The Chancellor of the Exchequer, George Osborne, delivered the annual Budget on 23 March. He was very keen to have a ‘Budget for growth’ given the pessimism of consumers (see Table 1, UK, line 3, in Business and Consumer Survey Results, February 2011) and the bad news on inflation (see 4.4% and rising?).
But what could he do? Despite being urged by the Labour opposition to stimulate aggregate demand by cutting the deficit more slowly, he ruled out this alternative. It would be perceived by markets, he argued, as a sign that he was ‘gong soft’ on the commitment to tackle the deficit.
If stimulating aggregate demand directly was out, the alternative was to use supply-side policy: to provide more favourable conditions for business by cutting ‘red tape’, providing tax incentives for investment, reducing regulations, simplifying tax, cutting corporation tax financed by tax increases elsewhere, creating 21 ‘enterprise zones’ and funding extra apprenticeships and work experience placements.
The links below give details of the measures and consider their likely effectiveness. Crucially, the Budget will be much more successful in encouraging investment if people think it will be successful. In other words, its success depends on how it affects people’s expectations. Will it help confidence to return – or will the impending tax increases and cuts on government expenditure only make people more pessimistic?
Webcasts
Budget: Chancellor George Osborne opens speech BBC News (23/3/11)
Budget: Osborne wants to ‘simplify taxes’ BBC News (23/3/11)
Budget: Osborne lowers corporation tax BBC News (23/3/11)
Budget: BBC Economics editor Stephanie Flanders BBC News (23/3/11)
Budget: BBC business editor Robert Peston BBC News (23/3/11)
Enterprise Zones on the way back Channel 4 News, Siobhan Kennedy (22/3/11)
Articles
Osborne’s Budget ‘to fuel growth’ BBC News (23/3/11)
A budget for big business BBC News blogs, Peston’s Picks, Robert Peston (23/3/11)
Budget 2011: tax grab is the real story Guardian, Patrick Collinson (23/3/11)
Budget 2011 – full details Independent (23/3/11)
Osborne shakes up corporation tax Financial Times, Vanessa Houlder (23/3/11)
Osborne unveils ‘Budget for growth’ Financial Times, Daniel Pimlott and Chris Giles (23/3/11)
Budget 2011: Guardian columnists’ verdict Guardian, Jackie Ashley, Martin Kettle, George Monbiot, Julian Glover (23/3/11)
Budget 2011: a million low-paid people escape tax but fiscal drag catches others The Telegraph, Ian Cowie (23/3/11)
Budget 2011: some good news and lots of micro-management The Telegraph, Janet Daley (23/3/11)
Micro trumps macro BBC News Blogs: Stephanomics, Stephanie Flanders (23/3/11)
George Osborne, growing giant of the Tory party, launches ‘slow burn’ Budget Guardian, Nicholas Watt (23/3/11)
Budget documents
2011 Budget, HM Treasury (23/3/11)
Budget 2011 press notice, HM Treasury (23/3/11)
2011 Budget documents, HM Treasury (23/3/11)
Questions
- What supply-side policies were included in the Budget?
- What will be the impact of the Budget measures on aggregate demand?
- What are the major factors that are likely to influence the rate of economic growth over the coming months?
- What would have been the advantages and disadvantages of a more expansionary (or less contractionary) Budget?
- What will be the effects of the Budget measures on the distribution of income (after taxes and benefits)?
In March 2009, the Bank of England’s base rate was slashed to 0.5% in a bid to boost aggregate demand and stimulate the UK economy. Since then it has remained at the same level. Interest rates are used by the Bank of England, which aims to keep inflation at the 2% target within a 1% gap either side. However, inflation has been above 3% for some 15 months and the latest figures for February 2011 show that inflation is rising. In January, it was 4%, but data for February calculates an inflation rate of 4.4% – significantly above the Bank of England’s target rate of 2% and above the forecast rate for the month.
One of the causes of such high inflation is the price of fuel, food and clothing. No-one can have failed to notice that petrol prices are higher than ever and this is one of the factors contributing to an increase in the level of prices throughout the economy. Clothing and footwear costs, which rose by 3.6% after the January sales have also contributed to this rising figure and will put increasing pressure on the MPC to raise interest rates in the not so distant future.
In the February 2011 meeting of the Monetary Policy Committee, interest rates were kept at 0.5%, despite markets pricing the chance of a rate rise at 20%. The negative growth experienced in the final quarter of 2010 is likely to have influenced this decision, but will the inflation data we’re now seeing influence the next meeting of the MPC. This undoubtedly puts pressure on the central bank to increase interest rates to try to get inflation back on target. The cost? It could put the recovery in jeopardy and create the possibility of a double-dip recession. There is a conflict here and whatever happens to interest rates, some groups will say it’s the wrong decision. As David Kern said:
“The MPC must be careful before it takes action that may threaten the fragile recovery, particularly in the face of a tough austerity plan.”
Perhaps the Budget will provide us with some more information about how the government intends to cut the hole in public finances, ensure that the economy does not fall back into recession and keep inflation under control.
UK inflation revives talk of early interest rate rise Reuters, David Milliken and Christina Fincher (22/3/11)
How to inflation-proof your savings Telegraph, Emma Simon (22/3/11)
UK inflation rate rises to 4.4% in February BBC News (22/3/11)
Interest rates: What the economists say Guardian (10/2/11)
Q&A: Impact of rising inflation Guardian, Phillip Inman (22/3/11)
Inflation soars to over double target rate Sky News, Hazel Baker (22/3/11)
Inflation and public borrowing add to budget 2011 headaches Guardian, Larry Elliott (22/3/11)
Inflation cutting savers’ options BBC News, Kevin Peachey (22/3/11)
Inflation: What the economists say Guardian (22/3/11)
Questions
- Is inflation likely to continue going up? What might stop the rise?
- Why are interest rates such an important tool of monetary policy?
- What is the relationship between interest rates and inflation?
- What are the costs of high inflation? Does anyone benefit?
- Who would gain and who would lose if interest rates are increased in the next MPC meeting?
- Which factors have contributed towards rising inflation in the UK? Is it cost-push or demand-pull inflation?
- Why does this pose a dilemma for the government in terms of public finances and the recession?
With the UK economy borrowing 11% of GDP, it is undeniable that spending cuts are needed. Of course, the big question is should they be occurring now or delayed until the recovery is more stable. However, another question is now being asked. Should taxes be cut to help the worse off? David Cameron says that this is out of the question. While he is a ‘tax-cutting Tory’ who ‘believes in tax cuts’, any significant cuts in taxes specifically aimed at the poor would simply make matters worse, especially as the Coalition government is already helping to move thousands of families out of taxation altogether, albeit by increasing taxes on the better off.
“It’s no good saying we’re going to deal with the deficit by cutting spending, but then we’re going to make things worse again by cutting taxes. I’m afraid it doesn’t add up.”
Those in favour of cutting taxes include John Redwood, the head of the Tory’s economic affairs committee, who argues that they would help to boost the economy, by ‘encouraging the wealth creators and the private sector’. By reducing the burden on residents, disposable income will increase, helping to stimulate consumption and investment, which should in turn boost aggregate demand. This would be a much needed stimulus following the latest data which showed: a shrinking economy once again in the last quarter of 2010, consumer confidence at its lowest level in the past 20 years, the possibility of unstable markets should the government be seen to ‘twitch’ on the austerity drive and 57% in a YouGov poll saying that the cuts are ‘being imposed unfairly’. Public approval for the Coalition’s budget deficit reduction strategy has fallen from 53% in June 2010 to 38% in February 2010. Add to this rising inflation and unemployment and the last thing people want to hear is surely ‘No big tax cuts’.
However, the budget deficit must be tackled: now or later. Whenever it happens and whichever party is in power, spending must be cut and/or tax revenues must rise and everyone will have to play their part.
Cameron: ‘Tax cuts impossible right now’ Sky News (6/2/11)
David Cameron says major tax cuts not possible BBC News (6/2/11)
Cameron vows ‘No to big tax cuts’ The Press Association (6/2/11)
David Cameron: Sorry, but we can’t afford tax cuts Telegraph, Patrick Hennessy (5/2/11)
George Osborne faces Conservative pressure for tax cuts BBC News (1/2/11)
Nick Clegg’s tax cuts will cost £4.3 billion, says IFS Telegraph, James Kirkup (2/2/11)
Doubts mount over Cameron’s austerity drive Associated Press (6/2/11)
Sorry it is so complicated BBC 2, Daily Politics, Stephanie Flanders (14/6/10)
Questions
- What is government borrowing? Who does the government borrow from?
- Analyse the impact of tax cuts on the economy. Think about which groups will be affected the most and in what ways.
- Which components of aggregate demand will be affected by cuts in spending and rising taxes?
- ’Cuts in taxation would boost the economy.’ To what extent do you agree with this statement?
- What will be the impact of tas cuts on the government’s macroeconomic objectives, given your answer to question 3?
- What are the arguments (a) for cutting the budget deficit now and (b) for cutting the budget deficit later?
A large deficit which needs cutting and this needs decisive action. This was the gist of the message from George Osborne, and generally from the Coalition government. Although there is nothing confirmed in terms of what to expect, it is thought that there will be a proposal to ease National Insurance for new businesses. He said:
“And so we’ve got to deal with that [the country in Europe with the largest budget deficit of any major economy]. In that sense it’s an unavoidable Budget, but what I’m determined to do is to make sure that the measures are tough but they’re also fair and that we’re all in this together and that, as a country, we take the steps necessary to actually provide the prosperity for the future.”
We already know that there are plans in place to increase capital gains tax from 18% to nearer 40%, but beyond that, little is known. There are concerns that this policy may actually cost the government more in tax revenue than it will raise. Other policies we might expect include a rise in VAT, and a slashed spending budget for pensions. These spending cuts and tax rises will help Osborne to eliminate the structural deficit in current spending by 2015, when the Coalitions’ current term comes to an end. The success of the Coalition’s policies and their ability to reduce the deficit without causing the economy to fall back into recession will be crucial in determining whether the current term is the only term.
Budget 2010: Britain on ‘road to ruin’ without cuts (including video) BBC News (20/6/10)
Where could spending axe fall? BBC News (9/6/10)
George Osborne says emergency budget cuts will be ‘tough but fair’ Guardian, Larry Elliott, Toby Helm, Anushka Asthana and Maev Kennedy (20/6/10)
Budget 2010: capital gains tax Telegraph (20/6/10)
What’s the Chancellor planning to take away in reverse Christmas budget Independent, Alison Shepherd and Julian Knight (20/6/10)
Public borrowing at a peak, says ONS, but tough budget awaits Independent, Sean O’Grady (20/6/10)
A bloodbath none was prepared for Financial Times, Martin Wolf (22/6/10)
Questions
- To what extent is it necessary to cut the budget deficit now and not delay it until the recovery is more secured?
- How will easing National Insurance for small businesses affect the economy?
- If capital gains tax goes up, why is there concern that this could actually cost the government? How is this possible?
- The Lib Dems will oppose any increase in VAT, as they argue it is a regressive tax. What does this mean?
- How will the report by the Office for Budget Responsibility have affected Osborne’s emergency budget?
- What is the structural budget deficit? Illustrate it on a diagram.
As one of his first acts, the new UK Coalition government’s Chancellor, George Osborne, set up an independent Office for Budget Responsibility (OBR) (see Nipping it in the Budd: Enhancing fiscal credibility?. The role of the OBR is to provide forecasts of the economy and the data on which to base fiscal policy.
On 14 June, the OBR produced its first forecast in time for the Budget scheduled for 22 June. It has some bad news and some good news. First the bad news: it forecasts that growth for 2011 will be 2.6% – down from the 3–3.5% forecast by Labour in its last Budget in March. But now the good: it forecasts that the public-sector deficit in 2010/11 will be 10.5% of GDP – down from the 11.1% forecast by Labour; and that public-sector debt will be 62.2%, not the 63.6% forecast by Labour. These forecasts are before any policy changes announced in the Budget on 22 June.
Meanwhile, the accountants BDO have published a survey of business confidence. This shows the largest drop since the survey began. Talk by the government of cuts and worries that this will impact directly on the private sector have caused many businesses to cut investment plans. The worries are compounded by fears of a decline in export demand as countries abroad also make cuts.
So what does the future hold? Should we put any faith in forecasts? And should we be more worried about a double-dip recession or by failure to make sufficient inroads to deficits to calm markets?
Articles
Growth forecast is cut but borrowing improves Guardian, Phillip Inman and Hélène Mulholland (14/6/10)
UK watchdog slashes growth forecasts Financial Times, Chris Giles (14/6/10)
Fiscal watchdog downgrades UK growth forecast BBC News (14/6/10)
OBR UK growth forecast downgraded BBC News blogs: Stephanomics, Stephanie Flanders (14/6/10)
‘Sorry it is so complicated’ BBC Daily Politics, Stephanie Flanders (14/6/10)
Britain’s new economic forecasts: what the analysts say Guardian (14/6/10)
Spending cuts under fire amid new borrowing forecasts Independent, Russell Lynch (14/6/10)
The self-fulfilling deficit spiral Guardian, Adam Lent (14/6/10)
UK business confidence sees ‘record drop’ BBC News (13/6/10)
Britain to avoid double dip but recovery will be weak, CBI warns Independent, David Prosser (14/6/10)
A winding path to inflation The Economist (3/6/10)
Is inflation or deflation a greater threat to the world economy? The Economist: debate (1/6/10)
A question for chancellor Osborne Financial Times, Martin Wolf (11/6/10)
Fiscal conservatism may be good for one nation, but threatens collective disaster Independent, Joseph Stiglitz (15/6/10)
Hawks v doves: economists square up over Osborne’s cuts Guardian, Phillip Inman (14/6/10)
Data and forecasts
Pre-Budget forecast Office for Budget Responsibility (14/6/10)
Pre-Budget Report data Google docs (14/6/10)
Forecast for the UK economy: a comparison of independent forecasts HM Treasury (May 2010)
Questions
- How reliable is the OBR’s forecast likely to be? What factors could cause the forecast for economic growth to be (a) an overestimate; (b) an underestimate?
- What is likely to happen to aggregate demand over the coming months? Explain.
- What is meant by the ‘structural deficit’. Why might the structural deficit fall as the economy recovers? Would you explain this in terms of a shift or a movement along the short-term aggregate supply curve?
- Which is the greatest threat over the long term: inflation or deflation?
- Do you agree that the debate about cutting the deficit is merely a question of timing, not of the amount to cut?
- Why may policies of fiscal tightening, if carried out generally around the world, involve the fallacy of composition?
- Is there any common ground between the fiscal ‘hawks’ and fiscal ‘doves’ (see the last Guardian article above)?