and sustained increase in expenditure. He based his assumption of affordability on levels of economic growth that we said at the time were optimistic and represented a gamble. He is still assuming strong growth to put things back on track.” In other words, Brown is throwing good money after bad.
But what about the thorny subject of membership of the European Single Currency (euro)? The consensus was that, as Brown took every opportunity in his Budget to contrast the lamentable performance of the eurozone with the resilience of the UK economy, UK membership will be declared premature come June. However, the Chancellor did give some crumbs of comfort to the yes camp when he announced initiatives that could help create the economic convergence the Treasury wants before it can give the euro its blessing.
Housing
House prices in the UK have risen much faster than those of Germany or France over the past 30 years. Gordon Brown believes that the predominance of variable rate mortgages in the UK market is largely to blame.
He hinted the inflexibility and volatility of the UK housing market — which in turn has made our economy more cyclical and unstable — is linked to the variable nature of most consumers’ mortgages and has commissioned Professor David Miles of Imperial College, London, to lead an inquiry into how Britain could develop a market for the fixed-rate mortgages that are the norm elsewhere.
Steven Andrew, chief economist at Isis Asset Management, says the proposals could rein in galloping house price inflation. But he is concerned plans unveiled by Brown to transfer 20,000 civil service jobs could further dampen the softening London housing market. “This comes at a time when London’s area of specialisation, financial services, is suffering both from a cyclical recession and structural consolidation,” he said.
Small businesses
Small businesses are seen as having fared particularly well in an otherwise broadly “neutral” Budget.
Rebecca Harding, chief economist at the Work Foundation, said: “This is a clever budget which takes a bottom-up approach to improving productivity through measures to encourage investment in small businesses and at a regional level. Brown continues with his faith that it’s smaller companies that will deliver innovation and productivity gains. He has given incentives to small businesses in two ways: extending the scope of research and development credit and he is going to extend, for another year, the 100% allowance for IT spend.”
But Andy Willox, Scottish policy convener at the Federation of Small Businesses, does not believe any of the measures introduced will boost economic growth or help the nation’s small business sector. “The Chancellor’s most positive measure was the pledge for further action to make work pay, and to help more people get off benefit and into employment – a measure which may help small businesses recruit additional staff.”
Regional development
Gordon Brown hinted at some bold initiatives to boost the flexibility of Britain’s regional economies. These included taking a fresh look at regional pay in the public sector, where national bargaining remains the norm with additional “weightings” for London and the southeast.
Richard Laverick, head of tax at Ernst & Young in Edinburgh, said: “Together with the emergence of regional inflation statistics, this is a way of breaking down centralised wage bargaining in the public sector.”
The trouble with existing arrangements is that they leave public services short of good staff in high-cost areas, but waste money on often inflated salaries in low-cost labour markets. Trade unions are expected to resist the changes. Goeson Brown did briefly outline proposals to devolve management responsibility for public services to the nations and regions. The moves would boost the flexibility of Britain’s labour market ahead of the arrival of the euro.
North Sea oil and gas
The Chancellor has lengthened the shelf-life of the North Sea sector — at the same time as removing some of the sting from last year’s controversial extra 10% tax levy on North Sea profits — with measures to promote the development of new oil and gas fields using existing infrastructure. He also announced a consultation exercise aimed at maximising recovery of North Sea oil and gas assets.
Brown said he would abolish Petroleum Revenue Tax for “new tariff” business on condition this makes use of existing North Sea infrastructure, such as pipelines, from January 2004.
Martin Findlay, tax partner in KPMG’s Aberdeen office, said: “This comes at a crucial time. We are roughly at the mid-point in terms of exploiting UK reserves; there are as many barrels still to be produced as have been extracted since the early 1970s. Tax may make the difference in companies’ decisions to further exploit reserves or abandon them.”
E&Y’s Richard Laverick said: “This targeted measure should permit the continued development of the North Sea.”
Commercial property
THE proposed rise in stamp duty on commercial property leases was greeted with concern by property professionals and occupier groups. The CBI said it could be “devastating” for high street businesses.
Susie Swift, a partner at accountants Saffery Champness, said: “The proposed stamp duty arrangements on leases are likely to have an adverse effect on the commercial property sector across the board — with the additional burden likely to be passed down the line.”
James Galbraith, chairman of property consultancy CKD Galbraith, said: “Far from providing flexibility this is a stealth tax on landlords and tenants which will further inhibit activity and make it more difficult for occupational tenants.”
Richard Rennie, a partner in law firm Burness, believes the money taken in through the revised regime will outweigh the amount lost through relief lower down the market. “This will mean a tenant taking a 15-year lease on a mid-sized, modern office in Edinburgh will see his stamp duty payment rise from around £7,000 to approximately £50,000,” he said.
This article was published in the Sunday Herald on 13 April 2003 – three days after Brown’s 2003 Budget