Deconstructing a piecemeal budget

By Simon Barrow
March 26, 2011

The Institute for Fiscal Studies (IFS) cannot be accused of being a radical think-tank, but its probing of the government's economic policies since May 2010 has been shaped by a social and environmental awareness (it has cooperated with businesses and researchers on a 'green budget') and by a determination to move below the surface of political posturing to examine what the data is and how it is being used. The picture it offers is rather different to the coalition's spin.

I do not concur with all IFS's judgments - for example on the likely impact of the two per cent corporation tax reduction - but the overall factual account is fair. The initial IFS budget 2011 response is below, and along with the more detailed deconstruction (which is still being digested) is worth reading in concert with the comments coming out of New Economics Foundation and others.

IFS does not take a political line on the meta-question, which is whether public spending cuts that hit the are really the way poorest are really the way to address the deficit - and how you stack up the different components of deficit measurement in politco-economic terms: total, cyclical and structural. Ekklesia has pointed out that the total UK deficit dwarfs the cuts, which are driven by factors other than the 'good housekeeping' that is being used to mask them, while other global responses, including transaction tax and financial reform (plus domestic reductions on multi-billion wastes such as Trident) are being ignored.

Meanwhile, here is what IFS had to say in the immediate aftermath of Chancellor Osborne's speech on 23 March 2011:


Public finances

Unlike George Osborne’s June 2010 Budget and October 2010 Spending
Review, the 2011 Budget was not a big fiscal event. The net impact on the
public finances of all announcements was minimal. The effective tightening
over the next four years remains formidable.

But the fiscal forecasts have changed, and for the worse. Given the reductions
in expected economic growth this year and next, that is not surprising. The
Office for Budget Responsibility (OBR) was expecting total receipts to exceed
non-investment spending by 0.3 per cent of national income in 2015-16. It now
expects a deficit of 0.2 per cent of national income.

What has not changed, or hardly changed, on the official forecasts is the
cyclically adjusted deficit – that is borrowing that is thought to be impervious
to economic recovery. The OBR is still forecasting a cyclically adjusted current
surplus of 0.4 per cent of national income by 2014-15. The reason is that their
estimates of potential output and potential growth have not changed.

As the OBR itself acknowledges the biggest threat to the public finances is “the
possibility that we have over-estimated the amount of spare capacity in the
economy, now or in the future”. In other words the forecasts are now even
more dependent on a bounce back in the rate of economic growth from 2013.
The OBR cut its growth forecasts for 2011 and 2012, maintained it for 2013
and raised them for 2014 and 2015. An overestimate of potential output of
just 1.5 per cent would, on the OBR’s estimates, be sufficient to breach the
Government’s fiscal mandate.

Personal tax and benefit changes

All the big changes to taxes and benefits that had previously been announced
to come into effect in April 2011 were today confirmed by the Chancellor.
These include the one per cent rise in all National Insurance rates, and the rise in the
income tax personal allowance to £7,475. Overall they will leave households,
and especially the richest households, worse off.

The Chancellor also announced a further step towards the government’s goal
of a £10,000 personal allowance: it will reach £8,105 in 2012-13, £240 higher
than it would have been had it continued to go up in line with the Retail Prices
Index (RPI). Unlike the change to come into effect next month, this giveaway
will benefit both higher-rate and basic-rate taxpayers, as the threshold at
which the 40p rate starts to be paid will be left unchanged in April 2012,
rather than cut.

Of greater importance for the longer term is the announcement that direct tax
allowances and thresholds will, in future, be indexed in line with the
Consumer Prices Index (CPI) rather than the RPI. This brings their treatment
in line with most benefits and will generally reduce their generosity over
time. The move will bring in over £1 billion by 2015-16, according to the
Treasury. The Chancellor chose not to implement CPI uprating of indirect
taxes which would have benefited households at the expense of the

Simplifying income tax and National Insurance

The Budget announced a consultation on integrating the operation of income
tax and National Insurance contributions (NICs), but stated that the
‘contributory principle’ will be maintained and ruled out extending NICs to
individuals above state pension age or to other forms of income such as
pensions, savings and dividends.

Stuart Adam, a senior research economist at the IFS, said:
“Moves to integrate the operation of income tax and NICs would be
welcome. But the value of reform depends heavily on the details,
which are yet to be decided. It is a shame that, even before the
consultation begins, the Government has already ruled out some of
the most radical options. Keeping savings and dividend income free
of NICs would help to maintain incentives to save, but means it would
remain hard to prevent people from converting labour income to
capital income in order to avoid tax. And while there may be a good
case for having a proper social insurance system, maintaining the –
largely illusory – ‘contributory principle’ in its current form is hard to

Carbon tax

The other main environmental measure announced was a carbon price
support rate which will apply to energy generation from 2013-14. This tax
will supplement the carbon price in the EU Emissions Trading Scheme and
will provide more certainty over the cost of carbon.

Paul Johnson, IFS director said:
“This new tax has some welcome features: it represents the first
carbon price that will directly affect households as well as businesses,
and helps improve certainty which could encourage investment in
renewable generation. However, it adds another layer of carbon
pricing to an already complex structure of rates applying to different
fuels and energy users and does not bring us any closer to a
consistent economy-wide price for carbon.”

Fuel duties and taxes on North Sea oil

The Chancellor announced an immediate 1p/litre cut in fuel duties. He
also announced that this year's planned inflation adjustment of 3p/litre
would be postponed until January 2012, and the inflation adjustment planned
for April 2012 will now take place in August 2012. This costs £1.9 billion in
2011-12. The long term cost of the change, including the ending of the 1p a
year escalator, will be £2.1 billion annually. This is effectively paid for by
increasing the supplementary charge on the profits of North Sea oil and gas
profits from 20 per cent to 32 per cent There is a 'air fuel stabiliser' in the sense that
both policies (the end of the escalator and the increase in North Sea Taxes)
would be reversed if oil prices fall in a sustained way below $75/barrel.

Andrew Leicester, Senior Research Economist at the IFS, said:
“The 'Fair Fuel Stabiliser' announced by the Chancellor is very
different from the more formal mechanism linking fuel duties to oil
prices that the Conservative Party talked about before the election. If
oil prices stay high but volatile, this policy will do little to stabilise
pump prices. The Chancellor also insisted that green taxes will rise
as a proportion of total receipts. This remains the case on current
Treasury forecasts, but by the narrowest of margins.”

Alcohol taxes

The Chancellor announced a 25 per cent rise in taxes on high strength beers (those
with alcohol by volume content above 7.5 per cent), and a 50 per cent cut in the duty on
weak beers (ABV 2.8 per cent or less). This may encourage consumers to substitute
from stronger to weaker products, and producers to manufacture more low-
strength products. The impact of the policy is, however, likely to be small: in
2010, low-strength beer accounted for one per cent of alcohol volume sold off licence
and high-strength beer just 0.8 per cent The change will bring the tax rate on strong
beer close to the tax rate on spirits, but will not change the relatively low tax
levels on strong ciders: a can of cider at 7.6 per cent ABV will be taxed at 7.1p per
alcohol unit, whilst a can of beer of the same strength will be taxed at

Encouraging investment and growth

The Budget and the accompanying ‘Plan for Growth’ set out a broad range of
measures aimed at encouraging business investment. The largest of these is a
2ppt cut to the main statutory corporate tax rate, bringing it to 26 per cent in April
this year and to 23 per cent by April 2014. For banks, the positive effect of the
additional 1ppt cut in the main rate (over that announced last year) will be
offset by an increase in the Bank Levy in January 2012.

There is also a raft of smaller (in revenue terms) measures which are aimed at
encouraging business investment. These comprise cuts to regulations and
simplified planning processes alongside a large number of initiatives aimed at
promoting specific industries and encouraging regional growth. Notably, the
Government will introduce enterprise zones which offer targeted support,
including 100 per cent business rate relief, in 10 areas identified as having
‘untapped potential’.

Helen Miller, a Senior Research Economist at the IFS said:
"Measures aimed at very specific industries or geographic
areas have not always proved successful. Past UK experience with
enterprise zones suggests that their main effect may be to cause
activity to relocate rather than to create new activity.”

(c) IFS 2011


(c) Simon Barrow is co-director of Ekklesia.

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