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You are here: Home > Current Topics > Mind your Business > 15 March 2004 |
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See In the News for the latest on the Chancellor's budget proposals 
Pressure on at No. 11 and No. 10? © Steve Woods: Stock.Xchng The Chancellor of the Exchequer will present his annual budget on Wednesday March 17th 2004. Gordon Brown has been at the helm of the UK's public finances since 1997 and whilst rumours continue to circulate that he would rather be in number 10 Downing Street rather than number 11, he remains a largely successful Chancellor in terms of economic performance. This budget however may well be even more crucial than all the others. Mr Brown has prided himself on being a 'prudent' Chancellor who is not willing to take risks with the UK's public finances but in recent months changes have occurred in the UK economy which could force the Chancellor to have to make some (even more) unpopular decisions that could be damaging, given the fact that a general election may be less than two years away. Fiscal RulesMr Brown's problem stems from the fact that revenues are not meeting expenditure plans and as such something has to be done to plug the gap. Mr Brown has put pressure on himself by laying down certain rules that he has insisted he will abide by. The 'Golden Rule' states that borrowing will only be carried out to fund investment projects that will increase the capacity of the UK economy and will not be used to fund 'current spending' on things like nurses and teachers pay rises and so on. The second is the 'sustainable investment rule'; this states that public sector debt will be stable over the period of the economic cycle and will not, in any event, exceed 40% of GDP. Borrowing LevelsThe Chancellor's budget therefore has to look at the potential income from taxation and match this to expenditure plans. In recent months, the level of borrowing to fund the gap between these two figures has risen fairly dramatically. In April 2003, Mr Brown reported in his budget that the borrowing level was being revised upwards by £3 billion to £27 billion for the year ahead. In the pre-budget report in December of the same year, that prediction was revised upwards by a further £10 billion and it is this increase in borrowing that is causing concern. The Chancellor has stated that the economic cycle is due to end in 2006. He therefore has to emerge by that date with a 'surplus' in public debt or at worst to balance the books. To be able to do this he must rely on the economy growing more strongly to bring in more tax revenue. The rates needed to achieve that are estimated to be between 3 and 3.5% whereas the current level is around 2.3%. Economic Growth?The difference might not sound much but in growth terms it is substantial. Spending would have to increase fairly substantially for this level to be achieved but the Bank of England is concerned at possible inflationary pressures. Mr Brown has written to the Governor of the Bank of England, Mervyn King, asking him to respond in an open letter why the Monetary Policy Committee (MPC) has failed to achieve the government,s inflation target if indeed they do not meet it. The very body he set up to control economic growth could strangle Mr Brown's desire for increased growth! The Birds of Prey are Circling!So, the next couple of budgets are going to be interesting in terms of how Mr Brown meets the numerous demands being placed on him and which he has placed on himself. If he does not adhere to his own rules it could not only damage the economy but also his own reputation. The opposition parties will be waiting for any sign that taxes - of any sort - will rise to fund the growing gap in the public finances. If they get wind of such tax rises they will not be hesitant in seeking to tear into he Chancellor. Mr Brown is fully aware of this fact and will be very conscious that his every word will be dissected even more than usual this time round. |
The budget is the annual estimate of the income and expenditure of the government for the coming financial year. In it, the Chancellor of the Exchequer provides details of the government's spending plans and how it intends to finance those spending plans. As such, the budget is central to the government's fiscal policy, the policy that aims to influence the economy through manipulation of government income and expenditure to achieve particular economic and non-economic objectives.
The government accounts for almost 40% of all spending in the UK and the range of services it provides is vast. The sheer size of the government's spending is mind-boggling. £53 billion on education, nearly £66 billion on health and a whopping £122.5 billion on social security over the last year. The government's aim is to provide key services and support mechanisms to the whole of society whether they be pensioners with no other source of income, the sick, business and industry, culture, media, the arts or sport. In so doing the government have key economic targets that they are aiming to achieve. These are:
In addition, the government will have a range of non-economic objectives that could cover virtually anything. It might be a desire to extend the provision of sporting facilities, a drive to reduce or even abolish child poverty, improve standards in education and health care, improve the environment and reduce regional imbalances.
Of course, none of these things are possible without the funds to carry them out. Governments get their money from tax revenue primarily. Taxes are not just income taxes but also include National Insurance Contributions, VAT, stamp duty, excise duties, inheritance taxes and so on. The imposition of taxes is never popular - whatever the government, but as the saying goes, there are only two certainties in life, death and taxes! Most governments will be looking to improve the efficiency of the tax system, that is, to get the maximum amount of tax from the minimum resources. That, of course is easier said than done. If tax rates of any kind are too high, there is an incentive for people to avoid paying them in some way; too low and the revenue is insufficient to meet needs. The balancing act is therefore precarious. These days, governments rarely change income tax rates - that is too obvious. Instead they have to look at the allowances that people are entitled to and amend those to change the margins at which people are drawn into the tax system - or not as the case and the policy might be.
Taxes may also be used to influence behaviour - tax on cigarettes to persuade people to give up smoking is one obvious example. One recent example of how successful this can be was the decision to tax leaded petrol at a higher rate than unleaded to encourage people to use a more environmentally friendly fuel. This policy, in conjunction with other measures was very successful in changing behaviour.
The importance of government finances to the whole economy can be seen if we look at the formula for aggregate demand.
AD = C + I + G + (X-M)
The nation's finances are one thing, but they have a direct effect on households. © iStock.com
Given we have said the government accounts for around 40% of total spending, it is clear that any decisions by the government about its income and spending affects directly and indirectly everyone in the country. It may not feel that we are part of the Chancellor's thoughts when he talks of the billions of pounds at the disposal of the government but every time we make an economic decision to spend or not to spend it has an impact somewhere. Individuals watch the budget to assess the impact on the price of beer, cigarettes, petrol, etc.; businesses are looking for tax breaks, investment incentives, grants and reductions in the administrative burdens that surround business activity; analysts are looking to see whether the Chancellor's figures add up because if they do not then it affects the whole macroeconomic environment and this in turn influences their decisions to advise clients on investment decisions. This in turn affects millions whose insurance and pension policies are affected by the movements in stock and bond prices.
The Chancellor therefore has a massive job on his hands pleasing everyone. In reality of course he never will. The key to this Chancellor's budget is how far his credibility as a man who can manage the nation's finances prudently can be maintained. It is not going to be easy!
All data Crown Copyright © reproduced under licence. Source: HM Treasury.
1. Given the Chancellor's self imposed 'Golden Rule', what options are open to him to keep within the guidelines set by his rule if growth is lower than predicted?
This should be a fairly straightforward question assessing your understanding of the basics of fiscal policy. The options are linked to the source of government income and the options for government spending, neither of which may be palatable! The key to this question is that the growth levels are below that which the Chancellor has predicted.
2. If one of your choices was to increase taxes, which taxes would you advise the Chancellor to increase and why?
The second question asks you to make a judgement about what areas of taxation to increase. This is not as easy as it sounds because you will have to consider the impact of your decisions. Putting up income tax by 1p for example would be extremely unpopular. You might therefore have to think about 'tinkering' with the tax system, adjusting allowances (not forgetting your non-economic objectives), expanding the scope of VAT, raising stamp duty, excise duties on alcohol and tobacco, fuel duty (could be tricky!) and so on. You may have to consider a range of tax options. In each case try to explain the reasoning behind your decision as well as the potential impact on those who will be directly affected. This will help you to think through the implications of tax decisions and help to avoid the bland 'raise taxes' answer!
3. If the option were to reduce public spending, where would you advise the Chancellor to concentrate his efforts?
This question provides similar opportunities as the question above but from a spending perspective. The approach to the answer is the same as that above.
4. Look at the budget statement or a summary of the statement - this is usually posted on the Treasury Web site (http://www.hm-treasury.gov.uk/budget/budget_04/bud_bud04_index.cfm).
The final question is split into two sections and is aimed at encouraging you to consider the effects of the Chancellor's actual decisions on your respective study area. If you are studying economics, you need to consider the effect on aggregate demand - consumption - of changes in taxation policy, investment (how far new policies might influence the willingness or otherwise of businesses both at home and abroad to invest), changes in government spending on aggregate demand and the possibilities for international trade (perhaps there has been help provided for exporters?).
If studying business studies, you are asked to consider the impact of the budget on business operations. Small to medium sized businesses often complain about regulations, tax administration, employment laws and so on in terms of how it limits their opportunities to 'get on' with their business. Any announcements made by the Chancellor are often analysed in detail on TV and radio programmes covering the budget - these are often very useful sources of information and can be used as part of your analysis.
In both cases, you are being expected to make judgements about the impact, try to be as precise as possible in your analysis and avoid making bland generalised statements. For example, if the Chancellor were to raise the duty on a bottle of Whisky by 5p, try to consider whether this represents a serious blow to the industry or whether it is something they will be able to accommodate in their planning. In terms of the economy as a whole, is it likely to have a significant effect on exports and thus the balance of payments or is such a product only a minor part of our total trade?
Whatever, this last section is likely to be a lengthy response, reflecting the assessment objectives of analysis and evaluation - the higher order skills!
