Fishburn Hedges

04.12.2009

Well down in the polls, with the country heavily in debt and still in recession, Alistair Darling is faced with an unenviable task on 9 December. With a general election on the horizon, he must try to turn around the Government’s political fortunes and set the tone for the economic debate that better favours Labour. This PBR could turn out to be Labour’s last roll of the dice.

So, what will the Chancellor say as he tries to balance the need to get the economy moving, while reassuring the markets that Labour has credible plans to reduce the £175 billion deficit? We expect:

- A rejection of calls for immediate fiscal tightening, but a clear direction for halving the deficit in four years
- Targeted strategic tax rises, including inheritance tax changes and possible moves on capital gains
- Specific measures aimed at investing in jobs and low carbon technologies
- Definition of what frontline services will be protected from the public spending axe, once it is wielded

The Economic context

This year’s Pre-Budget Report will be delivered in what is, arguably, the most restrictive economic environment any Chancellor has faced in the last 30 years. Last year, the name of the game was damage limitation, and the Chancellor was given political cover for a fiscal stimulus to stop a bad recession getting worse. This year, though there are signs of the beginning of a recovery, the heavy level of public debt will colour all of the Chancellor’s decisions, and the pressure to reduce that debt heavily limits his room to move.

Dealing with debt

The PBR was delayed by a month this year in the hopes that Q3 figures produced by the Office for National Statistics would lift hopes of a recovery. Despite the government confidentially predicting a return to growth by the end of the year, the official statistics disagreed, reporting that growth remained negative at -0.3%. The OECD has also predicted that the total number of jobless in Britain will reach 3 million in a year’s time. These figures mean that the government’s tax revenues have taken a substantial hit, while its commitment to unemployment benefits has risen exponentially. This, combined with bank bailouts and heavy borrowing, has saddled the UK with a predicted debt of a record £175 billion this year, which could yet rise further.

The Chancellor has been told in no uncertain terms by Mervyn King, analysts, bankers and credit rating agencies that he must introduce early fiscal tightening if the UK is to get itself out of the swamp. The value of the pound fell in early November when ratings agency Fitch stated that Britain could lose its AAA rating if the government did not impose “discipline on the books”. With such economic pressure, the Chancellor has little choice but to lay out a strategy to close the deficit, but with a general election just a few months away, it will be a delicate job of positioning and timing.

The politics

At least 10 points down in the polls and with the clock ticking down on this parliament, time is running out for Gordon Brown as he attempts to turn the political tide and extend the Labour government’s term of office. At the same time the PBR provides the Conservatives with an opportunity to attack Labour’s economic record, demonstrate that they have more credible answers to the country’s economic difficulties and define the economic debate on their own terms.

The dividing lines

The economic crisis has highlighted clear dividing lines between Labour and the Conservatives with both of the main parties having different views on how to minimise the recession and plan the country’s economic recovery. Yet in many ways it is the Liberal Democrats who have been clearest on their tax plans, proposing levies on properties over £2 million and taxing capital at the same rate as income.

For Labour, an active state is necessary, with targeted investment aimed at stimulating and sustaining economic growth, and reducing the deficit only when the economic recovery is secured.  Public sector savings can and should be made, but too early or too savage cuts could send the country back into recession.

For the Conservatives, the deficit must be addressed far quicker in order to secure Britain’s creditworthiness and get the country back on a sound fiscal footing.  Only significant spending cuts backed by support for entrepreneurship will improve international confidence in the UK economy and promote growth.

Brown is hoping that by winning the argument on who has the right economic strategy for the country, he can turn things around electorally at the death. But the current debate focuses on the need to pay down the deficit quickly, which is more closely aligned with Conservative position. Does Darling have enough wriggle room to reverse this trend?

What can we expect?

Jobs and growth

The overall theme of the Chancellor’s statement is expected to be ‘jobs and growth’ with Darling trying to draw a dividing line between the Government’s plans to protect frontline services and the Conservatives’ proposals to implement immediate spending cuts. However, the Chancellor will be forced to concede that the Treasury was optimistic in its growth predictions for 2009. Darling is expected to reveal that the economy shrank by 4.75% in 2009, compared with his Budget’s estimate of 3.75%. In addition, the Chancellor is likely to announce a cautious growth projection of between 1-1.5% for 2010. 

Protecting frontline services

While the Chancellor will reject pressure from cabinet colleagues, such as Ed Balls, who would prefer the government to announce extra money for key areas such as schools and hospitals in the PBR, he is likely to define those frontline services that will be protected from future cuts.  He will imply that less critical services will be subjected to spending restraint, with the Government indicating cuts to government departments of 8.6% in real terms for three years from April 2011.

Tactical taxation

If there is to be any surprise money, coming from strategic tax rises - such as changes to inheritance tax or a rise in capital gains tax from 18% - funds raised will almost certainly be used to stimulate growth and create jobs. Likely announcements could include investment in low carbon projects, a ‘Back to Work’ white paper giving the unemployed up to £800 tax-free support on how to become self-employed, as well as extra support for young people to get into work. In addition, VAT is already set to rise back to 17.5% from 1st January, but it is unlikely that Darling will announce any further increase until after the election. Similarly, the stamp duty holiday will not be extended next year.

What commentators will be especially looking out for will be other measures that target high earners or banks – which would both be popular with Labour backbenchers. On top of changes to capital gains tax, other potential tax measures could include lowering the threshold for the introduction of the 50% tax rate, changes to National Insurance for high earners and even a windfall tax on banks.
 
With the budget deficit at £175 billion this year and set to be revised upwards, Darling will have to show that he has a credible plan for balancing the public finances in the next few years. The Government has already announced a Fiscal Responsibility Bill, which will legislate for halving the deficit within four years, and it is likely this will be published on the same day as the PBR. However, with the general election in mind, the Chancellor is unlikely to reveal the full details of unpopular future spending cuts.

Efficiencies begin at home?

The Government, however, is expected to announce a pay freeze for senior public sector staff as part of a series of cuts and efficiencies across Whitehall. The Treasury’s plans for ‘smarter government’ will be published before the PBR and have reportedly identified in excess of the previously announced £9bn a year in efficiency savings by 2014 through cutting quangos, procurement and back office functions. Darling may also be forced to concede that the Government will have to shelve some planned major capital projects, although it is being reported that Crossrail is safe. Despite the relative absence of deficit-cutting measures, Darling will indicate the need for ‘tough choices’ in order to reduce public borrowing.

After the PBR

The traditional role of the PBR is to “encourage debate on the proposals under consideration for the Budget,” but we may not get that far this time. Labour may call an election before they are legally obliged to deliver a full Budget, thus escaping the most painful effects of further widespread cuts in spending. The earliest the budget could be is March 10th, so it is possible we may yet see a March election. Whatever happens, the PBR is one of the last remaining opportunities that Labour has to ensure it can fight the election campaign on more favourable ground.