Entangled Alliances

photo credit: HM Treasury

Last Wednesday, amidst the worst economic crisis since the Great Depression, the British Chancellor of the Exchequer Alistair Darling stood up in the House of Commons and announced the the UK’s budget for 2009. If  the reactions of his fellow MPs are to be believed, it was a bit like watching a horror film; albeit one where the crazed axe murderer has been replaced with a boring Scotsman reading out numbers. The ranks of Labour sat in stunned silence, while the Conservatives reacted with a series of  theatrical shocked gasps that accompanied the announcement of each new gruesome piece of economic news.  Meanwhile the media, who had known most of what was in the budget days in advance, had a lot of fun being shocked all over again by the poor state of the government’s finances and the woeful growth predictions for the UK.

Thanks to the current economic maelstrom, this budget was arguably like no other in living memory. It was certainly like no other in recent living memory. The usual budget questions – “how much do I have to pay for my cigs and beer now?” and “why did my national insurance just go up?” – are out and a new set of much more, uh, exciting questions are in:  “Is Britain going to default on its debt” “now their taxes have gone up, will those rich city bastards find some new ways to avoid paying them?” and “is that the average winter temperature in Iceland, or Britain’s growth estimate for this year?”

But what exactly was in the budget, what does it mean for Britain and can we make an incredibly complicated topic really simple in order to give the Chancellor a pointless high-school style grade? Find out over the fold!

Can you repeat those figures please?

photo credit: ktpupp

The buzzword for this budget amongst the news pundits was “historic”. This was not meant in a good way, e.g. “as we turn to Nelson Mandela, there is no doubt that this is a historic day for South Africa” but in a very bad way, as in “now that the fraud of Bernie Madoff has come to light, it’s obvious that this is a historic day for really stupid investment schemes”.  The first “historic” news came with the Chancellor’s announcement that he predicts the economy will shrink this year by 3.5%. This would be the worst performance since World War 2. Though it was brave of Darling to stick to such a grim prediction, his figures were still more optimistic than those of the International Monetary Fund – who predict the economy will shrink by 4.1% this year -  and even as I write this it’s just been announced that the figures for first quarter growth are a doom-laden 1.9%, which means that it’s probably going to be an even worse year than the Chancellor predicted. Nevertheless, it was brave of Darling to stick to such a grim outlook, though any praise is probably balanced out by his predictions  for the country’s growth in future years, which have been dismissed by, well, everyone as utter fantasy. According to the Chancellor, Britain’s economy will start to recover by the end of this year and actually grow in 2010 by 1.25% – a rather noticeable contrast to the IMF’s predictions, which see the economy shrinking again by 0.4%.  He also predicted that the economy will, after presumably taking some illegal steroids, grow at the rate of 3.5% from 2011 onwards.

3.5%! Why so optimistic, Chancellor? The generous amongst us might argue that he genuinely thinks that the economy will experience  a sort of “trampoline effect”, i.e. respond to a seriously bad patch by leaping back up to reasonable growth. The cynical, and more likely, reason for such a hopeful figure is that by saying the economy’s going to well and truly bounce back in a couple of years the Chancellor is able to predict lower borrowing figures, since a good economy means the government doesn’t have to borrow as much.  So his optimistic predictions allow him to present a picture that’s merely beat-your-head-against-the wall-bad, as opposed to head-to-the-nearest-bridge-and-jump bad.  And, most important of all, we’ll only know if he was right to be so optimistic well after the next general election. That’s pretty cunning.

One ray of light though: compared to Germany and Japan, our growth numbers are not as terrible as you might think. According to recent IMF figures, Germany’s economy will shrink by an ugly 5.6%, while Japan’s will contract by a catastrophic 6.2%. How’s that opposition to a global stimulus working out for you , eh, Germany?

Let’s get hysterical

The next set of “historic” figures concerns how much the government is going to have to borrow over the next few years. According to the Chancellor, the government will have to borrow £175 billion this year, or 12.4% of GDP. Britain’s net debt as a percentage of GDP will rise to 59% this year, and peak at 2013-14 at a rather alarming 79%.  These figures are, on the face of it, pretty bad and have sent everyone into a bit of a panic. The BBC’s business editor Robert Peston, for example, has questioned whether Britain will be able to sell all the debt it needs to this year to investors, and even mentioned the possibility of the UK losing its AAA Credit rating, which would effectively make Britain the equivalent of one of those awkward friends who you always try to avoid because they always want money but never pay you back.

Step back a bit though and you might be entitled to wonder whether all this hysteria over borrowing levels is really warranted. Take, for instance, this graph (courtesy of The Guardian), which shows Britain’s net debt as a percentage of GDP compared to other major countries:

What’s noticeable from these figures is that even when our net debt as a percentage of GDP goes up to 59% this year, it will still be less than Germany’s current debt. Even more striking, the highest net debt the Chancellor predicted we will see – 79% of GDP by 2013-14 – is still 90% lower than the current debt of the Japanese who, we can only assume, must have been borrowing from Michael Corleone. Once you put these figures next to the Japan/Germany vs UK growth figures I mentioned earlier, it becomes evident that we really aren’t the sick man of Europe, despite what David Cameron might have us believe.

One caveat however: as I pointed out above, the Chancellor’s borrowing figures are derived from his comparatively rosy prediction of future economic growth. Therefore, should Darling’s optimism prove unfounded, then Britain’s debt could actually become a lot worse, though certainly not in Japan’s league…

Hysteria aside, why is this level of borrowing so problematic? Well, as I explained in (a bit) more detail in my last post on the budget, the more a government needs to borrow, the less willing investors are to lend them money and thus the more expensive it becomes to pay off the debt the government already has. This becomes a real problem when borrowing levels become as high as the Chancellor says they are. One thing it means is that the government will probably have to cut public spending at some point. However, in another clever political move, Darling put off making such tough decisions; pointing merely to planned backroom efficiency savings of £9 billion a year and avoiding mention of actual front-line cuts in the future.  It’s difficult to imagine that such cuts won’t have to be made, but the crucial point as far as Labour is concerned is that the Chancellor seems intent on putting off any mention of deep cuts until after the general election. True, this makes Labour vulnerable to criticism that they are in denial on the inevitability of big cuts, but the problem for the Conservatives is that every time they make this point, they are then asked “What will you cut?” to which they always respond with the political equivalent of shouting “Look over there, it’s George Clooney!” then running away very fast in the opposite direction.

Surprise!

photo credit: marcelgermain

It had already been known before the budget that tax rises for the rich were probably on their way but even so it was still a big rabbit-out-of-the-hat moment when the Chancellor announced that the top rate of tax will be raised from 40% to 50% from next April, which will affect those earning over £150,000 – or the wealthiest 1% of the population as they’re also known. This announcement was, in its own way, historic. The last time a government raised the top rate of tax was in 1974. Moreover, ever since Margaret Thatcher went about viciously attacking the top rate with a pair of scissors in the 80s it’s been obvious that we don’t have a very progressive tax system.  Labour have seemed reluctant in the past to amend this, Tony Blair famously noting that he didn’t go into politics to stop David Beckham becoming  a millionaire (which never really made sense  given that you’d probably have had to tax Beckham at about 50 zillion percent to stop him becoming a millionaire by now). In Labour’s 2005 manifesto they promised not to raise the top rate of tax; indeed New Labour under Tony were quite a big fan of the rich all things considered. How times have changed. Indeed, one of the silver linings to come out of this economic crisis might well be the destruction of the myth that for the country to prosper the rich are best left alone: under regulated and taxed as little as possible.  Which as silver linings go is excellent, because it means we can have a proper debate at last over what is a fair amount for the comparatively mega-wealthy to contribute.

Furthermore, given the economic times and the accompanying dislike of the wealthy, the Chancellor’s surprise move was very good politics. Since the tax rise will come into place a month before the next general election (assuming it’s not held earlier than next May) the Conservatives will be forced to make a very hard choice. Do they choose to obey their base, who obviously detest the idea of this tax rise and want Tory leader David Cameron to promise to repeal it if they win the election? Or do they follow public sentiment and promise to keep it, at the risk of dividing the party? The splits are already showing, as Conservative London Mayor Boris Johnson has called on Cameron to clearly oppose the new tax, forcing his leader into a mealy-mouthed promise that it will ” form its place in a queue of taxes we want to get rid of”. It will be interesting to see if Cameron comes out more against it in a general election campaign.

It should also be mentioned that, despite the initial scepticism of the media, the new top rate will actually bring in quite a bit of cash for the government. In fact, if you include the other new squeezes on the rich – the  withdrawal next April of the personal tax allowance of those earning over £100k and the restriction of pension tax relief for those on incomes over £150k from April 2011 – then by 2012-2013 the new tax system for the wealthy will be bringing in 7 billion a year, which is not chump change. Still, there was more that could have been done in the budget tax-wise. Capital gains taxes, which are only 18%, help to make our system regressive in one important sense, since the wealthy can avoid paying as much income tax by funneling their wealth into stocks and shares and thus paying the more generous capital gains taxes instead. Furthermore, it’s instructive to remember that for the first nine years of Margaret Thatcher’s tax-hating government, the top rate of tax remained at 60% , until 1988 when it was reduced to 40%. A return, then, to 60%  really isn’t as crazy as the anti-tax brigade would have you believe. Why not apply the rate of 60% to those earning over £250,000? At the very least, the change in the top rate could have been accompanied by a more logical progression of tax rates: those earning over £100,000 -or the top 1.5% of the population -  could have been taxed at 45%, for example. There’s no real reason why we have to have a ridiculous jump from a 40% rate at £40,000 to 50% at £150,000. The key point here is that if you’re going to make taxation more fair and sensible, there is no better time politically to do it than at a time of great economic peril; so Darling’s surprise was, at the same time, very welcome but disappointingly small in its vision.

How Stimulating…

The stimulus package, which was focused mainly on job centre funding, green energy spending and the housing market, amounted to around a mere £5 billion. This was pretty weak stuff and not exactly  the economy-boosting fiscal splurge that large numbers of economists have recommended. What was particularly strange about the reaction to the budget is that the hysterical response to the gloomy borrowing figures massively overshadowed any concern about the inadequacy of the fiscal stimulus. This is pretty silly, since the size of a stimulus directly affects the issue of government borrowing. This is because the better an economy is doing, the less the government has to borrow. The main purpose of a big stimulus package is to pump enough money into the economy so that a significant amount of jobs are created, thus shunting the economy back towards positive growth… and less borrowing. A sufficiently large stimulus package is therefore helpful in reducing borrowing in the long term, if not in the short term.

But even if you disagree with this analysis, the fact remains that the Chancellor could have put in place a beefier stimulus of up to £13 billion without adding more to the levels of borrowing. How? Simply by repealing the VAT cut he put in place back in November, which has been more universally panned than the cinematic pairing of Ben Affleck and Jennifer Lopez. This would have netted an extra £8 billion. It’s not clear why he didn’t do this, but his decision to continue with the VAT cut means that a brilliant chance went missing to enact a decent stimulus while not contributing further to the borrowing figures.

photo credit: phault

Another criticism of the underwhelming spending package is that the Chancellor missed a brilliant opportunity to harness the economic theory behind a fiscal stimulus in order to get away with some  serious investment in industry, jobs and infrastructure. Nowhere was this more evident than in the stimulus measures to tackle climate change. For all the talk of the start of a “green budget”, the actual sums – £375m for home energy efficiency, £525m support for offshore wind power and £405m for the development of low-carbon technologies – aren’t nearly enough to really make a difference. As Friends of the Earth’s director Andy Atkins said: “The government has squandered a historic opportunity to kick-start a green industrial revolution and slash UK carbon dioxide emissions.”

Grading the Chancellor

It would be childish to try and give the Chancellor a high-school style grade for his budget. But I’m going to anyway. For his clever use of politics to put the Conservatives in a corner over further taxing the wealthy, and for the fact that he’s actually further taxing the wealthy, he gets an A. That goes down to a D when you factor in the rubbish stimulus and the rather obvious avoidance of the subject of public spending cuts, along with the daft predictions of future growth. But in the end, he gets a B- thanks to a big sympathy vote from my clearly very unprofessional hypothetical teacher. After all, would you have wanted to be in Darling’s shoes?

Pointless grading aside, one thing is very clear: this budget has completely changed the political and economic landscape. Gone are comparatively meaningless debates over public spending (the difference between the public spending plans of Labour and the Conservatives at the time of the 2005 election amounted to a now laughable £12 billion), in their place are truly significant debates on how much to tax the rich, what public services should be cut and how to reduce our ridiculous deficits. Sadly, the political window has now come and gone for a progressive, nation-changing British stimulus – a fact that should really be causing much more distress than it is – and we now enter, as annoying BBC political editor Nick Robinson has put it, “an era of austerity”. Thus the UK will have to take on the characteristics of Delboy Trotter: always looking to flog something, never able to buy anything.

Still, look on the bright side: at least Britain isn’t having to spend untold billions on staging a massive global sporting competition in two years time that never comes within budget and always drains the resources of the country hosting it. That would really suck.