(It’s battered red box time…)
Overview
Despite recent political headwinds, the overriding context for the Budget remains the deficit and the need for Chancellor George Osborne to show he is staying the course. Anything else would cause a huge loss of credibility that the Government (and certainly the Treasury) would argue is far more damaging to the UK’s standing than any failure to respond to immediate political pressures on VAT or bank bonuses (in the case of Labour) or even the personal allowance or avoidance (in the case of the Liberal Democrats).
Underlying all of this is a base political calculation: the Chancellor is fixated on achieving a Conservative majority in 2015, which requires strong economic performance, but also a Conservative revival in key conurbations in northern England. It therefore important for Osborne to be seen to be concerned about rebalancing the economy away from financial services, and investing in northern England.
In that respect, nothing much has changed since the Autumn Statement – when the Office for Budget Responsibility (OBR) downgraded their UK Growth estimates for 2011 to 0.9%, and the Chancellor increased his borrowing estimates. In this respect, arguably the decision by Moody’s and Fitch to put the UK’s AAA credit rating on negative watch strengthens the Treasury’s hand in favouring firstly fiscal conservatism, and secondly measures to promote growth. This dictates the political logic of the Budget – the paramount need to demonstrate that any tax giveaways are fully funded, and that the Government has a credible plan for growth.
Despite deficit reduction, the 2012-13 deficit forecast remains above 6.5%, leaving the public finances remain extremely stretched. However, due to higher than expected receipts, the 2011-12 Public Sector Borrowing Requirement (PSBR) remains between £5bn – 7bn lower than forecast last year. This has led some influential commentators (e.g. Tim Montgomerie from Conservative Home) to call for this to be spent on tax cuts or increased spending. However, Osborne has been clear that there will not be any unfunded giveaways, as the reduction of the deficit remains the Coalition’s overarching economic goal.
As this £5bn is a one-off, it cannot be used for multi-year spending commitments or tax cuts without creating an unfunded liability next year – although if sustained, these higher revenues will shorten the return to fiscal balance. Consequently, Osborne is unlikely to rely on this to fund anything beyond one-off give-aways – and, even here, he is likely to use the bulk of it to pay down the deficit.
Growth
Achieving pro-growth measures with fiscal restraint will therefore be Osborne’s goal. This suggests incremental changes, rather than grand designs. However, there are still some headline measures that might be affordable – of which, a further reduction in the headline rate of corporation tax (and the small profits rate) is presumably top of the Chancellor’s list. CT reductions are relatively cheap – approximately £1.7bn for each 1% cut in the headline rate and would have real political impact with the Conservative’s business base. They would also play well with Conservative backbenchers, who have regarded the Liberal Democrat-led debate around how to squeeze the wealthy in the run up to the Budget with ill-concealed dismay.
In 2011, when Osborne made a further reduction in the rate of corporation tax beyond that already decided in the 2010 Budget (bringing the rate from 28% to 26%), he adjusted the bank balance sheet levy to ensure that banks did not benefit from the CT reduction. For the same reasons, it is likely that he could take such action again if he did decide to cut the headline CT rate. Beyond this, however, we do not expect him to go further than he did in the Autumn Statement and substantively adjust the bank balance sheet rate again to raise yet further revenue.
Tax
Few issues have divided the Coalition as much as the 50p top marginal rate. To supply-side Tories it undermines economic incentives for the wealthiest, and raises less than £3bn annually. To social democratic Liberal-Democrats it is proof that there is some substance to the “we’re all in this together” rhetoric as painful welfare cuts are implemented – and any additional revenue is welcome. In deference to the latter view – and the net revenue – the 50p rate is likely to be cut incrementally to 45p, though Osborne is likely provide a roadmap to its abolition by the next election. In the absence of “wealth taxes”, this cut produces a major party management issue for Nick Clegg.
Closing the loophole that allows companies registered abroad to pay 0.5% stamp duty on properties over £1m rather than 5% seems certain, but would only raise about £200m. A mansion tax is politically popular in the country as a whole, but difficult to enact and potentially toxic for, especially, Conservatives in wealthy South East constituencies. Increased or additional council tax bands are therefore the most likely alternative. However, the Coalition scrapped the £200m/3 year revaluation project for Council Tax in the 2010 spending review. As a result, though the easiest route of adding one or two new higher Council Tax bands is a blunt instrument – in that it reflects relative values in 1991 – it remains the most likely.
Infrastructure
Infrastructure projects that are “shovel ready” are likely to be brought forward. In this respect, transport – especially rail – could be the big winner. Specific projects for consideration include the “Northern Hub” rail programme focussed on improving travel between Liverpool, Manchester and Leeds – and it is comparatively inexpensive at £560m. Improving strategic freight routes – especially for container traffic – is also possible, because as well as reducing truck miles, improved cross-country freight routes will divert freight trains away from London, improving passenger services in London and the South East. Projects in this category could include Ipswich to Nuneaton electrification, and reopening rail lines between March and Spalding, and from Bedford to Cambridge – which would also allow direct Cambridge-Oxford passenger services. One benefit of these schemes is that the cost would fall initially onto Network Rail’s books, rather than directly on the Treasury.
Despite this, the nature of the coalition – and the political running the Liberal Democrats have made recently around the need to increase the personal allowance – means that the Chancellor will have to make some move to meet this demand. In providing a tax cut for middle income earners, it also provides political headroom for reductions in the 50p top marginal rate. The political and economic logic then follows that this is likely to be paid for through measures aimed at the wealthy, who are far more able to afford it than those on middle incomes, or business, both of which carry far greater political risks.
So what?
Overall, this suggests a fiscally conservative Budget aimed at reassuring the markets and ratings agencies, while at the same time throwing bones to both the Liberal Democrats (tax cuts for the less well off) and Conservatives (tax cuts for business and high earners; supply side reform). The question is how far the Chancellor will be able to go towards meeting all these pressures, and to what extent he will be able credibly to avoid increasing taxes on the better off, in particular, through spending cuts.
