Andrew Smith, Chief Economist at KPMG in the UK, comments on the key issues around the forthcoming budget.
With budget day fast approaching, the Chancellor finds himself rather boxed in by his predecessor’s rules at a time when the economic outlook is looking distinctly unclear.
Next week’s budget will almost certainly see the fiscal rules being bent, if not outright broken and / or rewritten.
Taking the Northern Rock liabilities onto the public finances’ balance sheet will blow the “sustainable investment” rule (which limits the government debt to GDP ratio to 40%). But this may not count as an out and out rule “break”. It is most likely to be treated as a one-off breach, with figures presented both including and excluding the “temporary public ownership” of the stricken mortgage bank.
Another way around breaking this rule would be to raise the 40% limit. This is fairly unlikely though as some commentators might suspect that Northern Rock was being used as an excuse for a broader relaxation of the rule.
And then there’s the “golden rule” which dictates that that current spending must be matched by revenue. An economic slowdown would most certainly put this one at risk.
However, there is one “get out of jail free” card that the government can play on the golden rule:. it applies over the economic cycle as a whole. Where the cycle starts and where it ends is not prescribed. No doubt the Treasury will argue (as it has in the past) that extra borrowing resulting from economic weakness over the next few years will be recouped when the economy rebounds later on in the cycle.
Perhaps it will be a case of new Chancellor, new rules. We’ve had the current ones for several years now. Given the timing problems with the golden rule, it might make more sense to move to a rolling target, always aiming for a small current surplus, say, five years ahead.
And how realistic do current growth forecasts look, given the emerging ramifications of the credit crunch? Growth in 2007 came in at 3% as officially projected, but many outside forecasters, including the Monetary Policy Committee, now expect a deeper and longer slowdown than the Treasury anticipated when forecasts were last officially updated in the October Pre-Budget Report. Adopting a weaker forecast, would suggest that government finances would not achieve the Pre Budget Report prediction of returning to balance by 2009/10 without tax increases or spending cuts. As seems to be the case with the fiscal rules, the Chancellor faces a choice on the growth targets between undergoing some painful belt-tightening or moving the goalposts.
And dramatic tax increases or spending cuts are unlikely. It makes little sense to tighten fiscal policy going into an economic slowdown. In any case, current plans already incorporate a halving of public spending growth and a rise in revenues as a proportion of GDP over the next few years.
So given current uncertainties and the risk of a policy tightening propelling us into a downturn, it may be best to opt for a neutral package. Cutting taxes looks dangerous on public finance grounds but raising them carries economic risks.
-ENDS-
Further information:
Margot Cowhig, Corporate Communications Manager, Tax and People Services, KPMG in the UK
Tel: +44 207 694 4246 / +44 7920 274856
e-mail: margot.cowhig@kpmg.co.uk
