Why Britain's New Budget Is a Big Gamble

After swinging into surplus in the late 1990s, Britain's finances are taking a turn for the worse, as Chancellor of the Exchequer Gordon Brown's ambitious expansion in public spending runs into lost revenues from a softer economy and the stock-market bust.

Not surprisingly, the budget for the fiscal year beginning in April, presented by Brown on Apr. 9, was greeted with a mixture of hope and skepticism. The concerns: the budget's economic projections and the tax hikes that may be needed to prevent the deficit from ballooning.

Brown had to backtrack on his overly optimistic economic forecast made back in November (table), and some private analysts think his numbers are still too high, especially for 2004 and 2005. He also set forth some small tax hikes to help limit the coming year's deficit, which he projected at £27 billion ($42 billion), or about 2.5% of gross domestic product.

But with revenues already falling at the steepest rate since the 1991 recession, with his growth projections in doubt, and without more tax hikes, the red ink could exceed 3% of GDP in each of the next two years. Britons have only now begun to feel the hikes that Brown pre-announced last year, such as the Apr. 1 jump in national insurance contributions.

The Iraq war is one of Brown's headaches. Falling confidence is crimping consumer and business spending and tax revenues, while the war and its aftermath are certain to cost more than the £3 billion previously allocated, in addition to £330 million for domestic counterterror measures. But the top risk is the housing bubble, a key support under consumer spending. A sudden collapse in house prices, up 26.2% over a year ago, is unlikely, but even a slow leak will depress spending.

Brown is clearly taking a big risk both economically and politically. If his economic forecasts fail to pan out, he will be in the predicament of having to raise taxes just before the next election or let the deficit swell, possibly making Brown a political liability for Prime Minister Tony Blair.

By James C. Cooper & Kathleen Madigan

    Before it's here, it's on the Bloomberg Terminal.
    LEARN MORE