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The June 2010 Budget: An Analysis

June 24, 2010 1 comment

Mr Pike is unavailable at the moment, all views specified in this post are of my own opinion and may or may not represent Mr Pike’s views.

This government, as does any government, has a responsibility, in the long-run, to keep public finances in good order. A cynical person might point towards a desire to keep the markets happy – that person would be partly correct. Britain currently has a structural deficit of about £150bn and the debt that Britain owns is about £770bn. Debt interest payments at the moment, and for the next 10 years or so, remain manageable. One could ask the question: “why not delay?” Because if you delay dealing with a problem you only exacerbate it. It is better to deal with the problem as soon as possible rather than letting it, potentially, spiral out of control or even forgetting and neglecting it. Also, if credit rating companies decide to downgrade Britain’s credit status this will mean a more expensive borrowing rate, less time to pay the debt and a dramatic drop in the confidence of Sterling and the British markets ultimately leading towards a default on debt repayments. Many have, and will, cry out that “the markets don’t own us!” Unfortunately in this life they do. The Budget report states that “high levels of debt put an unfair burden on future generations” which, for the above reasons, it does.

The government aims to eliminate the structural deficit by reducing expenditure by £32bn per year by 2014-15, which will be detailed in the October Spending Review. They will also reform the welfare system saving an anticipated £11bn a year. Added to these savings is an increase in VAT from 17.5% to 20% expected to raise £13bn a year in revenue. The government aims to consolidate debt by £113bn per year by 2014-15 and £128bn per year by 2015-16. Breakdowns with this forecast indicate that the structural deficit will be eliminated by 2014-15 with a projected surplus of 0.8% of Gross Domestic Product (GDP) in 2015-16. It will also reduce public debt from a perceived 70.3% of GDP in 2013-14 to 67.4% of GDP in 2015-16. THe previous Labour government wanted to halve the deficit by 2014-15, this was perceived to be a good plan by international financial bodies and markets. The Coalition government, on the other hand, are being far more ambitious by eliminating it completely within the same time frame. The government does risk sending the economy into a double-dip recession but the current rate of growth coupled with increasing global stability (now that the Chinese are revaluing the Yuan) should avoid the double-dip but will reduce the rate of growth by about 1% by 2011-12 meaning growth will be about 1.5%.

The government also aims to encourage growth, exceeding my predicted 1.5%, by “rolling back the state” so that the private sector steps into the gap previously filled by the public sector. If national economic growth is provided by the public sector it becomes unsustainable as growth is heavily reliant upon debt. Of course there needs to be growth in the public sector and this can be achieved through competition between the public and private sectors but growth in the private sector needs to be stimulated to create and sustain national economic growth. However, if the public sector is withdrawn too rapidly from the market, or the private sector is too small, it will damage the recovery and could stimulate a black market into activity in an attempt to fill the void. As a common principle – “Nature abhors a vacuum”.

The government hopes to encourage growth by reducing Corporation Tax from 28% to 24% over 4 years. This will stimulate growth and competition in the private sector and will likely raise enough revenue, because of growth, to negate the effects of the reduction. However there is a risk, as with everything in economics, that the reduction will not stimulate growth nor will it raise enough revenue to plug the shortfall. The reduction in small profits rate to 20% will encourage the growth and expansion of Small-Medium Enterprises (SMEs) which, over the past two years, have been heavily dependent on public investment. The majority of this budget is aimed as SMEs and Start-up businesses rather than the big businesses that the Conservatives are typical of favouring.

On the bright side, the personal allowance is being raised by £1,000 to £7,475. Whilst this is a positive move, at the proposed level, current levels of inflation coupled with the rise in VAT will wipe out the benefits from the increase. However it is a move towards the £10,000 personal allowance which receives near universal support. Capital Gains Tax (CGT) will be increased to 28% which is another positive move and inhibit the practice of short-selling. The bank levy is an awkward issue mainly because it is being imposed unilaterally. Of course there is the argument that if you lead the way others will follow. I sincerely hope so, but history has taught me to be cautious and expect no one to follow. The freezing of Council Tax is a double-edged sword  as it works in favour of taxpayers by not having to pay an increase but services that they rely on will be cut in real terms due to inflation and a reduction of £1bn of the Local Government and Communities budget. There will be much-needed review and reform of the welfare state. Redistribution of wealth through the welfare system would always cause problems as it creates overcomlexity whilst also creating an entitlement culture. Redistribution of wealth should always be pursued through the tax system in order to ensure simplicity and effectiveness. Redistribution through tax will also end the entitlement culture – the only things one has an entitlement to are human rights, everything else has to be earnt, of course there has to be equality of opportunity to start off with, which can only be administered through education but that is another matter that shall be addressed in the near future.

Pensioners benefit from one Lib Dem manifesto commitment of the triple guarantee of “earnings, prices or 2.5% whichever is highest”. This measure will ensure that, year on year, pensions will always be, at least, on par with inflation.

The BUDGET

The government acknowledges that it was debt that primarily fuelled growth, they say over the past decade though it is closer to two decades, this, rightly, creates instability which ultimately led to the financial crisis in the first place, among other things. The aim, therefore, is to rebalance the books and when the structural deficit is £150bn it requires a lot of tough decisions and harsh measures – hence this budget. The government acknowledges that the financial sector and the housing market played a large part in the financial crisis which makes me wonder if Vince had a hand in writing this budget – see V. Cable, The Storm, (2009).

As noted above the deficit needs to cut drastically and, as is the case with this government, eliminated. This will ensure confidence, whether it is market, business or household, in the economy. The debate surrounding this issue is not how much to cut spending but when. This government has decided that it will begin spending cuts this year whilst the previous government prescribed cuts to occur next year. To begin cutting this year could damage the recovery and send the economy into a double-dip. However one would hope that if a double-dip did occur the government of the day would abandon austerity measures and re-implement a variation of Keynesian economics – but only time will tell to see if the abandonment of austerity measures is necessary. At the last growth forecast the abandonment should not be necessary.

This budget does lay blame on the previous governments which is fair considering some previous poor judgements in regards to the economy. Spending and borrowing increased during growth periods when saving should have been the order of the day. If Labour, and the country is to move on, then both need to own up to past mistakes. The Conservatives do not escape blame either as their handling of Black Wednesday was truly awful. The spend and borrow programme was rightly rolled out during the financial crisis, much to Conservative opposition, but it was not targeted in the right areas (discussed later). Once public finances have been brought under control and operating in a surplus Britain will be in a much better position to roll out Keynesianism when another ‘bust’ occurs.

The overall aims of this budget arises out of necessity. If you disbelieve this I direct you towards the Stability and Growth Pact which provides a fiscal framework within EU member states. It details that the deficit should be below 3% of GDP by 2014-15. The government claims that austerity measures under the previous government only reduced the deficit to 4% of GDP by 2014-15 and austerity measures under this government will bring the deficit below 3% of GDP by 2014-15.

The Bank of England will be given new powers and responsibilities such as control over macro-prudential regulation and oversight of micro-prudential regulation. Macro-prudential regulation concerns itself with the overall stability of the financial system. Micro-prudential regulation, on the other hand, concerns itself with the regulation and certification of those working in the financial sector. By giving these regulatory measures to the Bank of England the country should avoid a financial crisis on a level recently experienced. The budget has also allocated provision for an independent commission on banking which will report its recommendations on banking reform by the end of September 2011. If the commission uses the entirety of its alloted time it could prove too late to create long-lasting change in the financial sector.

The government details a 4:1 cut to tax ratio. Labour leader contender, David Miliband, has been said to favour a 2:1 cut to tax ratio. I favour this ratio as it softens  the blow of the axe and os more likely to tax fairer. However without specifics, or even vague notions, this alternative can be, regrettably, discarded.

Unfortunately the Spending Review is not due to report until October which means that the specifics of the cuts will not be known until then. However there will be a consultative programme beginning on the 24th fo June where public sector workers and members of the public can input their ideas how to reduce spending. However, as with all good intentions, the results of which will probably be ignored in favour of the results prescribed by the governments own findings in the Spending Review. Taking all this into consideration the extent of budgetary cuts will be extended by 5% on the 20% allocated by the previous government on unprotected departmental spending. Ringfenced budgets include NHS, Overseas Aid, Schools, 16-19 education, Sure Start and Police Numbers. But for efficiency, effectiveness and overall cost-to-performance savings no budget should ever be ringfenced.

A two-year pay freeze for public sector workers is not unexpected as for the previous two years the majority have had their pay frozen. This will save £3.3bn a year but, because of inflation, will mean a pay cut in real terms.

Expenditure on welfare has increased by huge amounts over the past 10 years, the government estimates that it has increased 45% or £60bn, but the majority of the increase has arrived in the last 2-3 years as unemployment has reached relatively high levels coupled with and ageing population puts a large and heavy strain on the welfare state.

One of the main cruxs of this budget is to increase the competitiveness of British business. It does not favour big business much, in fact the biggest winner of the budget are the SMEs which have, for the past 2 years, survived off government handouts. The SMEs are vital to increase, encourage and stimulate growth and to fill the void left by the retreating public sector. This budget has provided for the reform of the Controlled Foreign Company rules so that the market is more competitive whilst enhancing long-term stability and providing adequate protection of the UK tax base so that a Cadbury-Kraft situation will be increasingly unlikely. The government will also look into a reform of the grant/tax relief system for Research and Development, however this is entirely dependent upon the findings of the Dyson Review – it looks positive.

The bank levy is based on banks’ balance sheets set to be introduced on the 1st of January 2011. Whilst critics point out that a levy on transactions would yield a greater revenue it is also highly impractical without international backing. As it stands the move to impose a levy on the balance sheets is a sensible move as it recuperates some of the money owed whilst it is still a relative unilateral action. The government has not ruled out further review of the bank levy, so fans of the Robin Hood Tax watch this space.

There also appears to be moves to rework the tax system through the creation of an independent Office of Tax Simplification (Quango) but details are currently murky.

The “Jobs Tax”, otherwise known as National Insurance Contributions (NICs) and which the Conservatives vehemently campaigned against, will continue to operate albeit in a slightly different form. The increase of 1% will go through as planned but the threshold will be lifted by £21 per week excluding about 650,000 workers from employer contribution. Because this tax is not shared equally by employer and employee it could create resentment between the two parties – but that is the extreme – in all likelihood there will be more grumbling and a tightening of personal belts to accommodate the change.

Despite cuts to the public sector investment in infrastructure will continue as before by establishing Infrastructure UK to lead the Treasury in directing public and private investment in infrastructure in order to ensure a dynamic and efficient national infrastructure.

The aim of the welfare reforms is to encourage a move from unemployment to employment assuming that the private sector will be strong enough to support the level of jobseekers currently standing at around 3 million.

The government provides for lone parents by moving those with their youngest child over 5 onto Jobseekers Allowance (JSA) from income support as of 2011-12, those with children under 5 will remain on income support if they wish. The rationale behind it assumes that employment available to lone parents is flexible and fits in around school hours, failing that lone parents will have to do with part-time employment often leaving them worse off than if they remained on JSA. The minimum wage needs to be readdressed to afford a living wage so that is enables those on JSA to actively seek employment.

The reform of the Housing Benefit is designed to encourage those claiming into employment. Yes there have been some horrendous claims and it does need to be addressed but not to the level proposed – £400 per week cap. However even if the property market was all but abolished and the rental market was better regulated, £400 per week would not be enough without a rapid increase in the number of houses built and empty properties seized. The housing issue is too large for this post and another will be dedicated to it in due course.

The Disability Living Allowance is being reformed so that those with the highest medical need will continue to receive it. Therefore if you are physically and mentally able to work, even in a limited capacity, expect to do so.

Family Tax Credit is being reformed so that the upper threshold for gaining the benefit will be capped at £40,000 for household income with provision for further review targeting low-income families. This review will reduce the upper threshold year on year until 2014-15 when it will have reached £25,000 so that those on low incomes receive it. This is unfair to those on medium incomes who need it just as much as those on low incomes.

By linking Consumer Price Index (CPI) to the indexation of benefits and tax credits, as of April 2011, it will, in real terms, be operating at a cut. If the link to Retail Price Index (RPI), a more accurate and higher rate of inflation index, had been maintained then this budget would be less hard on the vulnerable.

In terms of impact on individuals those earning less than £14,000 will be 1.25% worse off. £14-17,000 1% worse off. £17-19,000 1% worse off. £19-22,000 1% worse off. £22-25,000 1% worse off. £25-28,ooo 1.25% worse off. £28-32,ooo 1.25% worse off. £32-38,000 1.25% worse off. £38-50,000 1.4% worse off. £50,000+ 2% worse off. The overall pain coming in at 1.4%

This budget is not really a budget as the majority of the decisions in regards to cuts, tax and investment will occur after this budget such as the October Spending Review which will report on where to cut. This budget hits individuals hard. It does, as a percentage, hit those earning £50,000+ hardest. The vulnerable, those earning less than £14,000, will, proportionately, be hit hardest but it is a move to encourage those on the lowest income to move into full-time employment as opposed to part-time employment or unemployment. The winners from this budget is business, not big business as they get stung, but SMEs. SMEs are vital for growth and employment opportunities for when the public sector withdraws its activity from the market. George Osborne gambles, not just with public finances but, with people’s lives. If it pays off he will be hailed as an economic genius, if it does not then he will be the most hated man in Britain. If critics say that “it will never happen under Labour” the stark reality is that the majority of what has been detailed in this budget would have been detailed in a Labour budget (bar the welfare reforms). Tough times call for tough measures.

If we return to the original values of the budget, being ‘Responsibility’, ‘Freedom’ and ‘Fairness’, we can see if the budget lies within the values the Treasury set for it.

Responsibility

The government has a responsibility to keep the public finances in good order. Measures detailed above should produce a small structural surplus by 2015-16 thus bringing the public finances into good order. Government has a responsibility to protect the most vulnerable in society – if the cuts are delivered responsibly, in an even and gradual manner, then the vulnerable should be protected because a) provision of services will be directed at the most vulnerable and; b) the private sector will be able to move into the gap left by the public sector creating growth and employment which will have a positive effect on everyone especially the vulnerable.

Freedom

Point ‘b’ leads us on nicely to ‘Freedom’ as SMEs are given a lot of freedom. Freedom from overbearing regulation, freedom from high rates of tax and freedom to expand and grow into the gap left by the retreating public sector.

Fairness

‘Fairness’ is easily the most contentious issue as, due to the increase in VAT, the vulnerable will be hit hardest. However, because of reforms in the provision of services in other areas, the pain is, more or less, distributed evenly across all income brackets.

Make what you will of this budget – it is not great but it is not bad either – it is a risk that may or may not pay off. It does, however, leave options open to improve society, not through the ‘Big Society’ but, through projects such as Housing reform, Tax-system overhaul, Welfare reform etc., nothing in this budget is final and is subject to alteration from Reviews and the Liberal Democrat coalition partners.

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The Future of the Euro and Europe

June 10, 2010 2 comments

Germany has recently won the Eurovision Song Contest. It was an OK song and a cynical person would suggest that Germany only won because of its bail out of the Eurozone.

But talent contests aside, there is something much greater at stake than the future of Eurovision. This greater something is the Euro and the European Union. Whilst we commend Germany’s action by bailing out the Eurozone, its action also hides and ignores the greater issue that needs to be addressed – further union.

It can be argued that the PIGS (Portugal, Ireland, Greece and Spain) should be removed from the Eurozone and perhaps the European Union. One would be correct in implementing it as a short-term solution. However the problem is long-term as opposed to short-term.

Greece found itself in its awful predicament through a combination of its own economic incompetence and not being able to devalue its currency. Devaluing the currency would have allowed Greece to negotiate with its creditors and alleviate the pressure and given Greece time to sort out its mess without a bail out. However, because the Euro’s monetary policy is set by the European Central Bank (ECB), the ECB was unwilling to devalue  the Euro as it would have damaged, in the short-term, Germany’s economy – as Europe’s largest exporter. The Greece situation also brings into question the effectiveness of the ECB.

To make the ECB and the Eurozone effective, so that a situation like Greece does not occur again, is a fiscal and tax union alongside the existing monetary union. If tax and general economic aims are set centrally in a single currency zone – the entirety of the economic functions available can be put in force so that the entire Eurozone area is protected from future crises. The further union of the Eurozone will be, of course, a huge step towards Federalism.

The problem is economic the solution is political, and there will be opposition. The main source of opposition, we imagine, will be from Germany. Germany, as Europe’s largest economy and exporter, is likely to lose out in the short to mid-term whilst this union settles down.

Politically, many countries, for many xenophobic reasons, will not want to hand over more sovereignty. But it needs not be like that if the federal model that Europe adopts is based on the German model. The German States remain fiercely independent and autonomous yet they have a central government to give them a unified direction.

In conjunction to this move towards federalism we also propose a halt to the expansion of the EU as further expansion eastwards will only serve to weaken Europe. We also flatly reject Turkish application to the EU, this is because Turkey is not part of Europe – it does not share a culture, its economy is essentially third world and its record on human rights etc., is atrocious.

Now to confront Britain’s future with Europe. Britain’s future is with Europe and at the heart of it. Britain’s future is not with America, we share a language but not a culture. America embraces its own form of Anarchism where everyone is out for themselves. Europe, on the other hand, embraces, broadly speaking, variants of Liberalism such as Liberal Socialism or Liberal Conservatism. But whatever variant of Liberalism is embraced the collective ideas of community and society is embraced, largely, by all. Britain’s political and cultural traditions are largely similar with the rest of Europe. A strong Britain in Europe makes Europe strong. A Britain outside Europe is weak.

The problem with Europe at the moment is that it is not the federal super-state that is should be nor is it the trading bloc that it used to be. Because of the current transient nature of the EU, it is scorned by outsiders and by those that should be on the inside.

Once the move to federalism has been established the pooling of resources will be easier and more efficient. No longer will there be cross expenditure on products, services etc.

There is also the matter of a common language in order to execute the provision of services. We advocate Spanish as it is one of the easiest languages to learn. However we do not advocate the eradication of native languages but merely a move towards multilingualism, bilingualism at the least, of all European citizens.

One should take note that what has been discussed above are broad ideas. We understand and appreciate that our end goal, of a federal Europe, will not materialise over night nor is it likely that it will happen within our lifetimes. We would, however, love to see it in our lifetimes and strive at every possible opportunity to make our dream a reality and unleash the true potential of a United and Federal Europe.

Ust’s Week

The Oldfield-Pike Project would like to inform you that, due to other commitments, Ust’s Week will no longer be running on a weekly basis, but will in fact be showing specials every so often. The next episode coming up will therefore be a Gordon Brown Special.

Kind Regards,

Messrs. Oldfield and Pike

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