Magazine article Management Today

A Tall Order for Future Growth

Magazine article Management Today

A Tall Order for Future Growth

Article excerpt

ECOMINICS

David Smith suspends disbelief to consider optimistic recovery forecasts as tax increases bite

If there is one question that has been dominating discussion of the British economy, it is this: can the economy withstand the impact of the record peacetime tax increases introduced by the Chancellor of the Exchequer, Kenneth Clarke, and his predecessor, Norman Lamont?

The only definite answer one can give to this question is that we will know quite soon. It is not strictly accurate to say that we have yet to feel the impact of the tax measures announced in the two 1993 Budgets - the freeze on personal tax allowances announced by Lamont last March took effect immediately (and was repeated, for the 1994-5 financial year, by Clarke). But it is true that most of the burden of reducing the budget deficit through higher taxation begins in April.

The legacy of last year's two Budgets is that taxes will increase by more than 8 [pounds] billion while public spending will be reduced, compared with previous plans, by over 3 billion [pounds]. The combined effect is a fiscal tightening equivalent to 2% of GDP. Nor is this merely a temporary hit. In 1995-6, the cumulative tax increases are of the order of 15 billion [pounds].

From April, householders will begin to pay VAT, at an 8% rate, on dometic fuel bills. The majority of wage and salary earners will set their pay cheques reduced by 1% as a result of an increase in National Insurance contributions from 9% to 10%. Tax-paying home-buyers will note that their monthly mortgage payments are increasing, because of a reduction from 25% to 20% in the rate of tax relief on mortgage interest, and on the married couple's allowance. Further down the road will come a new 3% tax on insurance premiums and a new tax on airport departures. VAT on fuel will rise to 17.5% and the tax relief on mortage interest will come down to 15%. Morgan Grenfell has calculated that the 1994-5 increases will slice 3% from the income of a married 30,000 [pounds] earner who has a mortgage and drives a car (excise duties on petrol are pledged to rise by 5% a year in real terms).

Running the tax numbers through conventional economic models produces the result that, other things being equal, GDP this year will be reduced by between 1% and 1.5%. In other words, to achieve the Treasury's growth forecast of 2.5% with the tax increases, one would have to be confident that in the absence of them, the economy would have grown by about 4%. This seems to ignore, among other things, the consumer caution and subdued housing market conditions that are legacies of the recession. But let me suspend disbelief for a moment and look at how this might happen.

The fist line of the argument is that exports and investment will take up t'e strain of supporting economic growth, the early stages of recovery having been mainly down to the efforts of the consumer. Alongside this, it is hoped that the impact of higher taxes on consumer spending will not be as great as the economic models suggest, because in an environment of low interest rates people will be prepared to run down their savings in order to maintain spending and, more importantly, they will increase borrowing. The combined effect of these actions will, it is hoped, offset the tax squeeze. …

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