Darling gambles for growth

by Ed Bowsher on 09 December 2009  |  1 comment
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The Chancellor has put off big deficit cuts until 2011. Understandably he doesn't want to choke off recovery, but he's risking a debt downgrade.

Alistair Darling has announced tax rises and spending cuts, but for the most part, they won't start until 2011. Here are the main ones: 

• 0.5 per cent increase in National Insurance contributions for both employers and employees.
• the threshold for 40 per cent income tax will be frozen. So more people will end up paying the higher rate.
• Freeze on inheritance tax allowance at £325,000. This applies from April 2010.
• Public sector pay rises to be capped at 1 per cent from 2011.
• £5bn in efficiency savings from government spending.

The Chancellor has also given forecasts of how borrowing will fall from 2011 onwards. He claims the deficit will fall to £82bn in 2014/15. Now that's all well and good, but there's a lack of clarity on what will be cut.

But the crucial point is that Darling isn't wholly withdrawing the fiscal stimulus until 2011. He's understandably worried about choking off the economic recovery. However, the risk is that the government's debt will be downgraded by the ratings agencies because the deficit isn't being cut fast enough for their liking. And that, in turn, will make it more expensive for the government to borrow which will make the government's finances even worse.

It's a difficult balance for the Chancellor and I think he's made the right decision. However, if we see a downgrade and long-term interest rates soar, everyone will condemn Darling. As for me, I'll just hope that no one remembers me getting it wrong in this blog! 

Bonuses 

I think Darling's best move was his tax on bonuses. The treasury boffins have come up with a clever solution. They've not gone for a direct tax on bank profits as this would go against the need for banks to improve their balance sheets. And he's not taxing the recipients of the bonuses either. Doing that would be a logistical nightmare as UK banks are giving deferred bonuses at the moment which won't be received for three years. 

Instead the Chancellor will tax the banks - but only if they give bonuses. Bonuses larger than £25,000 will be taxed at 50%. So if banks don't give out bonuses, their balance sheets won't suffer. Clever stuff.

Critics will say that we'll see an exodus of City talent as a result, but this is a one-off tax, so I suspect that impact won't be as great as some people fear. 

I laughed out loud 

The worst part of the Chancellor's speech was his claim that he was acting from 'a position of strength.' This is a risible statement. 

The sad truth is that the UK went into recession with a serious structural deficit. Gordon Brown spent too much for most of the noughties. If the government's finances had been stronger in 2007, the Chancellor could have implemented a fiscal stimulus in 2008/9 without having to worry about debt downgrades. 

I also fear that some of the Treasury's forecasts are over-optimistic. Apparently economic growth will reach 3.5% in 2011/2. I suspect this forecast has been driven by the need to make the Chancellor's numbers add up rather than an objective estimate of what the economy might achieve in two years' time. 

In fact, the picture going forward from 2011 is the biggest weakness of this pre-budget report. Darling failed to give a proper explanation of how the deficit will be cut from 2011 onwards. Given the political backdrop, I can understand why the Chancellor hasn't said more. But that lack of clarity won't reassure the financial markets.