Budget day looming in Britain

Alistair Darling must not frighten voters or international markets, writes Mark Hennessy, London Editor

NEXT WEDNESDAY, British chancellor of the exchequer Alistair Darling rises in the House of Commons to present his budget.

With it, Darling must do nothing to frighten international financial markets worried by the UK’s debt and borrowing and, yet, he must not harm Labour’s chances of clinging on to power.

Almost everyone in the UK agrees that the country is borrowing too much and that this must be curbed.

Few, however, agree on when the work should start, how long it should last and, most importantly, how much of the problem should be spread between tax rises and spending cuts.

So far, Labour has pledged in the next parliament to halve annual borrowing, which is now likely to reach £166 billion (€186 billion) for the year to April – less than the £180 billion originally predicted.

If elected, the Conservatives want the work to start sooner and more deeply – though they have, for electoral reasons, avoided putting out too much detail that would be seized upon by their opponents.

In reality, everything that both parties say now must be treated with caution.

The Conservatives have already said they will produce an emergency budget within weeks if elected, and Labour can be expected to put on the brakes more strongly, regardless of anything senior cabinet figures such as Darling and British prime minister Gordon Brown are saying at the moment.

The Darling budget will include none of the giveaways traditionally beloved by governments about to go before voters.

But equally, Darling has to endeavour to avoid offering the Conservatives a clearly identifiable target that they could exploit with voters, who may understand intellectually the need for cuts, but who are not going to appreciate them when they come.

However, there is one unpredictable ingredient: Darling’s desire to protect his political legacy. It is clear, given the tensions that exist between Darling and Brown, that he will not be returning to the treasury if Labour wins the election outright, which is unlikely in the extreme, or manages to cobble together a coalition or minority administration, which cannot be ruled out.

One budget move Darling could make would be to announce that VAT, which returned to 17.5 per cent in January, will rise later this year. Each extra percentage point levied raises £5 billion, though it also hits inflation, which is already worrying the Bank of England.

From a political perspective, Darling could match that with a capital gains tax increase from 18 per cent to, perhaps, 25 per cent, which is unlikely to bother most people thinking of voting Labour.

Darling, however, has a slightly fairer wind next week than he envisioned in last December’s pre-budget statement. Income tax, national insurance and capital gains tax receipts are all stronger today than he predicted at the time.

Brown, who has gone from contrasting “Labour investment versus Tory cuts” to accepting that cuts must be made, is still shying away from taking the knife to day-to-day spending.

Under Labour’s current plans, just half of the curbs due will come from current spending; the rest will come in increases in average tax rates and capital spending falls.

The European Commission this week pushed for faster, deeper action, suggesting that an extra £26 billion a year needed to be cut. In addition, a series of ratings agencies – which are seeking to rebuild their own reputations after their weak performance at the height of the global financial crisis – and the Bank of England have warned that the deficit is unsustainable.

Currently, 7 per cent of all British tax revenues are spent to pay off national debt interest and this figure is expected to rise to 12 per cent – a level that frightens international markets.

However, the situation could be even worse once quantitative easing – where the Bank of England buys government debt – is withdrawn, since it could add a full percentage point to the costs faced by the treasury.

Under Labour’s projections, which are dependent upon growth figures that are challenged by many economists, some £100 billion of the UK’s current annual borrowing will disappear by itself without intervention from the government, assuming that economic recovery beds down. But the remainder – £80 billion – will have to be tackled by spending cuts and tax rises.

Some of the recovery hopes are based on exports rising on the back of sterling’s fall in value. But January statistics were disappointing, showing a drop in exports, which suggests that companies are either seeking to improve sales margins, rather than volumes, or they are simply waiting to see if signs of recovery are temporary or lasting.

Speaking at the Guildhall in London this week, Liberal Democrats leader Nick Clegg said both Labour and the Conservatives were peddling myths.

He said they claimed that the spending cuts needed could be secured by “better management, efficiency drives and waste reduction, as if we can reduce public spending by £80 billion or more a year without anyone noticing”.

“That is not true and it is wrong to pretend otherwise,” he said.

“This is an unprecedented challenge in the modern era. We need to bring about the biggest fiscal contraction in post-war political history. This will mean enormously tight spending rounds for many years to come.”

If handled badly, austerity measures in the UK could provoke Greek-style disturbances.

A recent Goldman Sachs report neatly highlighted the scale of the public expenditure increases that have taken place under Labour since it came to power in 1997.

Day-to-day government spending doubled, on average by 7.2 per cent a year, compared with the 5 per cent rise in personal spending, leaving UK public spending 16 per cent higher than the EU average.

There is room to cut if the political will exists.