U.K. Budget Was Better Theater Than Economic Policy
The budget announced Wednesday by Britain’s Conservative government was less a change of economic direction than an exercise in political theater.
The good news is that the is no longer deteriorating. For the first time since coming to office in 2010, the Tories didn’t have to explain how worsening growth projections had wrecked their plans. Chancellor of the Exchequer George Osborne could have simply confirmed his previous revenue and growth targets, but in Britain budgets call for melodrama. So he enraged the Labour opposition by cutting the top rate of income tax from 50 percent to 45 percent.
Under different circumstances, that wouldn’t be such a bad idea. A top rate of 50 percent is high by international standards, and there are better ways to collect revenue from the rich. But Osborne’s justification -- instead of raising substantial sums, the 50 percent rate caused economic distortions -- was weak. The politics could backfire if the public agrees with Labour’s characterization of Osborne’s blueprint as “a budget for millionaires.” The typical U.K. household, after all, still struggles with stagnant wages and deep cuts in public services.
No Second Recession
Britain’s projected growth is just 0.8 percent this year. Not great, but at least the U.K. has avoided a second recession. The fiscal-squeeze program, amended in November, can proceed as planned. After assessing the new budget, the independent Office of Budget Responsibility says public debt will peak at 76 percent of gross domestic product in 2014, and the structural budget -- adjusted for the business cycle -- will be balanced by 2016. Growth in output should pick up in 2013 and beyond.
Growth of less than 1 percent in 2012 could justify a milder fiscal squeeze, though the question isn’t clear-cut. Another deviation from the program would have rattled the markets and could have raised borrowing costs. Also, Britain is doing better than its European neighbors, and the Bank of England is ready with unorthodox monetary stimulus if the economy slides back. In all, the budget’s macroeconomic judgment is defensible. More so than some of its details.
Osborne justified the cut in the top tax rate by saying that it had raised less revenue than expected. Tax-avoidance schemes, he said, had virtually neutralized it, so trimming the rate back to 45 percent would cost just 100 million pounds ($159 million) in revenue. Other changes, including a big increase in the tax on sales of very expensive homes, would more than make up for it.
These calculations look dubious. Revenue grew by less than expected in the first year of the 50 percent rate because taxpayers shifted income forward in anticipation of the rise. But this was a first-year effect. Once the tax is in place, shifting like that stops. The revenue loss will probably be more than the government says.
In addition, the increase to 7 percent from 5 percent in stamp duty (transfer tax) on sales of houses costing more than 2 million pounds ($3.2 million) is a bad way to raise more from the rich. The main effect will be to suppress turnover. A simple property tax on expensive homes would be harder to avoid, bring in more revenue from a broader base of well-to-do taxpayers and provide a steadier flow of money. This was an option the government considered; Osborne was wrong to reject it.
The budget’s other headline was an increase in the basic income-tax allowance -- the amount you can earn before you pay any tax. This will rise to 9,205 pounds in 2013, from 8,105 pounds this year, and the chancellor said he would raise it to 10,000 pounds in due course. That’s a nice round number and the move will be popular. But it’s a bad way to help those on low or moderate incomes, which Osborne said was his aim.
The poorest, who pay no tax, get no benefit. And with the increase spread across everybody else, the policy surrenders a lot of revenue -- about 3 billion pounds’ worth. Targeted credits to those on low incomes would make more sense.
Osborne is right to want to make Britain a better place to invest. His cut in corporate tax -- to 24 percent right away, with more to come later -- is wise. Once the fiscal situation improves, a lower top rate of income tax would also be good, provided it is honestly accounted for. But while severe fiscal tightening is under way, changes that mainly benefit the rich are bad politics and bad economics.
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