Weakening UK growth creates tax cut Catch-22

September 7, 2011

By Ian Campbell The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The UK should cut taxes on high earners to stimulate growth, say some economists. Lightening the load on the poor would be better. Politically, that would be a lot easier for George Osborne. But the UK chancellor faces a Catch-22. While tax cuts would help growth, weak growth means deficit reduction already looks behind schedule. The government needs all the revenue it can muster.

Osborne said on September 6 the government was “ahead of the curve”. But that’s disingenuous. The UK announced its intention to get its deficit down loud and early. To date, it hasn’t got very far. In the first four months of this fiscal year current revenue is up by only 4.3 percent. That is well short of the 7.7 percent rise projected for 2011-12. Corporation tax receipts are up only 1.6 percent, against a projection of 14.2 percent. Weak growth may mean the numbers wander further off track.

Osborne acknowledged the difficulties, albeit obliquely, when he mentioned a need to “revise” short-term expectations. He steered clear of specifics: but UK growth will be closer to 1 percent than the estimate of 1.7 percent from the Office for Budget Responsibility. Worldwide weakness and crisis in the euro zone are unhelpful. But the biggest obstacles are still home-grown: the housing market is feeble; lending is subdued; unemployment is high; consumers are cowed.
The government’s opponents say public spending cuts make matters still worse. In fact, UK government spending is up 3.3 percent on a year earlier. The government has not been nearly as harsh as its opponents say.

Osborne’s aim was to get the deficit down from 142.1 billion pounds in 2010/11 to 122 billion pounds in 2011/12. That now looks unlikely. With growth shrinking, the deficit-to-GDP figure could be a full percentage point higher than the 7.9 percent projected in the March Budget. The UK could have a worse deficit than Spain or Italy.

What will Osborne do? The likelihood is that he will stick to his plans but admit they will take longer to materialise. If the government had done more to reverse the spending binge of previous years it would have had scope to do more for tax cuts and for growth now. As it is, the UK is stuck on a painfully slow road back to fiscal rectitude and economic growth.

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