Thursday, July 8, 2010

Britain's Budgetary Blues

The financial crisis of 2008 has left the British Government this year with a fiscal deficit of 11% of GDP. To combat the growing deficit that is crippling the British economy, George Osborne, the newly elected Conservative Chancellor of the Exchequer, presented a new austere budget called an “emergency package” aimed to reduce government spending by 6.3% of GDP by 2014-15. Three quarters of the projected budget cuts will come from spending in many of the governments departments, including welfare. The rest will come from tax hikes, including a rise from 17.5% to 20% in the consumption (VAT) tax rate starting January 2011, which is expected to raise £12.1 billion or 0.8% of GDP next year.

In an attempt to prevent more businesses from leaving the British market, Osborne has planned to reduce the corporation tax from 28% gradually to 24% by 2014. The chancellor is also expected to keep many of the tax increases proposed by the previous labor government of Gordon Brown, however Osborne plans to mitigate the rise in national insurance contributions next April by raising the tax-free NIC allowances of employers. All of these measures will in no doubt ease the deficit crisis Britain is currently facing, however, whether all the proposed budgetary cuts are realistically possible remains unclear.

One of the biggest concerns revolves around the Government’s refusal to implement any cuts on the very popular National Health Service. The program absorbs over 25% of government spending alone, and has grown faster this past decade than any other program. Because of the political pressure to keep the system intact, other government departments will have to suffer enormous cuts, in some cases averaging up to 25% by 2014-15, which will be politically problematic as divisions between the Tories and Liberal Democrats may become exposed. Some critics believe there was a missed chance to redesign the tax system in order to incorporate a carbon tax that could be used to fund infrastructure construction. Others believe more emphasis needs to be put on the implemented methods of delivery government services have rather than the programs themselves. Nevertheless, Osborne’s proposals amount to £113 billion in government spending cuts by 2014-15, £40 billion more than his predecessor projected.

Chancellor Osborne and the British cabinet clearly believe that by lowering the debt burden to reduce or eliminate future cuts in services and welfare, the British economy will grow. Smaller government will allow businesses to invest more freely, stimulating exports, expanding the economy and lowering unemployment. Even so, that excess capacity could limit business investment. Restraining spending and higher taxes could also complicate the domestic markets ability rebound from the recession. The OBR, an independent think tank, believes the British economy will slow down to 2.3% rather than the projected 2.6% in 2011. Whether the new measures are realistic or not remains to be seen, what is certain is the Chancellor Osborne needs to produce some results while remaining flexible and cautionary during these volatile times. As the Economist notes, “Osborne has proven courage, but wisdom dictates that he better have a plan B”.

Information cited from the Economist Magazine, Website and other news Sources.

Tom Rodelli
Research Analyst
Analyze Capital LLC

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