Osborne Levies Banks, Raises Sales Tax to Cut Deficit

Osborne to eliminate U.K.'s 'structural' deficit by 2015
U.K. chancellor of the exchequer George Osborne. Photographer: Tomohiro Ohsumi/Bloomberg

June 22 (Bloomberg) -- U.K. Prime Minister David Cameron will impose a levy on banks and raise the sales tax in what the government called its biggest peacetime deficit cut, seeking to guard the top credit rating without stifling economic recovery.

Lowering forecasts for growth to 1.2 percent this year and 2.3 percent in 2011, Chancellor of the Exchequer George Osborne announced a freeze on public workers’ pay and subsidies for children along with a reduction in housing benefits. Capital-gains taxes were raised and corporate-profit taxes cut.

“This is the unavoidable budget,” Osborne told lawmakers today in London, delivering the package six weeks after taking over. “Everyone will be asked to contribute.”

Tackling the largest fiscal shortfall in the Group of 20 nations may test the durability of the Conservative-Liberal Democrat coalition and the strength of union opposition. It also leaves Cameron at odds with President Barack Obama’s stimulus drive on the eve of his first summit of world leaders.

The changes planned by Osborne, 39, the youngest chancellor since 1886, and cuts already proposed by the previous Labour government total 113 billion pounds ($167 billion), 15 percent of the 737 billion-pound budget foreseen for 2015, according to the Treasury. Agencies outside the National Health Service and overseas aid budgets face a 25 percent cut over four years.

‘Strong Statement’

Fitch Ratings, which said June 8 the U.K. may lose its AAA rating if it fails to speed cuts, called today’s budget a “strong statement of intent.”

The fiscal tightening amounting to about 40 billion pounds a year by 2015 would nearly erase a deficit that reached 11 percent of gross domestic product in the last fiscal year. About four-fifths of the correction will be based on spending cuts with tax increases accounting for the rest.

“It’s a pretty severe fiscal tightening,” said George Buckley, chief U.K. economist at Deutsche Bank AG in London. “They’ve had to deliver and the ratings agencies probably won’t act to downgrade.”

The pound and gilts rose as Osborne announced the plan would eliminate the structural deficit by 2015, with net debt peaking at 70 percent of gross domestic product by 2014. He rejected suggestions the government needed to choose between growth and fiscal order as a “false choice.”

The pound climbed 0.6 percent to $1.4849 at 4:53 p.m. in London, and yields on 10-year gilts fell 6 basis points to 3.45 percent.

Spending Cuts

Overall, Osborne said spending would be cut by an extra 30 billion pounds a year, including 11 billion pounds from welfare, while the increase in value-added tax to 20 percent in January from 17.5 percent would yield 13 billion pounds a year by the end of the Parliament in 2015.

The levy on banks would tax their balance sheets starting next year, generating 2 billion pounds of revenue. The tax will be set at 0.04 percent in 2011, before increasing to 0.07 percent. The levy will apply to British banks as well as the subsidiaries and branches of overseas banks. Firms will only be liable for the levy when their relevant aggregate liabilities exceed 20 billion pounds, the Treasury said on its website.

Pledging to bolster investment and employment, the government put the corporate tax on track to fall four percentage points to 24 percent over four years and raised the threshold at which employers start paying national insurance. At the same time, the capital-gains tax for those who pay the higher rates of income tax was lifted to 28 percent from 18 percent.

Tax Ceiling Raised

To blunt the impact of the cuts, Osborne raised the ceiling at which the lowest rate of income tax is levied by 1,000 pounds to 7,475 pounds, exempting 880,000 low earners. He also maintained spending on schools, hospital buildings and other infrastructure projects. The basic state pension will from next April be linked to earnings rather than prices, he said.

Unemployment will peak at 8.1 percent this year before falling to 6.1 percent in 2015, Osborne said, citing the estimates of the independent Office for Budget Responsibility. That body revised down its forecasts for employment by 100,000 for each of the next four years as a result of his plan.

In increasing the income-tax threshold, Osborne adopted a policy of the Liberal Democrats, junior partner in coalition with Cameron’s Conservatives. The increase in VAT may still lead some Liberal Democrats to rebel as unions call for an emergency meeting to develop a strategy to fight.

Policy makers say a Greek-style bondholder revolt is a bigger risk to the economy than a return to recession and that restoring order to the public balances will ultimately boost the economy. Bank of England Governor Mervyn King last week backed retrenchment and said monetary policy could respond if the prospects for growth subsequently deteriorated.

Euro Crisis

“Some have suggested that there is a choice between dealing with our debts and going for growth,” Osborne said. “The crisis in the euro zone shows that unless we deal with our debts there will be no growth.”

The argument over how soon to withdraw stimulus as the global recovery gains momentum will play out on the world stage when G-20 leaders convene in Toronto on June 26-27.

Obama said in a June 16 letter to his counterparts that they must avoid the “mistakes of the past” when economic support was withdrawn prematurely, while German Chancellor Angela Merkel says “there is no alternative” to cutting deficits. Japanese Prime Minister Naoto Kan’s government today vowed to cap annual spending for the next three years and balance its books in a decade.

“The U.K. is a test case,” said Tim Adams, a former U.S. Treasury undersecretary and now managing director of the Lindsey Group, a Fairfax, Virginia-based investment consulting company. “If Osborne’s budget works that will have a profound impact on the debate in the U.S.”

To contact the reporters on this story: Simon Kennedy at skennedy4@bloomberg.net; Gonzalo Vina in London at gvina@bloomberg.net.

To contact the editors responsible for this story: James Hertling at jhertling@bloomberg.net; John Fraher at jfraher@bloomberg.net.