Budget background: Dark with light patches

March 17, 2014

–Laurence Copeland is a professor of finance at Cardiff University Business School. The opinions expressed are his own.–

Spring has sprung.

The grass has riz.

I wonder when the Budget is….

On 19th March actually or, more importantly in this age of nonstop campaigning, six weeks before the European elections and barely a year away from the general election. Since the 2015 Budget will be too late to affect our wallets before we go to the polls, this is George Osborne’s last chance to reassure us that the economic situation is under control. Will he be able to resist the temptation to give us a reward for our patience through four years of austerity and to reassure us that the misery is nearly over?

If he does, it will be a statement as dishonest as Gordon Brown’s annual hymn to prudence in his Budget sermons, because the truth is that we are only halfway along the road to fiscal probity. In fact, according to the autumn statement, government borrowing will be about £110 billion this year, adding well over 6% to a national debt now approaching 90% of GDP.

Now some folk may be inclined to take comfort from the fact that those figures are more or less the norm in the industrialised world – the debt-to-GDP ratio for France is about 90%, for example, and even for Germany, it is 80%. Then, of course, there is Japan, with 250%. The problem with such comparisons, however, is that none of these countries has levels of household debt comparable to our own, which peaked at 160% of income in 2008 and has now come down only to 135%. In case you’re thinking it’s a miracle that households have reduced their debts even as much as this, given the squeeze on living standards in the last five years, you also have to bear in mind that rock-bottom interest rates made paying off debt easier than ever before.

Easier – but less attractive. At current interest rates, saving looks like a mug’s game, and people have responded accordingly. As a proportion of after-tax income, savings, which at 8% before 2008 were already among the lowest in the world, have now fallen to barely 5%, as households have chosen to raid their piggy bank to sustain their standard of living, rather than worry about old-fashioned notions like putting something away for a rainy day or building up a nest egg for their old age.

In the textbook story, the low interest rates would at the same time have spurred the corporate sector to take advantage of the almost-free finance to borrow more and invest in new production capacity, boosting output and exports. Perhaps, just perhaps, this is starting to happen, but until now it has singly failed to occur because all too often the near-zero interest rates were not reflected in the rates banks charged for lending, especially where the customers were SME’s. Instead, banks found more profitable, less risky uses for the funds, notably to replenish their reserves (as they were being urged to do by their regulator) or even to buy long-dated government debt, which offered a riskless 3% yield. Even when banks did lend, they took advantage of the reduced competition to charge quite high interest rates, thereby jacking up their margins to the highest in history.

In any case, many firms probably felt it wisest to hold off investing in present circumstances, in view of the apparent determination of our economic policymakers to reflate the pre-2008 bubbles in double-quick time, a scenario hardly likely to inspire confidence in any businessman who had survived the post-Lehman crash.

This is ultimately a monetary rather than a fiscal policy story, but it is impossible these days to separate the two. In fact, with expenditure decisions and the broader fiscal framework having already been set out in the autumn statement and monetary policy jammed on full throttle, Wednesday’s piece of political theatre will be an even emptier affair than usual.

Given the constraints and the tendency for budgets to become ever more political, I have no idea what the chancellor will decide to do, but there are a number of little things he could do which would help, albeit in a small way, to rebalance the economy. He might for example reduce the tax burden on savers. My own favourite wrinkle on this would be to exempt peer-to-peer lending from tax or to allow it to be included in an ISA, thereby encouraging both saving and SME investment, while also giving a boost (and something of an official imprimatur) to this new sector whose growth has been one of the few bright spots in the gloom of the last few years.

Otherwise, we can expect to see the chancellor unveil with maximal fanfare a sequence of steady-as-she-goes measures involving index-linkage upgrades to this or that tax allowance, excise duty, licence fee or whatever. Unfortunately, there are no grounds whatever to hope for the most urgently needed long-term reform. It is long past the time to set in train a multi-year process to simplify our tax system, which has been allowed to grow like a Japanese knotweed. A good starting point would be national insurance contributions, which have long since ceased to be anything but a tax, so may as well be recognised as such and swallowed up into income tax. No doubt there is plenty of other low-hanging fruit, but don’t be surprised if none of it gets picked in this budget.

In a fiscal position as grim as ours, the key to reducing the country’s crippling tax burden is in reducing expenditure first, so if there are to be concessions in one area, they need to be matched by increases in another. The chancellor certainly cannot afford net giveaways – which is not to say we won’t get any. At times like these, you wish governments, like doctors, took the Hippocratic Oath never to do any harm. Alas, the urge to operate is irresistible.

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