A make-work Budget, but it could have been worse

Of all the meaningless rituals in the Parliamentary calendar, the annual Budget show is probably the most pointless. Governments, like companies, should of course every year present retrospective annual accounts and a forward-looking multi-year business plan covering planned public expenditures, expected tax receipts and all planned discretionary changes in the structure of public spending and taxes. Under normal circumstances, a government that has the nation’s best interest at heart won’t have much if anything to announce that is new on the fiscal front (other than some routine updating of forecasts and estimates) after its first year in office.

But politicians cannot bear the sound of silence. The annual budget slot has to be filled with a raft of announcements of new or recycled fiscal measures, introduced without much thought as to how they shape incentives and income distribution when they interact with the existing mass of tax and benefit schedules and entitlement rules. Gordon Brown was a manic micro tinkerer during his ten years as chancellor. He could not see a social or economic problem without throwing a dozen tax and subsidy incentives at it. This has left the UK with probably the most complex tax and benefit system in the known universe, one whose overall impact on incentives and distribution is incomprehensible but no doubt perverse.

So I looked forward to less frantic fiscal fireworks from the new chancellor. And less frantic it was. Listening to chancellor Alistair Darling deliver his budget speech today in Parliament was like being beaten over the head with a sweaty sock. I will go through the low lights in turn.

Macroeconomic prospects

The chancellor tells us the UK is an island of stability and a beacon of fiscal-financial virtue in a naughty world. The undisciplined Americans brought us the subprime crisis, so Northern Rock is really their fault. High inflation is due to rising world energy prices which isn’t our fault. Growth is expected to be between 1¾% and 2¼% in 2008 (below the PBR forecast of 2.0% to 2½%), between 2¼% and 2¾% in 2009 and between 2½% and 3.0% in 2010. Somewhat optimistic, but not crazy, especially in view of the Treasury’s superior GDP forecasting record.

Demand growth will shift to net external demand. It certainly ought to, as the UK is running a six percent of GDP current account deficit. With a slowing global economy this will not be simple, however, unless sterling depreciates very sharply, in which case the inflation target would come under stress.

We are told public investment will be £33 bn in 2009. That will still just be 3 percent of GDP, way too little to make a dent in the decades-old backlog of public investment, which has given the UK some of the worst infrastructure in the industrialised world.

The chancellor believes the UK is better positioned than other countries to meet the challenge of the global slowdown. Not so. There is little room for expansionary policy on the monetary side given the inflation prospects. The UK’s fiscal position is weak. With the economy growing above-trend during 2007, the government’s overall budget should have been close to balance or in surplus. Instead the deficit came in at close to three percent of GDP.

As soon as Northern Rock comes officially on the books of the government, and with most past PFI fiddles about to be brought on budget and on balance sheet, the government’s Sustainable Investment rule will be violated. Fortunately that rule never made any sense, so its violation is not a substantive economic issue. Nobody pays any attention to the Golden Rule anymore. Since this rule also made no economic sense, we shall let it pass.

The government probably will be able to get away with letting the government deficit rise in line with the automatic fiscal stabilisers as the economy weakens, without spooking the markets. Should things get dire there is, however, little room for a discretionary fiscal stimulus.

Incentive-oriented and distributional measures

A true dog’s breakfast – a hodgepodge of half-measures and pre-announcements of things that could become government at some time in the future. Some examples.

A new contract was promised to incentivise working families not to look after their children properly (by inducing them to accept paid work outside the home). A number of minor measures were announced to combat child poverty. The objectives of halving child poverty by 2010 and eliminating it by 2020 will not be met unless the government fiddles the data. A few more small pots of money for education and training.

On non-doms the chancellor has wisely ignored those who argued the UK would, should his proposals be implemented, be bereft of talent and sans tax base. It would have been more sensible simply to abolish non-dom status for long-term residents, to forget about the 30,000 non-dom fee option and to tax every long-term resident on his world-wide income. Perhaps for the budget after next?

On capital gains tax the chancellor has also wisely stuck to his guns, except for a sop to SMEs. At some point good sense will break out and all capital income (dividends, interest and capital gains) will be taxed at the same rate. Since wage income and capital income are fungible in small family-owned enterprises, that common rate should also be the income tax rate on labour income. Then abolish corporation tax (or simply make it a withholding tax for the personal income tax on capital income, with full offset of profit taxes paid at the company level against the personal capital income tax liability). Finally, lower the common top marginal income tax rate on all income to, say, 35 percent and abolish all exemptions. What you have is a nice, simple, relatively non-distortionary and pretty fair income tax system.

A number of minor green measures were announced – some substantive, some prospectively potentially substantive, some vapour. Aviation duty, plastic shopping bags, studies and pilot schemes to determine the scope for nationwide road pricing (which would help congestion but should also have environmental benefits), son-of-Kyoto carbon emissions targets (by 2050!), carbon budgets – window dressing pure and simple.

Crossrail funding was secured, albeit 15 years late. I am no longer sure it is going to be such a great thing to be able to get to Heathrow more easily. I would much prefer never to have to go there again – ever.

The chancellor wants more fixed rate mortgages, presumably because he believes this will help borrowers. Has he though about the other side of the mortgage market? Who will take the long side in fixed-rate mortgage lending? Northern Rock? This is something best left to the market.

Taxes on vice: booze, tobacco, fuel, high-emission cars.

Some quasi-fiscal shenanigans: the chancellor will lean on energy companies to give lower prices to 5 million customers on pre-payment deals. Voluntary or else…

More Haile Selassie distributional economics. The late Emperor used to be driven through his capital Addis Abeba throwing coins and currency out of the car windows for the benefit of his impoverished subjects. The increase in winter fuel payments for the old reflects the same ethos and spirit. Why not have a decent state pension instead?

I owe the chancellor a debt of gratitude for only using the words ‘world-class’ once – in conjunction with (public) services. Not having ‘world-class’ juxtaposed with ‘education’ is worth something.

Basically, a make-work budget. There wasn’t enough beef to make the 50-minute presentational hamburger the chancellor provided us with. But it could have been worse.

Maverecon: Willem Buiter

Willem Buiter's blog ran until December 2009. This blog is no longer active but it remains open as an archive.

Professor of European Political Economy, London School of Economics and Political Science; former chief economist of the EBRD, former external member of the MPC; adviser to international organisations, governments, central banks and private financial institutions.

Willem Buiter's website