The last Budget before the General Election included a series of carefully targeted measures to help...
The last Budget before the General Election included a series of carefully targeted measures to help Labour to a second victory. Some steps had been pre-announced (children's tax credit, climate change levy, road fuel duties) but the Chancellor again took the credit. Other measures had been well flagged (research and development tax credits, Isa limits).
The Chancellor was criticised from several quarters before the Budget, and will be criticised afterwards too. Despite his protestations about raising productivity growth in the UK, he is making the tax system more complicated and there is little in his statement to enhance the supply side of the economy.
There are few areas to worry the markets in the short-term. But longer-term fears remain about the expansion of public sector spending against the backdrop of robust domestic demand and tight labour markets, along with the growing tax burden on industry and the over-regulation of the enterprise sector constraining the Government's aim of raising productivity growth.
The Chancellor's economic forecasts are generally in line with the latest City consensus, or support the MPC's inflation target. The most important changes to the Treasury's view concern the composition of growth. In particular, the current account deficit is expected to rise to rather worrying levels of £25bn a year or 2.5% of GDP. The rationale is that buoyant consumer spending and business investment plus the surge in Government spending will lead to imports growth of some 7% a year in real terms.
The Government is giving the UK a sizeable fiscal boost, from the spending and tax plans announced in last year's Budget, the Comprehensive Spending Review (CSR) and the Pre-Budget Report (PBR). The real increase in total managed expenditure presented by the Treasury is 4.4% in 2000/01, falling away to 3.4% by 2003/04. This reverses the undershoot of spending seen in the past year and keeps total expenditure on track for a solid increase over the coming parliament.
The giveaways this year can easily be explained. Tax revenues as a percentage of GDP have risen over the past four years, from 37.6% in 1996/97 to 40.5% in 2000/01. This seems to assume that the higher than previously estimated tax revenues will hold up. Public spending has fallen from 41.2% in 1996/97 to 37.8% in 1999/00. The net result is a steady decline in the debt/GDP ratio, forecast to fall below 30%.
The underlying improvement in public finances is understandable: stronger economic growth, average earnings and fiscal drag have led to receipts growth of some 7% a year. Nominal spending has been 6% per year against a PBR forecast of 8%, which has been due to lower unemployment but also Government problems in raising public investment. There have also been changes in the relationship between VAT and consumption, although it is too early to know whether this is cyclical or structural. The Chancellor's fiscal rules easily allow him to portray himself as prudent.
Nevertheless, the finances allowed the Chancellor to give back a further £4bn, in tax and spending, which was in line with City estimates. The combination of a US slowdown and an impending Election encouraged the Chancellor to distribute some further largesse, rather than reduce the debt burden further.
Tax and spending
The Chancellor likes to take the credit several times in a row, and March 2001 is no exception. Various measures have been pre-announced (principally the 'pensioners' package) or were subject to 'consultation' last November (cuts in road fuel duties, for example). These cost some £4bn already and that is on top of £3bn of measures announced in last year's Budget and the new money today.
As expected, the latest giveaway is worth some £3-£4bn in terms of taxes, and spending was designed with the Election in mind. Labour has spread the largesse thinly and widely, to working households (through raising the 10% band), small companies (VAT thresholds), pensioners (a new credit), families (children's credit, maternity pay), and Labour supporters (health and education spending). The road fuel and green lobbies saw a series of steps to cut vehicle ownership costs and promote green fuels. Surprisingly, there was very little for the farming community.
The Chancellor was widely criticised in the run-up to the Budget for raising the tax burden on business and the rise in red tape. He responded with a series of minor measures, simplifying the VAT system for smaller companies and extending research and development tax credits to large companies. The sums involved though are small, many small and medium-sized businesses still have cause for complaint and few new measures were announced. The Government's efforts to create a more flexible labour market were supported with another round of focused measures aimed at the youth unemployed, lone parents and apprentice schemes.
The MPC will not be constrained by the closeness of the Budget or the Election from making any interest rate changes. Treasury officials have briefed the body on the details of the statement. On balance, the Budget will encourage some members of the MPC to be more cautious in cutting rates further, with an expansionary fiscal stimulus worth some £4bn in terms of tax cuts and public spending. However, developments in the US and movements in the oil price and sterling will be more fundamental as RPIX drifts towards the 1.5% floor this summer.
There are only a few minor sectoral implications for the equity market, for example, transport, gaming, spirits and pharmaceuticals. The efforts to be business-friendly were clear throughout the Chancellor's opening remarks. There was a small sigh of relief that the oil companies did not suffer a windfall tax, unlikely though this always was, but the City will be disappointed about the Chancellor's decision, yet again, not to make any changes to stamp duty.
The gilts market looked at the Budget in terms of Emu, inflation, gilts issuance, and the minimum funding requirement (MFR) with few surprises on any of these. The Chancellor avoided the Emu, leaving this thorny topic for after the Election.
Freezing excise duties will have a marginal downward impact on RPIX as it drifts towards the 1.5% floor, partly offsetting the upwards impact from foot and mouth and increase in the minimum wage. There was relief in the index-linked market that the inflation target would not be altered, despite weekend speculation.
The main impact of the Budget therefore is on the long end of the gilts market, which sold off straightaway. This followed the announcement to abolish the MFR and accept the proposals of the Myners Report, which contained a number of proposals aimed at trustees, consultants and fund managers (in that order).
The abolition of the MFR is welcomed, although the precise details of its replacement will be key for the long end of the gilts market. If Myners' proposals are put into legislation, rather than into a voluntary code as the Chancellor has threatened, there is a risk of over-regulation of the fund management industry, putting it at a competitive disadvantage in a global market.
On the currency, the knee-jerk reaction to the Budget has been negative as Myners' proposals worry some gilts investors. In the medium term, this is a Budget that will support sterling, as a relatively tight fiscal position is projected forward in time, while the implications for the MPC are limited. Further ahead, the projected increase in the current account deficit to £25bn a year is not sustainable, reflecting the impact of stronger government spending on an already buoyant economy, and could require MPC action.
The Treasury will present this Budget as another prudent piece of fiscal management. However, the fiscal stimulus is notable and the Statement will not reverse the concern about an unduly easy fiscal policy that has been expressed, for example, by the European Commission and the IMF.
There have also been mounting concerns about the burden placed on business since 1997, both in terms of regulation and the tax burden (tax on corporate income is about 4% or GDP in the UK versus about 2.5% in the US and Europe.
Most recently, research found little evidence of any improvement in UK productivity despite the Chancellor's efforts since 1997. He may protest that he is trying to raise investment and productivity in the UK but he is making the tax system more complicated with little in the Budget to boost productivity or enhance the supply side of the economy
The Treasury has admitted that its borrowing forecasts are always on the conservative side, partly as its growth forecasts are overly cautious. In the circumstances, the criticism is increasingly valid about whether the Chancellor's fiscal rules are at all helpful in practice, as opposed to theory.
Andrew Milligan is head of global strategy and Keith Skeoch is chief investment officer at Standard Life Investments
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