Budget 2005 - The Economy

The economy is on track to perform in line with the Chancellor's Budget 2004 forecasts. But what happens next? The Ernst & Young ITEM Club forecast shows the UK economy improving modestly throughout 2005 with expected GDP growth of 2.6%, driven principally by the public sector, but hitting a wall in 2006 as the government's funding problems culminate in tax rises in Budget 2006.

The ITEM Club, which uses the same economic model as the Treasury, claims that taxes would have to rise by at least £8 billion, while the Institute for Fiscal Studies says £11 billion.

Treasury Select Committee Chairman John McFall MP recently highlighted the fact that, "Tax receipts have been below forecast for the last four years." However, the Chancellor still expects to meet his fiscal "golden rule" - that the government should borrow only to invest over the economic cycle.

In February 2005 he received some help in his aim from the Office of National Statistics, which discovered it had been double-counting road maintenance expenditure. Making the correction added back more than £2 billion to Gordon Brown's coffers. If the Government's statisticians can't add up - what hope is there for the rest of us?

The Office of National Statistics stresses that it made the decision "to correct" itself, but admits the Treasury (its boss) was involved in the talks. Gordon Brown will recall how often he castigated the Tories when they altered the unemployment figures over 20 times to make them smaller. Meeting the golden rule is not important in itself, as it was self-imposed by Mr Brown. But it has become a mantra vital to his reputation.

A Budget for voters?

Speaking in Shenzhen on February 24, during his tour of China, the Chancellor said that rather than short-term issues, the budget will focus on areas like education, science and research and development. He obviously wouldn't want to be seen doing anything as grubby as vote-buying.

The Chancellor is under pressure in his own party to introduce windfall taxes on both the oil and banking industries. However, it is thought unlikely that he will break the pledge given when he last raised offshore taxes in 2002: no further rise before the General Election.

Inflation and interest rates are out of the Chancellor's hands. A Reuters poll of 50 economists at investment banks in February showed 22 expecting the next move in base rate to be down, 25 believing there would be at least one more rise and three refusing to answer.

The Bank of England traditionally prefers to move interest rates in months such as May that coincide with its quarterly inflation report. The first estimate of GDP is published on 22 April, a fortnight before the Bank's Monetary Policy Committee sets interest rates on 5 May. Will political pressure to defer a rate rise come into play?

However, most notably all the pundits thought that interest rates would end the year not far from the current rate of 4.75%. All the forecasters agree that the UK can expect, at least in 2005, relatively steady economic growth and inflation without large moves in interest rates.

Labour went into the 1997 and 2001 general elections pledging not to increase the standard or top rates of income tax. Tony Blair went even further in 1995 saying, "We have no plans to increase taxes at all." Labour has kept its pledge not to raise income tax rates but the Chancellor has devised a variety of alternative revenue-raising schemes, including a 10% rise in National Insurance contributions.

Gordon Brown also made more money for his coffers by refusing to raise income tax thresholds in line with increasing earnings. This has dragged 1.5million more people into the higher tax rate since 1997, meaning that 2.8 million people now pay 40% tax. The Treasury is forecasting its tax take to rise from 38.3% of GDP in 2004-05 to 40.5% in 2009-10 without tax increases

The Institute for Fiscal Studies' Green Budget suggests that growth in national income after tax will fall to its the lowest for 20 years. It forecasts growth to average 1.7% over the five years to 2010 and in that final year to be just 1.3%.

Unlike the UK, most of the world's industrialised countries cut their top tax rates between 2000 and 2003. Only three countries increased the "all-in" level for high income earners over this period: Sweden, Greece and the UK/

The Paris-based Organisation for Economic Co-operation and Development says the reason why most wealthy countries cut their top tax rates is growing concern about disincentives. Advocates of lower taxes for high earners point out that the proportion of total income tax paid by the top one per cent of taxpayers went up from 11% to 15% under tax-cutting Conservative governments of the 1980s, when the top income tax rate was brought down from 83% to 40%.

During Labour's first term, prudence was the Brown watchword. After the last election, the Chancellor has run down the surplus he built up and has borrowed heavily to finance his spending plans. The reckoning will come after this year's election. It may prove to be painful for those voters who have to pay for Labour's free-spending ways.

Since 1997 Mr Brown has redistributed income from the rich to the poor. The big gainers are the poorest 20% of the population while the richest have been clobbered hardest. The pattern of income redistribution has become much more marked in the past four years as Mr Brown has increasingly played Robin Hood.

The Institute for Fiscal Studies says tax rises on the richest 10% of households cut their disposable incomes by 5.8%, while tax cuts and benefit rises for the poorest 10%of households has meant their net incomes rose by 10.1%.

On average, the losers from Labour's tax and benefit reforms have been childless workers, while the gainers have been lone parents, non-working families with children, and pensioners

By next year, it has been forecast that the Government will be taking 2.1% more of national income in tax and other receipts than when it came to power. It expects to take a further 1.3% of national income by the end of the decade, raising the tax burden to a 25-year high.

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