The toughest Budget ever

April 16, 2009

david-kuo_motley-foolthumbnail– David Kuo is a director at the financial Web site The Motley Fool. The views expressed are his own. –

The 2009 Budget could be the toughest that any Chancellor will ever have to produce. There is a gaping hole in the country’s finances. Alistair Darling, as custodian of the country’s cheque book, has to find a way to plug it. Not bridge it, not tiptoe around it, not spin across it, but to close it before it gets bigger.

Now, anyone who has ever been responsible for a budget will know that shortfalls eventually need to be filled. In the case of the UK’s finances, there is a forecast deficit of 77 billion pounds for 2008/09. The deficit projections for the following three years are even higher.

THE STORY SO FAR

Of course occasional fiscal deficits are tolerable. But an accumulation of annual deficits, in other words our national debt, is a different matter. In Britain, including the recent banking bailouts, it’s 717 billion pounds which is 49 percent of our gross domestic product.

But that’s not all. The UK economy, which was originally only expected to contract around 1.5 percent over the course of this year, is now forecast to shrink by more. That means even less tax revenues to pay for the Government’s planned expenditure. By 2012, the debt could rise from its current level to well over 1,000 billion pounds. Does the Chancellor grit his teeth and hope the gilt market can bear the additional debt or does he take decisive action to cut the projected shortfalls over the next three years?

WHAT WILL THE CHANCELLOR DO?

Of course, Alistair Darling can’t rely on economic growth to boost tax receipts. In normal times, he could cut spending or raise taxes to plug a shortfall. In the current economic climate though, both of these will harm an already fragile economy.

Of the two, targeted tax rises seems the most likely option. The only three taxes that bring in enough revenue to make any serious impact on the budget deficit are income tax, national insurance and VAT.

The Chancellor has already announced the introduction of a 45 percent tax band during the next parliament for people earning more than 150,000 pounds a year. But he could bring this forward – and it could affect 400,000 to 500,000 people!

The new 45p in the pound tax band is estimated to raise around 1.2 billion pounds. As you can see, this is small beer compared to our national debt. Could the Chancellor go one step further? He could introduce a 50 percent tax band for those earning more than 100,000 pounds a year, or announce another increase in National Insurance. VAT was cut to 15 percent at the end of last year but we could see it rise to 20 percent rather than reverting to its previous rate of 17.5 percent.

GOOD NEWS FOR SAVERS

The Government has already said it would like to do something for savers, who have seen their interest rates slashed in recent months. So we could see an increase in ISA allowances, particularly for the cash element of this scheme. We may also see greater flexibility between switching from shares into cash within the ISA wrapper.

CAR SCRAPPAGE SCHEME

A car scrappage scheme to boost flagging carmakers has been widely tipped to be a headline grabber in this year’s Budget. Through the scheme, the Government could offer car owners up to 2,000 pounds towards the cost of a new greener model. The danger with such a scheme is that it would appear to be a bail-out for carmakers at the expense of other industries, and at a time when cutbacks on spending should be the order of the day.

The 2009 Budget could be the best time or the worst time for the Chancellor. It depends on whether he wants to get the country’s finances on the straight and narrow as soon as practically possible, or whether he has both eyes on the next election. We’ll find out on April 22.

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