Thursday, 22 March 2012

Much ado about nothing

“Have patience, and endure” – Shakespeare, Much Ado.

The first thing to note about this year’s budget was that the fanfare of its announcement exaggerated its impact.

Despite the bombast with which the chancellor delivered his opening salvos about “far reaching tax reform”, the flagship adjustments to the personal allowance cost around £3.5bn. Billions of pounds always sound like a lot of money but, when earlier in the day, February’s public sector net borrowing was a whole £5bn worse than the most pessimistic forecasters expected, and net debt reached £995bn, it is unsurprising that this budget will not budge economists’ forecasts.

Much about the budget had been leaked prior to its announcement and so we were left in little doubt about its contents. One of the major themes was always going to be the fiscal neutrality of the budget (namely that any cut in taxation will be matched by a cut in spending). A more general theme of the coalition’s economic policy is that both spending and taxation should be reduced.

The desire to reduce spending and tax can generally be assumed to be positive as, if done well, they will reduce economic distortions and improve economic competitiveness and productivity. However it is a difficult balance to make as, generally tax cuts are to some extent saved whereas spending is, by definition, spent. A contracting fiscally neutral budget (i.e. one where both tax and spending are being reduced) tends to hinder growth. 
There are a few ways trying to compensate for this:
  • One of these is through boosting international competitiveness. This is clearly at the heart of the Chancellor’s economic philosophy and so he accelerated the pace of corporation tax cuts. In time this will encourage companies to stay or relocate to the UK, increasing the “market share” of global corporate tax receipts and bolstering UK employment.
  •  Reducing waste and tax avoidance also tend to crop-up as recurring themes of every budget and, although they often fail to deliver, some of the measures announced this time around look robust. 
  • A further method is through redistribution. Lower income families have a higher propensity to spend than higher income families and so moving the tax burden from the poor the wealthy can balance the economic drag of lower public spending.
Redistribution is what the chancellor has attempted through his moves to raise the personal allowance, although as the “I want to go much further and much faster” phrase betrayed, this was really a nod to the Liberal Democrats. An offset to the benefit of tax breaks for lower income households will be through phasing out higher allowances for pensioners most, but not all of whom, have lower incomes.

Lower income households received good, bad and indifferent news from duties: Alcohol (not raised), cigarettes (raised sharply), and fuel (not lowered) all form higher percentages of their disposable income than they do for wealthy households. Cynics might suggest that smoking is declining amongst the wealthy while wine consumption remains robust. Alcoholic beverages will, however, form part of a separate review this year.

The cuts to child benefit for higher income households (or more accurately for middle income earners) and the lowering of the threshold at which higher rate tax is charged means the burden falls largely on middle income families. This, fails to vindicate the chancellor’s statement “The rich should pay the most, and the poor least” (when he cited Adam Smith). But it does reflect a depressing economic reality: namely, the poor can’t afford to pay tax, the rich can afford to avoid tax and so tax increases will invariably end up falling on the middle income households. 

Further pain for middle income earners may come through the review of regional public sector pay that was announced.

That is not to say that the budget has been quite the millionaire’s giveaway that has been portrayed in the press. The increase in stamp duty on homes transacting for more than £2m, and the far more punitive measures attached to the small number of homes held in corporate wrappers, were both redistributive. Taxing physical property remains one of the most effective means of preventing avoidance available. Measures to limit tax relief coming into effect next year are too.

We have to remain wary over the promise of a General Anti Avoidance Rule where, to use that horrible budget time cliché, the devil will be in the detail after the consultation this summer. Hopefully the chancellor’s insistence that he is simplifying the tax system will mitigate the risk of a bureaucratic and inefficient restriction. The chancellor also eloquently berated the 50% tax rate with the aid of both the independent OBR and HMRC who had investigated its impact.  As one would imagine the, already discussed, impact of tax avoidance has meant the special rate has almost certainly been pointless or damaging. 

Armed with such evidence however, from rational economic perspective, it is exasperating that the rate remains. The fact that it does, and is being reduced rather than eliminated next year, demonstrates that politics have largely trumped economics in this budget.

GUY FOSTER

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