eInsight, Economics Update Bulletin, June 2010_________________________
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Welcome__________...to the eInsight Economics Update for June 2010, our Emergency Budget special. For the last six weeks the country has been wondering what course of action the new government would take. This speculation ended on Tuesday with the publication of the emergency budget. So, what has the emergency budget done?See below for a brief summary of the main tax and spending changes as well as other recently announced reviews and consultations. |
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Main Emergency Budget measures »
Tax rises
- VAT will rise to 20% from 4 January 2011
- Capital Gains Tax – will rise from 18% to 28% from 23 June 2010
- Insurance Premium Tax standard and higher rates will increase from 6% and 17.5% to 6% and 20% respectively from 4 January 2011
- Bank levy of 0.07% (0.04% in 2011) on banks’ balance sheets introduced on 1 January 2011, following consultation
Tax reductions
- Corporation tax will be cut from 1 April 2011 – SME rate will fall from 21% to 20%; main rate will fall by 1% per annum from 28% to 27%, then gradually down to 24% by 2014/15
- Personal allowance for basic rate tax payers will increase by £1,000, with a commitment to gradually bring in the Lib Dem policy of raising this to £10,000
- The landline levy from the March 2010 budget has been scrapped, as has the increase in Cider duty
Spending cuts
- Two year pay freeze for public sector workers earning over £21,000
- Further government department face cuts of up to 25%
- Freeze on child benefit
- Cap on housing benefit (£400 per week for 4 bedroom homes)
- Reduction in tax credits for families earning more than £40,000
Spending increases
- The Enterprise Finance Guarantee which supports lending to SMEs will increase
- New businesses locating outside of London and the South East will be exempt from up to £5,000 of employer NICs for each of the first 10 employees hired
In addition, the budget announced:
- Review of the tax system with the purpose of making it more competitive, simpler, greener and fairer. The tax system will be reviewed against the maxims of predictability, stability and simplicity, underpinned by transparency.
- Spending Review – reporting back October 2010
- Structural review of public service pension provision by Budget 2011
- Scheduled regulation changes are to be viewed by the Reducing Regulation Committee
- Review of all capital spending plans to ensure they are affordable and identify areas of spending which will achieve the greatest economic returns
- Non-domiciled individuals – review taxation of them
- The FSA has been asked to consider various factors as part of its review of its Remuneration Code
- Review into developing broader indicators for well-being and sustainability
- Independent review on poverty
- Review when the State Pension Age will rise
- Review the effectiveness of SDLT relief for first time buyers
- Review Alcohol taxation and pricing, reporting in Autumn, specifically with a view to tackling binge drinking without unfairly treating responsible drinkers, pubs and important local industries. Legislation will be introduced shortly to increase tax on cheap, strong ciders.
- White paper to be released this summer will outline plans to abolish RDAs and replace with new local authority–business led economic development bodies
- A review of small business taxation
- Consideration of changes to aviation taxation including changing from per person to per plane
- Publish proposals to reform the climate change levy in order to provide more certainty on carbon price
By far the most controversial measure is the rise in VAT to 20% from January 2011. Retailers believe this will lead to staff cuts and reduced sales. We expect a rush to the shops in the next 6 months (or more likely near Christmas) as consumers try to buy products at the existing rate of VAT, followed by a slowdown next year. This is likely to suppress retail property rents and returns and lead to a rise in unemployment or, potentially reduced hours for the majority of staff – many businesses have taken this option to reduce overheads but not make people redundant. However, as many commentators have stated, this only brings us in line with many European countries which already charge higher rates of VAT.
The balance between tax rises and spending cuts »
George Osborne promised to tackle the deficit through significantly more spending cuts than tax rises. Spending cuts have taken the form of pay freezes for public sector workers, a freeze on child benefit, cap on housing benefit, reduction to tax credits and wider government department cuts of up to 25%. The budget estimates that these will save £32bn per year by 2014/15.
As well as the VAT rise, the Tax rises include increases to Capital Gains Tax (CGT) and Insurance Premium Tax (IPT) and a new Bank levy. The controversial landline charge and increase in Cider duty from Labour’s March 2010 have been scrapped.
So, is this the right balance between tax rises and spending cuts? Should public sector pay take the brunt of the freeze? Volterra thinks so. Over the last decade a gap has grown between public and private sector pay with median public sector pay now 12% higher than median private sector pay. These need to be brought back into alignment and a public sector pay freeze will begin to address this balance. Furthermore, the lowest earners are protected as the freeze is only implemented on salaries over £21,000, which means that just over half of public sector employees will be affected.
Further tax rises have not been ruled out. The first time buyer Stamp Duty relief, Alcohol taxation to tackle binge drinking, and changes to Aviation taxation to incentivise fuller planes are all going to be the subject of reviews. The government published a paper on taxation reform which emphasises the need for taxation to be predictable, stable and simple, and most importantly transparent. We completely agree with this sentiment. The existing taxation systems are complicated enough in their own right but once reliefs and exemptions are considered, they become impossible to disentangle.
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What capital spending gives the best return? »
As part of the budget, the government announced a review of all capital spending plans to ensure that they are affordable and to identify areas of spending which will achieve the greatest economic returns.
We welcome this review; however it also needs to be done alongside a review of how we estimate the economic returns of investment. At present our methodologies are flawed. We underestimate the impacts of regeneration and convergence, for example, because our methods are ineffective at quantifying these sorts of impacts into standard ‘economic return’ boxes – how many jobs are created, how much does GVA rise? These measures do not capture transformational impacts of investment such as place making, community cohesion and ‘happiness’. With this in mind, we are pleased that the budget identified its aim to develop broader indicators for well-being and sustainability. Sustainability is yet another word which is too often misunderstood.
Despite decades of trying to narrow the north-south divide, GVA per capita remains as far apart as ever. The budget mentions some tax breaks for new businesses setting up outside of London and the South East and this is welcomed but it won’t do enough to provide the required step change in fortunes. Similarly the reliance on the public sector in the north is likely to have an impact on its growth in the near future. We need to identify cost-effective capital investments which can support growth across the whole of the UK.
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The Output Gap and the Structural Deficit »
The Budget reports on the work of the Office of Budget Responsibility. One interesting feature is the view this implies for the state of capacity utilisation in the UK. The chart here is taken from the Red Book and shows the different views of the output gap from the March Budget. On that occasion, the economy was viewed as operating around full capacity for most of the period from 2001 until the collapse during 2009. The new view shows significant overheating before the crash and although this is a steeper fall, it also leaves the economy with less excess capacity than before.
This is the root of the view that the structural deficit is larger than previously thought and also suggests that the previous government’s view that it had raised the underlying rate of growth of the economy was profoundly mistaken.
