The Great Debate UK

from The Great Debate:

Britain’s austerity experiment is faltering

It was the Welsh sage Alan Watkins who remarked that a budget that looked good the day it was delivered to the British Parliament was sure to look terrible a week later, and vice versa. The avalanche of new information dumped by the Treasury is simply too much to grasp at a single sitting, and governments tend to bury bad news in a welter of statistics. And so it proved with finance minister George Osborne’s budget served up last week.

The immediate headlines stressed that rich Brits would pay less income tax – down from 50 percent to 45 percent – but it only took a day before even traditional Conservative cheerleaders like the Daily Mail were condemning Osborne for funding tax breaks for bankers and billionaires by stealing from those living in retirement. The paper’s cover screamed: “Osborne picks the pockets of pensioners.”

Osborne insists he is sticking to his “Plan A” to reduce the public deficit by sharply cutting state spending by 25 percent over the five-year parliament and imposing severe austerity. Because he believes his “Plan A” is on target, all he needed was a touch on the tiller. He therefore designed his budget to be fiscally neutral – that is, for every tax cut there was a corresponding tax increase. He put up tobacco and alcohol duties and sliced a little off corporation tax.

Osborne’s broader economic experiment, however, is fast faltering. If it were a drug trial, doctors would be urgently taking patients off the snake oil and feeding them the placebo. In 2010, he inherited from Gordon Brown’s Labour government a fast-rising recovery in economic growth, but now, after two years, GDP is headed south, and Britain is teetering on the edge of a government-inspired double-dip recession. In the last quarter of last year, GDP shrank by 0.3 percent.

As predicted, “Plan A” is not working. The number of jobless is 2.67 million (8.4 percent) and rising, the highest rate for 17 years, and the cost of paying the unemployed to do nothing is soaring. Inflation is running at 3.7 percent. Most galling of all, no doubt, for Cameron and Osborne, who were rushed into taking drastic measures when Bank of England Governor Mervyn King spooked them into believing the markets would punish them if they did not tackle the deficit right away, the rating agencies Moody's and Fitch have warned that notwithstanding the debt-reduction efforts, Britain could soon lose its AAA status.

Far from spurring the British economy to greater things, the Cameron coalition’s slash-and-scrimp policies have moved the government sector even deeper into debt. According to the latest Treasury figures, in February the current budget deficit rose to £11.1 billion. Borrowing rose to £15.2 billion. And the net public debt was £995 billion, or 63.1 percent of GDP. Critically for the coalition, even by the Treasury’s optimistic estimates, public-sector net debt as a percentage of GDP will continue to rise for another two years, maxing out at 76.3 percent just in time for Cameron to call a general election.

Debt reduction and austerity may be popular with the financial markets and Austrian economists, but British voters are fast beginning to tire of hard times. Cameron’s cry of “We’re all in this together” sounds a little hollow when he and his multimillionaire colleagues, such as Osborne – 23 of the 29 members of the Cabinet are worth more than $1.6 million – are so conspicuously not consuming the gruel they are feeding the rest of the nation. Cameron took five expensive high-profile family holidays last year, four of them abroad, all dutifully recorded in detail by Fleet Street’s finest.

Osborne’s “difficult” Conference Speech

By Kathleen Brooks. The opinions expressed are her own.

Chancellor George Osborne has weathered criticism of his economic policies from both sides of the political isle in recent months, so it was no surprise that the buzz word from his Conservative Party Conference speech was “difficult”. Life at Westminster is difficult for Osborne at the moment and it’s unlikely to get any easier.

The problem for the Chancellor is that he has staked his credibility on bringing down the UK’s deficit, yet he is also trying to be a pioneer of growth and jobs. In the current environment neither goal looks achievable.

Public sector net borrowing has failed to slow in any sustainable way. Since January borrowing has been on average GBP6.6 billion per month. But that disguises the fluctuations throughout the year, which brought the total to more than GBP60 billion by August. This makes the government’s target to cut borrowing by GBP20 billion to GBP120 billion this fiscal year difficult to achieve.

The Office for Budget Responsibility (the independent verifier of the government’s fiscal plans) forecasts public sector net borrowing to fall to 7.9 percent of GDP in the current fiscal year, down from 9.9 percent in 2010/11. By 2015-16 borrowing is expected to fall to 1.5 percent of GDP, but at the current pace targets such as these seem utterly detached from reality. Either more spending cuts come into play in the coming months or the government misses its 2011/ 2012 forecasts. At this stage the latter seems most likely. For a country that is meant to be on a path to fiscal consolidation, slippage at this early stage of budget restraint suggests the ship has blown dramatically off course.

The latest OBR forecasts date back to March, the next set is due to be released next month. Expect to see revisions to both fiscal and growth targets. The OBR expects to see growth of 1.7 percent this year, 2.5 percent in 2012 and 2.9 percent in 2013. This is far higher than credit rating agency Standard & Poor’s, which has forecast growth of 1.8 percent on average between 2011 and 2014. The International Monetary Fund (IMF) cut its forecast for the UK growth for the third time in nine months in September. It now expects the economy to expand by a fairly lacklustre 1.1 percent this year, and only 1.5 percent next year. It also warned that further growth under-performance would warrant a U-turn in policy and a slower pace of fiscal consolidation.

This is very worrying for Osborne. Low growth will hit tax receipts. Revenues and Customs reported that receipts from income tax, capital gains and national insurance fell as a proportion of GDP to 16.8 percent of GDP in 2010-11, compared with 17.8 percent in 2007-08 as a direct result of the recession. If we get sluggish growth as the S&P predicts then the UK’s tax receipts are unlikely to recover anytime soon.

U.S. debt downgrade: Who cares?

By Laurence Copeland. The opinions expressed are his own.

As I write this blog, it looks as though the U.S. Congress is going to pass a bill raising the debt ceiling and making modest cuts in Federal Government spending over the coming years. Although it is, quite rightly, being presented as a somewhat hollow victory for the forces of reason, there is one extremely puzzling aspect of the crisis.

It is being reported on all sides that the credit rating agencies may well downgrade U.S. sovereign debt in spite of this “happy ending” – indeed, Egan-Jones, one of the smaller agencies, cut its rating of U.S. debt some weeks ago, and there is much talk of Moody’s and S&P following suit in the very near future.

This is all rather puzzling. After all, a credit rating is an assessment of how reliably lenders can count on the borrowers repaying their dollar loans (principal plus interest) in full and on time.  Now the only scenario I can imagine in which the U.S. Treasury fails to meet its legal obligations to its creditors is one in which the Congress blocks a rise in the debt ceiling explicitly so as to bring about a default – and even then it would presumably require the collaboration of the executive because, as many people have pointed out in the current cliffhanger, even if further borrowing is impossible, U.S. tax revenues are far greater than the cost of servicing the debt.

In other words, the Administration can always pay its legal debts – it is only about to run out of money on August 2nd, in the sense that tax revenues are insufficient to cover legally required payments to Uncle Sam’s creditors plus hundreds of billions of dollars of other commitments which the federal Government is politically (and no doubt to a great extent morally), but not legally bound to pay, such as: social security payments, purchases (unless already ordered), wages to civil servants without contract, and so on and so forth. It can delay most of those payments without contravening criminal or civil law, and in most cases can walk away from its commitments altogether with no legal penalty, though of course the outcome might be politically or socially explosive.

In short, whichever way you tell the story, as far as I can tell, default by the USA (or indeed by Britain) could only occur as a result of a conscious political decision to do just that. By contrast, all the forecasts are that Greece will have no choice in the matter. The distinction, as I have pointed out before, is that while Greece’s debts are in a “foreign” currency – it has no right to print euros – the Fed or Bank of England can print as many dollars or pounds as it takes to repay their debts. In the process, of course, the domestic and foreign purchasing power of their currencies will be devastated, but they will have discharged their legal debts. As far as America is concerned, with the exception of a relatively small quantity of so-called TIPS (Treasury Inflation Protected Securities), U.S. bondholders have what economists call a purely nominal claim i.e. one that is denominated in current dollars, not dollars of constant purchasing power. By lending to the USA, they have given a hostage to fortune, a risk which, if they were wise, ought to have been reflected in the yield they demanded before buying the bonds in the first place.

All of which does nothing to resolve the original puzzle, because however dishonest, disreputable or unethical one may think is this scenario, “backdoor default”, as Mark Calabria of the Cato Institute has called it, does not qualify as a default in the sense relevant to the a country’s credit rating, nor (I assume) does it count as a credit event for the purposes of credit default swaps, the main instrument for insuring investors against default by bond issuers.

from Breakingviews:

U.S. jobs rout should give fiscal hawks pause

By Agnes T. Crane and Christopher Swann The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

The latest U.S. jobs report should give fiscal hawks pause. With economists expecting employment to rise by a modest 100,000 in June, the piddling increase of 18,000 proved a bitter blow for a country amid the throes of an austerity debate.

Last month's gloom was compounded by a dip in wages. And more than 250,000 people gave up the job hunt altogether. At this rate, it would take over three decades to recover the 7 million jobs lost during the recession.

At the root of the problem is the reluctance of private firms to hire, despite a strong rebound in profits since the financial crisis. The 57,000 positions they added to payrolls in June was less than half of expectations. And a fall in temporary positions and the number of hours worked may point to further weakness in the months to come.

Still the continued bleed of public sector jobs -- 39,000 more last month -- is also proving a powerful drag. Over the past year, constrained federal, state and local governments have dumped 659,000 jobs. That has offset more than a third of the gains by businesses small and large. This should not be lost on lawmakers in Washington, who are in full combat mode over budget deficits.

Chronic shortfalls have taken their toll. State and local authorities have already been forced to make painful cuts, including in education, to offset falling revenue and the end of Uncle Sam's generous stimulus packages. Now it's the federal government's turn.

Democrats and Republicans are fiercely debating the best way to cut as much as $4 trillion from the budget over the next decade. If tax increases are off the table because of their potential to inflict further pain on the job market, deep spending cuts will be the only way to narrow the deficit gap.

A hopeful budget, but only time will tell

By Joe White

Delivering his second budget speech yesterday, Chancellor George Osborne revealed that he is leaving in place all of the austerity measures which will have a direct impact on the public sector. Meanwhile, there was a lot of policy aimed at supporting business and the private sector. The implicit assumption is that the private sector will take up the slack and continue to drive growth. This is the gamble, and we will have to wait and see if it works.

The government’s predictions for growth are down, and the reliance on the OBR forecasts could come back to haunt George if it starts to get worse and they continue to further revise down their independent estimates. Growth is the ultimate balancing factor for the public finances, so it is all important.

Simplification was a big part of this budget. Focusing on making the tax code easier to understand (43 tax reliefs abolished), and a potential merger of National Insurance and income tax will help. The calculation of payroll taxes is something that can only be done by a seasoned professional, so simplification matters and we can build on this.

Simplification also affects medium and longer term decisions to invest in the UK, as it makes a more attractive prospect for business. Flagging the 50 percent tax rate as temporary is also a nod in this direction to say, “stick around, it will get better”. Corporation tax is coming down for the same reason.

The increase in  R&D tax credits by 200 percent (rising to 225 percent) will help stimulate small business. This is linked to £100m further investment in new science facilities, funding of 12 new technical colleges and other initiatives like a reduction in times for clinical trials which will affect life science businesses. There will be further enterprise zones with tax benefits, but the welcome news is that there will be one in London, which as a major driver of UK growth is too often overlooked for additional support, particularly for start-ups and high tech businesses. A lot of this is longer term, but hopefully protects and develops the UK’s ability to build modern and high tech businesses.

For us as a business, the biggest benefit will be in the R&D tax credit, and in future the continuing reduction in corporation taxes, with the ongoing tax simplification being a good thing too. For our customers, 90 percent of which are small businesses who build and host their websites with us, the simplification of the tax code and the increase in personal allowances should reduce costs a bit and provide a bit more income. Other longer term business benefits around investment in skills and science should also help.

A long, hard slog in the right direction

By Dr Gerard Lyons

This was a good budget in difficult times. Trouble is, just how difficult the times are is still not fully appreciated. The economic environment the Chancellor inherited was not good. The recent economic performance has not been good. And there is no reason to think it will get better anytime soon. Indeed the scale of fiscal tightening previously announced will probably weaken growth further in the near-term. The UK economy faces a long, hard slog.

Today’s budget provided some clarity about what type of economy the Chancellor hopes to see in the future. And there the message was well directed. One of Britain’s biggest problems has been its lack of strategic thinking. It still has some way to go on this to compete with China, Germany and many other economies. The budget outlined four areas the government wants to focus on, all of which made sense:

First, to boost competiveness. The Chancellor talked of the need for the tax system to be efficient, certain, simple and fair. One could not disagree. However, today’s budget showed it is not even certain now for banks and oil companies. Making tax more competitive is a modern day reality. The Chancellor was right to address this, particularly in terms of the cuts in corporation tax. Also, to retain the highly skilled, offering some certainty that income tax rates may fall in the future might be helpful.

The second and third ambitions the Chancellor talked about are interlinked. The second is to make the UK the best place to start a business, by boosting incentives for entrepreneurs and for research and development. In a globalised world, it is as important to stop losing business as it is to encourage new start-ups. The third is to restore manufacturing, exports and investment. This means reversing a downward trend in manufacturing. The economy that leads in this area in Europe is Germany. Moreover, we have to compete on quality, not just cost.

Uncertainty about the UK economic outlook, when domestic demand is sluggish and the infrastructure poor, hardly suggests a large rebound in investment. The UK has had a poor track record in investing, and it will be hard to change this. The UK is also not best positioned to benefit from rapidly growing emerging economies. We export more to our Ireland, than to Brazil, India, China, Russia and South Africa combined. Unlike Germany, we don’t produce the capital goods they need. And large firms may be more inclined to invest in emerging economies, not here. Moreover, if the growth in investment is to be from small and medium-sized firms then not only are the measures announced by the Chancellor good, but we need to build on them to make British firms global in their outlook.

The Chancellor’s fourth aim is to address the UK’s skills shortage. The UK needs to spend more on its appalling hard infrastructure like road and rail, and more on its soft infrastructure like skills and education. Our education system is like a fork in the road, one route leads to some of the best universities in the world, now starved of cash, the other route to the bottom end of the system where education attainment is low. A few years ago a House of Lords Committee talked about the need to invest more in apprenticeships and technical skills. Today’s budget announced steps to address this.

George Osborne and the band-aid effect

The second budget presented to Parliament by Chancellor George Osborne is likely to be less talking and more doing when it comes to bringing the UK’s public finances under control.

This won’t be to everyone’s tastes. Some argue that the UK is in less financial danger than Europe’s financially troubled states, yet Osborne is embracing deficit reduction plans with as much gusto as Ireland or Greece.

Osborne has indeed been faithful to the ‘band-aid effect’ when it comes to remedying the UK’s bloated balance sheet. There is to be no picking at the corners for him, he is getting ready to rip that plaster off with all of the short-term excruciating pain that goes with it.

The Chancellor’s fiscal targets are ambitious. He wants to virtually eliminate the budget deficit by 2014-2015 and to halve government borrowing over the same time period. Seventy-seven percent of this will be achieved through public spending cuts, with the rest of the 23 percent coming from tax increases.

In the clip above, Kathleen Brooks says this will be “a budget of no surprises.”

The budget must help SMEs to survive and grow

By Bobby Lane, Partner at Shelley Stock Hutter LLP. The opinions expressed are his own.

Everyone in my practice, and no doubt anyone advising the five million UK small and medium-sized enterprises (SMEs), welcomed the Prime Minister’s latest show of support for them at the recent Conservative Party conference.

Yet this “power to SMEs” speech is something we have heard from politicians on all sides of the house in the past. In 2009 when discussing the pre-budget report, Alistair Darling talked about providing “real help when businesses need it most” and “better access to credit”. We are now in 2011, and my clients will confirm they are still waiting.

Declaring war on the “enemies of enterprise” and being on the side of “go-getters” may be rousing rhetoric from our current government. However, my concern is that we have heard it all before and the time for talking has long passed.

Access to finance is, in some instances, harder than ever to obtain — especially if you are starting up. In addition, the cost of employing staff is due to increase in April this year and the full effects of the spending cuts are still on the way. In my view the government has to act quickly, decisively and significantly by introducing hard and fast measures that will assist all SMEs within the UK — both to survive and assist in their growth.

The national insurance contribution holiday that was introduced to assist start-ups in some areas was a step in the right direction, but should be extended to include the whole country. The creation of new enterprise zones may also go some way to provide support to start-ups.

The Enterprise Finance Guarantee (EFG) scheme has received much bad press, but has gone some way to help businesses and should be reviewed further to identify ways of encouraging the banks to lend more under the scheme. With the banks’ credit committees still nervous to lend to any business that does not tick every box and then some, the government could look at increasing the initial size of the guarantee provided from 75 percent to 100 percent and then scale it back to 75 percent over the period of the loan.

A budget for Growth?

By Thomas Story, Tax Director, BDO LLP. The opinions expressed are his own.

George Osborne has promised that measures to boost sustainable growth will be central to this week’s Budget. To meet this objective, the Chancellor faces the challenge of accelerating the reform of business taxation within the severe constraints imposed by the overall fiscal position and the political imperatives of the coalition government.

Many previous reforming Chancellors have benefited from a more benign fiscal outlook to facilitate fundamental fiscal reform (Nigel Lawson and Gordon Brown spring to mind). The daunting fiscal deficit means that any tax reforms must be achieved within a tax neutral framework; Geoffrey Howe’s Budgets in the early 1980s are a closer precedent but the need to accommodate both parties to the coalition agreement provides additional dilemmas in 2011.

The emergency budget in June 2010 set out the road map for corporate tax reform which outlined a vision of a more competitive tax framework with the aim of making the UK the location of choice for international business. This set out underlying principles including a commitment to a simpler taxation system with lower headline rates but acknowledged that these must be achieved for the present without any overall reduction to the levels of corporate tax receipts. In practice, this can only be achieved by restricting targeted tax reliefs.

The main rate of corporation tax is already scheduled to be cut from 28 percent to 24 percent over four years, which will be partly funded by reductions in capital allowances on plant and machinery. To maintain this momentum, the Chancellor must be tempted to go further, perhaps by announcing a target corporation tax rate of 20 percent or less. This may be achievable if there is a substantial improvement in levels of corporate profitability provided, of course, that the growth targeted by the Chancellor can, indeed, be sustained over the next four years.

To date, the other main thrust of corporate tax reforms have been to simplify and restrict the scope of rules addressing Controlled Foreign Companies (‘CFC’s) and overseas branch profits. The common themes of these reforms is to promote the UK as a location for international groups by introducing a more territorial basis of taxation and ensuring that anti-avoidance rules apply only where profits are artificially diverted from the UK.

It is understandable that the emergency budget focused on these areas given the pressing need to enhance the attractiveness of the UK as a location for large international groups. Further details of these reforms can be expected in this budget. The Chancellor must tread carefully to fulfill these objectives while taking account of the growing public intolerance for wholly artificial tax planning.

Budget will force ‘squeezed middle’ to muddle through

By John Evans, CEO of Incahoot.com. The opinions expressed are his own.

It’s a cold November morning last year, and in the Today programme studio Ed Miliband sits across the desk from John Humphrys.

John: “So Mr Miliband, can you tell us exactly what you mean by the ‘squeezed middle’?”

Ed: “Well John, we mean those above and below the median salary and, in particular, those earning less than £45,000 and therefore on the basic rate of income tax. This is a separate group from what we would normally call the ‘middle classes’.”

If that definition seemed vague, five months later we are getting a clearer picture of who falls into this group – and it’s clear they will suffer the most when the Budget is announced.

While some of the Budget’s finer details will only be revealed on 24 March, what appears certain is that favourable tax breaks will only benefit the wealthy, and the less well off.

It’s not such good news for those earning from £40,000 to just under £44,000. The reduction in the higher-rate threshold will mean basic-rate taxpayers with incomes just below the current £43,875 figure will become 40 percent taxpayers this year. I’ve seen figures bandied about in the press that lowering the threshold to £42,375 could add around 700,000 individuals to the 40 percent tax bracket. This would push the total number of higher-rate taxpayers to nearly 4 million.