Wednesday, 23 June 2010

Emergency Budget - will it work?

I thought the emergency Budget was pretty sensible, but the Government is nevertheless taking a big risk. We now have a plausible roadmap for managing the deficit and balancing the annual books by 2016, but will it work?.

Let’s start by looking at the Budget projections for spending and revenue to get a feel for the big picture.


Government accounts


Forecasts for the Government's current budget:
























































2010/112011/122012/132013/142014/152015/16
Revenue£548m£584m£622m£662m£700m£737m
Spending£637m£651m£665m£679m£693m£711m
Depreciation£21m£22m£22m£23m£24m£25m
Annual Balance£-110m£-88m£-65m£-40m£-17m£0m
Total Deficit-£932m-£1,059m-£1,162m-£1,235m-£1,284m-£1,316m
Annual Debt Interest£43m£46m£52m£58m£63m£66m
Source: OBR Budget Forecast

Spending is still projected to increase, but at a slower rate than under the previous government. While tax revenues are projected to grow by more than a third over the next five years.


Even if these targets are met, the total deficit will still swell, from an estimated £932 billion this year to £1,316 billion by 2015/16. And so will debt interest payments, from an estimated £43.3 billion this year to £66.5 billion in 2015/16 – the annual interest equivalent to over £2,500 per household.


So the going will be very tough, but the saving grace is that if the plan works then we should start to see the overall deficit start to fall from 2016/17.


However, the plan is based on a number of assumptions about economic growth, including employment, inflation and how much we all spend. If these assumptions turn out to be too optimistic then the budgetary plan will fail and very grim times could lay ahead.


The assumptions


The forecasts behind the Budget plans include (figures show annual change unless specified):























































































201020112012201320142015
UK GDP1.2%2.3%2.8%2.9%2.7%2.7%
Household Consumption0.2%1.3%1.7%2.1%2.2%2.2%
Government Consumption1.7%-1.1%-2.0%-2.3%-3.0%-2.1%
Business Investment1.4%8.1%10.0%10.9%9.5%8.2%
Inflation (CPI)2.7%2.4%1.9%2.0%2.0%2.0%
Inflation (RPI)3.7%3.2%3.2%3.3%3.4%3.5%
Average Earnings2.1%1.9%2.3%3.8%4.4%4.4%
Real Household

Disposable Income
0.2%1.2%1.3%1.5%1.7%1.8%
Unemployment (rate)8.1%8.0%7.6%7.0%6.5%6.1%
House Prices5.9%1.6%3.9%4.5%4.5%4.5%
Source: OBR Budget Forecast


I think it’s fair to say the assumptions are reasonably optimistic. Gross Domestic Product (GDP), a measure of our economy’s health, is assumed to grow consistently, by over 2% a year from 2011 – by contrast European GDP is predicted to grow at less than 2% over the next 3 years.


If we slip back into recession (i.e. GDP falls rather than grows) then we can throw most of the assumptions out of the window, as they’re all interlinked with economic growth the lynchpin.


For example: economic growth means higher employment, which fuels wage rises, giving us more disposable income to spend, increasing household consumption which helps stop inflation from falling too low – with all of this boosting tax revenues via VAT, income tax, NI and corporation tax etc along the way. Take out economic growth and the house of cards might collapse.


So the key question is can the economy grow?


In part this will depend on whether the spending cuts and tax rises announced are palatable or too fierce. Labour has strongly argued the latter.


Spending cuts & Tax rises


This table shows the estimated benefit to Government finances of some of the bigger spending cuts and tax rises announced:




















































2010/112011/122012/132013/142014/15
Spending Cuts
Switching Welfare

Increases to CPI
£0m£1,170m£2,240m£3,900m£5,840m
Tax Credit Reforms£0m£1,180m£2,860m£3,110m£3,220m
Total (net) Spending Cuts£5,245m£8,855m£17,300m£23,820m£31,940m
Tax Increases
VAT Increase£2,850m£12,100m£12,500m£12,950m£13,450m
Capital Gains Tax£0m£725m£825m£850m£925m
Total (net) Tax Rises£2,830m£6,255m£6,950m£8,515m£8,230m
Source: Budget 2010

No-one can argue that the impact of these spending cuts and tax rises won’t hurt. Logic says they’ll probably push us back into recession as most of us will have less to spend and our economy is hardly robust at the moment - although the Government is hoping to stimulate business (hence jobs) by cutting taxes for companies. But I think the outcome will depend on how much fat there really is on the bone.


There’s little doubt that the public sector probably has quite a lot of fat, so while cuts will hurt they’re unlikely to be lethal. And squeezing household incomes will hurt, but provided interest rates remain low then most households should be able to keep their heads above water and keep spending - although if they spend far less it would cause problems.


Conclusion


I’m far from convinced, but I can see some reason to think that we might avoid recession, giving the Government a fighting chance of meeting its targets.


The whole situation is very much in the balance - just like England’s World Cup prospects. After an awful start there’s some cause for hope, but you’re a braver man than me if you’re betting on a wholly successful outcome.

Read this article at http://www.candidmoney.com/articles/article122.aspx

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