What the PBR should have said

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I’ve written before about how dramatic the deterioration of Britain’s public finances has been over the last ten years, but it is worth underlining again in the wake of yesterday’s Pre-Budget Report. According to OECD figures:

  • In 2000, we had the 7th lowest public spending among the 30 OECD countries at 36.6 percent of GDP. In 2010, we will have the 6th highest at 54.1 percent of GDP.
  • In 2000, we were the 16th most indebted country in the OECD. In 2010, we will be the 8th most indebted country.
  • In 2000, we had the 7th lowest deficit in the OECD (in fact, we had a surplus). Next year, the UK will have a 14 percent deficit (10.4 percent of which is structural. That’s the most unbalanced budget of any OECD country.

What Alistair Darling should have done in the PBR was unveil a 5-year fiscal plan to return to 2000 levels of spending, adjusted for inflation and population growth. That would mean cutting spending from £661bn to £457bn, a reduction of some £204.4bn, or almost 30 percent. That would eliminate the £178bn budget deficit with enough left over for some pro-growth tax cuts.

Impossible, people say. But is it really? If management consultants can go into profitable, private-sector organizations and cut operating expenses by 20 percent – I’m told that’s the ‘magic number’ – then surely 30 percent cuts in the government sector should be more than feasible. After all, even factoring in inflation and population growth, public spending has risen by 45 percent in ten years, without corresponding rises in output.

Ultimately the problem is not an economic but a political one. With so many people on the government payroll – whether as direct employees, or as people who get more in benefits than they pay in tax – the client state has become enormous. That will be Gordon Brown’s most lasting legacy, and the next government’s biggest headache.

Cameron on health and safety

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David Cameron’s speech on health and safety at Policy Exchange was on the whole rather refreshing and worthy perhaps of a modicum of praise. The central message was right: that the health and safety bureaucracy “treats adults like children, encouraging them to think that others have considered the risks for them, are taking responsibility for them, so they don’t have to think or take responsibility for themselves".

As such, Cameron has asked Lord Young to lead an extensive review to determine the clear principles of any health and safety legislation and to look into curbing the compensation culture built around it. As both are at route the fault of government, it is well within Cameron’s power to effect change if elected.

Despite this praise, the falsities in Cameron’s speech should not go unnoticed. Though critical of health and safety legislation, he argues there are three reasons why people still need protecting. These being a lack of information, the abuse of power by employers and market failures.

In a free market economy a lack of information is not a problem. The reputation of companies rises and falls upon the health and safety of what they are offering, through the feedback mechanisms of purchases and publicity. So customer is king and reputation and branding become everything. This best explains why Coca Cola is not poisoning its customers.

The power dissymmetry and market failure arguments are also unconvincing. The reason workers are better protected than in the past is the result and luxury of economic growth. Health and safety regulations that are in force do one of three things: all are bad. Firstly and most benignly, they are a waste of resources to administer standards that the market would otherwise provide. Secondly, they are a distraction from safety measures that are not regulated, but could otherwise be attended to if it wasn’t for the costs of administering unnecessary regulations. And finally and most perniciously, regulations can stop economic activity that would otherwise take place between two consenting parties. As Cameron stated in his speech “Excessive rules have given the impression that we have a right to a risk-free life… The consequence has been spiralling costs and a slow death of discretion, judgement and social responsibility".

I'll conclude with the words of John Blundell: "Socialism survives, by transmuting itself into new forms. State-run enterprises are now frowned upon, but the ever-expanding volume of regulation-financial, environmental, health and safety-serves to empower the state by other means". It is time to turn the tide.

One small mercy

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It’s sometimes tough to find silver linings in every cloud, but one small mercy of the Pre-Budget Report was that it did not raise Capital Gains Tax. Before Alistair Darling’s speech, there was much speculation that CGT was sure to go up as part of the government’s ‘soak the rich’ offensive. Some commentators were suggesting a new rate of 30 percent (up from 18 percent now) or even 40 percent. In the end, the Chancellor left CGT unchanged. He was right to do so. ASI research (admittedly a bit out of date now, but I doubt things have changed much) has suggested that the revenue-maximizing CGT rate is somewhere around 15 percent, while the growth-maximizing rate is significantly lower. In other words, raising CGT too high would hit revenues, because people react by making fewer investments, while also damaging prospects for economic growth. There may be a case for aligning CGT and income tax as part of a comprehensive overhaul of the tax system, involving much lower and flatter rates, but hiking CGT to score a political point would have been pure folly. Kudos to Darling for resisting the temptation.

Is there more bad news out there?

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As I said, the Chancellor’s estimate of his deficit for this year has risen again. Back in the 2008 Budget he predicted that this year’s borrowings would be £38 billion. In the autumn 2008 pre-Budget report he increased it to £118 billion. In the spring 2009 Budget it jumped to £175 billion, and now he is predicting £178 billion.

But in the 2009 Budget he was expecting the economy to contract by “only" 2.75% this year, and now he concedes that the true contraction will be 3.5% - an additional 0.75%. Surely an extra 0.75% fall in GDP would increase borrowing by more than £3 billion?

Let’s do a quick comparison.

A year ago, in the 2008 pre-Budget report, Darling estimated that GDP would fall by 0.5% this year, giving an estimated deficit of £118 billion. By the spring 2009 Budget the estimated fall in GDP was 2.75%, and the estimated deficit £175 billion. So an extra 2.25% fall in GDP gave an extra deficit of £57 billion.

OK, it’s only a crude calculation, but on that basis I’d expect today’s extra 0.75% fall in GDP to result in an increase of £19 billion in the estimated deficit, taking this year’s deficit to £194 billion.

That’s close to the £200 billion that various economic analysts were predicting recently, based on the Treasury’s monthly figures for tax collection. Hmm.

Just how big is the deficit?

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After a decade of Gordon Brown spouting billions everywhere, it hardly seems like a big amount any more. But ten billion here, another twenty billion there, and before long it starts adding up to serious money.

To put it in context, the National Debt pretty much started with the Napoleonic War, about 200 years ago. From then to 2000, the total cumulative debt run up by all the governments over that period came to just over £300 billion.

Darling is proposing to borrow that much, not in 200 years but in just 20 months.

Record deficit

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So the estimated deficit for this year has been increased, from £175 billion to £178 billion – the biggest deficit ever for the UK government. That’s 12.6% of GDP.

Frankly we’re unlikely ever to pay that off, especially with the government predicting more deficits every year for the foreseeable future, so we’ll be paying interest on that debt forever.

If interest rates go up to 7% (hardly unlikely), we will be paying about £12.5 billion interest each year, just on this year’s borrowing – never mind all the accumulated borrowings from previous years and all the extra debt the government is planning for the future.

That’s about 3% on VAT, forever, just to pay the interest on this year’s deficit.

Pre-Budget Report

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I've just got back from CNBC, where I have been analyzing the pre-budget report for their Strictly Money programme (I'll put the video up once it is available). My line was that the economy needed three things from Alistair Darling today. Firstly, it needed a credible plan to restore some semblance of sanity to the public finances - which are now by far the worst of any OECD country. Secondly, it needed the government to make a short/medium term commitment to policy stability - i.e. no more nasty, politcally motivated surprises for businesses. And thirdly, it needed the chancellor to make a long-term commitment to a low-tax, enterprise economy. The underlying goal should have been to restore business, investor and consumer confidence, so that the private sector can drive our recovery.

Needless to say, that is not what we got from the chancellor. Instead, we were told that even if the government's heroic growth assumptions are met (Darling says 3.5 percent growth in 2011, the average independent forecast is 2 percent) we will still be overspending by £100bn per year come 2013/14. There was no real detail on how spending would be brought under control. Indeed, most of the speech was devoted to unveiling eye-catching new programmes that the government was somehow going to fund - guaranteed jobs for the under 24s, more government support for green technology, more spending on infrastructure, above inflation rises in the state pension, and so on. Fundamentally, Alistair Darling was whole-heartedly embracing the crass, Keynesian notion that government spending drives economic growth, while failing to realize that every pound government spends must first be taken away from the part of the economy that actually produces wealth.

Ultimately, I think one of my fellow guests on CNBC summed it up best: "I've always thought Alistair Darling was on another planet. Now I think he must be in a different galaxy." More to follow...

Eyes down for the oddest pre-Budget report ever

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So with the worst government deficit ever, the Chancellor’s main proposal is – to help pensioners by reducing Bingo Duty from 22% to 20%.

How sweet.

Is the Chancellor completely out of his depth, or is this a sign that he has won a titanic struggle against demands from the Prime Minister for huge tax increases on the “rich"? I guess we won’t have to wait long for their memoirs to be published to find out.