New UK coalition deserves 7 out of 10

May 13, 2010

— Hugo Dixon is a Reuters Breakingviews columnist. The opinions expressed are his own —

The new UK coalition deserves 7 out of 10. The pact between the Conservative and Liberal Democrat parties, led by David Cameron as the new prime minister, seems determined to address the country’s most important problem — the deficit. This is vital given that the euro zone debt crisis could still prove contagious. It should also be positive for sterling.

Some good ideas are also emerging on tax and spending. But other plans for tax and banks look odd — and there are doubts about whether these bedfellows will be able to work together. After all, Britain has not had a coalition government since World War Two.

Some will be disappointed that George Osborne, who has not been impressive as the Tories’ finance spokesman, will be Chancellor of the Exchequer. But the overall policy stance looks promising. The new government clearly sees dealing with the mess in the public finances as its top priority. The LibDems, led by Nick Clegg, have signed up to Cameron’s plan to find 6 billion pounds in efficiency savings in the current financial year.

This is, of course, only a pin prick given that the deficit is expected to top 160 billion pounds, or 11 percent of GDP. But it is reinforced by several other measures: an as-yet vague promise to significantly accelerate action on borrowing; an emergency budget within 50 days; and plans to involve both the Bank of England and a new Office of Budget Responsibility in vetting budget plans. Asking a bunch of technocrats for advice could give the new government the necessary alibi to implement more savage cuts than the Tories indicated during the election campaign.

The specifics on tax — insofar as they have been revealed — are more mixed. On the positive side, there will be a move to equalise capital gains and income tax rates. That will both raise cash and prevent the tax arbitrage encouraged by the current system. The Tories have also downgraded a promise to increase inheritance tax thresholds.

Unfortunately, there are also several expensive tax promises. In the horse-trading over the coalition, the LibDems have won backing for their plan to raise the income tax threshold to 10,000 pounds. Meanwhile, the Tories are sticking to their plan to scrap the former government’s decision to raise employers’ national income contributions (NIC). The best thing that can be said about these plans is that the former will be phased in while the Tories are at least keeping the planned NIC increase for workers.

Nobody likes tax. But the country simply cannot afford tax cuts at present. And though the coalition has rightly agreed that the bulk of future fiscal adjustments will come from spending cuts rather than tax rises, these particular tax cuts will mean that other taxes — probably Value Added Tax — will have to rise.

Banks will be worried that Vince Cable, the LibDem treasury spokesman who has been particularly vocal in his attacks on the City of London, seems likely to be given responsibility for financial services. Some of his more extreme ideas, such as capping cash bonuses at 2,500 pounds, may not survive. But there will be a commission to look into structural changes in the industry, including separating retail banks from “casino-style” investment banks. The hope must be that the commission will realise that the City could be badly hurt if these ideas were pursued without international agreement.

Unfortunately, it looks like the government will move ahead unilaterally with a levy on bank liabilities. The idea of imposing such a tax multilaterally is an excellent one — and there is quite a good chance that other countries will do it. But this is not certain. If others demur, a go-it-alone tax would damage the UK’s most important industry.

On the positive side, the coalition does seem to have provided an excuse for the Tories to abandon their bad idea of breaking up the Financial Services Authority and giving its powers over banking regulation to the BoE. Instead, there is what looks like a sensible plan to give the BoE responsibility for “macro-prudential” regulation — essentially the business of spotting and preventing bubbles — while leaving the FSA in day-to-day charge of regulating individual banks, albeit under some sort of BoE oversight.

Of course, the biggest uncertainty is whether the new government can hang together. The Conservatives and LibDems have committed themselves to a fixed parliament. If they fall out, the next five years could be messy. Investors will have to hope that the grown-up behaviour displayed in the past few days continues.

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