Chancellor George Osborne is positioning his 23 March budget as "moving from rescue to reform."
On the rescue side, the Chancellor has made it clear he will be sticking to the long-term budget consolidation plans he set out in his emergency budget in June 2010 and then fleshed out in last October's Spending Review.
This means there is no scope for major fiscal giveaways in this budget. Any new handouts will need to be essentially offset by increased savings or revenue-generating measures elsewhere.
Despite an inability to splash the cash, the Chancellor, as well as Prime Minister David Cameron and other senior members of the coalition government (both Conservatives and Liberal Democrats), have all indicated this will be a pro-growth budget.
With room for fiscal manoeuvre seriously constrained, any efforts aimed at stimulating economic growth will have to come from reform. This reform will be focused on creating a more friendly and pro-business environment in which it is easier to operate.
Emphasizing this point, the government will release its growth review at the same time as the budget. This is reported to focus on revamping the planning system and introducing a series of measures aimed at reducing the regulatory burden on businesses. One problem is that some of the reforms unveiled may take some considerable time before they have a significant impact.
Also, there is always a fair degree of scepticism over just how much various reforms will actually boost growth. If there is anything obvious and not very costly that could be done to significantly boost growth, the chances are it would have been enacted already, unless the measures are hugely controversial or potentially have some problematic or adverse consequences.
The best hope is that the government manages to put together a package of reform measures that may be relatively small individually but in their totality are perceived by businesses as showing that the government really is pro-business for the long term. This would then be apt to provide an environment in which businesses are more prepared to engage in longer term investment and employment plans and commit to boost employees' skills.
Fitch and OECD Give Chancellor a Boost
The rating agency Fitch has given the chancellor a boost ahead of the budget by re-affirming in mid-March the UK's AAA credit rating and maintaining a stable outlook. Indeed, despite the unexpected contraction in GDP in the fourth quarter of 2010 and expected modest growth going forward, Fitch indicated it believed the negative risks to the UK's AAA credit rating were easing due to the credible budget consolidation efforts, as well as an improving banking sector.
Also in mid-March, the OECD indicated its support for the chancellor's fiscal programme. Specifically, the secretary general of the OECD, Angel Gurria, commented that Mr. Osborne's plans "strikes the right balance between addressing fiscal sustainability and preserving long-term growth" and advised the chancellor to "stay the course."
The Fiscal Backdrop
Mr. Osborne has already made it clear that he will essentially stick to the budget targets already set out.
The chancellor is aiming to eliminate the structural budget deficit by 2014–15 and even achieve a surplus of 0.8% of GDP in 2015–16. The structural deficit is seen at 4.8% of GDP in 2010–11. Overall, the public-sector net borrowing requirement (PSNBR), excluding financial sector interventions, is projected to fall from £149 billion (10.1% of GDP) in 2010–11 to £116 billion (7.5% of GDP) in 2011–12, £89 billion (5.5% of GDP) in 2012–13, £60 billion (3.5% of GDP) in 2013–14, £37 billion (2.1% of GDP) in 2014–15, and £20 billion (1.1% of GDP) in 2015–16.
The average spending cuts across government departments will be a truly eye-watering 19% in real terms over four years, given that the National Health Service and overseas aid are being ring-fenced, while education is also being protected to some degree. The October 2010 Spending Review confirmed the government is sticking to these plans and fleshed out more details of exactly where the axe will fall. Some departments are facing cuts of much more than 19%, including the Home Office, Foreign Office, and Ministry of Justice. In addition, funding to local government falls by 7.1% a year over four years.
Following much-better-than-expected public finance data for January, it is likely the PSNBR will come in lower than expected in 2010/11. If current trends over the first 10 months of fiscal 2010/11 are replicated over the entire fiscal year, the PSNBR would come in around £139 billion, meaning the chancellor would undershoot his targeted PSNBR by around £10 billion.
On the face of it, this gives the Chancellor a little "wiggle room" in his 23 March budget for 2011/12. However, he needs to be careful in what he does, as his targeted PSNBR of £116 billion in 2011/12 looks challenging, particularly as we expect that GDP growth will be less than Mr. Osborne is looking for. Specifically, the Office for Budget Responsibility (OBR) currently forecasts GDP growth at 2.1% in 2011 and 2.6% in 2012. We expect growth of 1.6% in 2011 and 2.2% in 2012.
Indeed, we suspect that the OBR will revise down its GDP growth forecast for 2011 at least, although this may not lead to it revising up its PSNBR forecasts given the likely better-than-expected outcome in 2010/11.
Also, Mr. Osborne will not want to give any impression that he is loosening the fiscal reins significantly.
Likely Tax/Spending Measures in the Budget
Significant changes to the current planned cuts in spending have already been ruled out by the chancellor.
The 50% rate of income tax will stay in place for now at least, as Mr. Osborne has rejected calls for this to be scrapped. While there are doubts over whether or not this generates any extra net revenue for the Treasury (due to high earners moving away), the government considers it important that the highest earners are seen to be taking their share of the pain. Removing the 50% tax rate at this time would be seen as sending out the wrong message to the less well off. However, the chancellor may indicate that the 50% tax will be reviewed at a future date when the fiscal position is healthy.
There will also be no going back on the plans to raise employees' national insurance contributions by 1.0% in April.
Major changes to income tax are unlikely, although the government could announce that it plans to further raise the tax-free allowance in 2012/13. This will rise from £6,745 to £7/745 in April, and the coalition government wants to get this up to £10,000 by the end of its term in office.
One tax hike that may be deferred, or at least reduced, is the planned increase in fuel duty in April. This is currently set to rise by a rate of 1% above the rate of inflation.
It has also been noted that the chancellor will announce further work reviewing the current tax/National Insurance system with the aim of simplifying it. However, this will likely be a lengthy process, and any changes resulting from such a review would be unlikely to take effect for some time to come.
Commitment to Business and Growth
Prime Minister David Cameron has touted the budget as "the most pro-enterprise, pro-business budget for a generation"; however, the government will need to find ways of delivering on this promise without spending much extra money.
The government will reaffirm its commitment to reduce the corporation tax rate to 24% by the end of this parliament, starting with a cut to 27% from the current level of 28% in April.
The government has also announced that 10 enterprise zones will be set up. Over four years, £100 million in funding will be provided for tax breaks on business rates, split between central and local government.
It has been reported that there is likely to be an extension and widening of the tax breaks that are given to investors in small businesses under the current Enterprise Investment Scheme.
The government will prioritize the reduction of the current red tape facing small businesses in order to try and encourage their formation and to help existing small businesses thrive. In particular, businesses that employ less than 10 people are expected to see a substantial reduction in the regulations they face. This will include a simplification of the auditing rules for small businesses.
In addition, it has been announced that small businesses will see a three-year moratorium on new regulation.