One small mercy


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 ASI research (admittedly a bit out of date now, but I doubt things have changed much) has suggested that the revenue-maximizing CGT rate is somewhere around 15 percent, while the growth-maximizing rate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?


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?


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


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


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


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.

Three words: "talent is mobile"


We keep reminding the government (and for that matter, the opposition), as they contemplate punitive tax increases, of those three words. Land and houses can't be moved abroad, and factories find it difficult, but talent finds it easy. It finds it easy to move away from lower rewards and towards higher ones, whether this be across national frontiers and tax jurisdictions, or within a country between different employers. This is one reason why employers have to pay "the market rate" or risk losing their key workers. The latest evidence of this comes in a report that 1,000 investment bankers have quit the RBS for rival firms since the government ordered it to clamp down on bonuses.

Talk of a 'windfall' tax on bonuses is misleading, since they are already subject to tax at 40 percent (soon to be 50 percent). What is being bandied about is a swingeing tax increase on certain classes of currently unpopular employees. The result is as predictable as the sequence of night and day. If some firms are prevented from paying bonuses, their top talent will move to ones that are not. If all bonuses are subject to massive tax increases, many high achievers will move to jurisdictions where this does not happen, or will rearrange their affairs to avoid it. The effect will be not much more money to the government (and maybe even less), but a major incentive for people to move jobs or countries. This is why Gordon Brown and the EU are trying to harmonize taxes and eliminate 'tax havens,' so they can keep talent at their mercy and tax whatever they like. It won't happen.

You might include Madsen Pirie's "101 Great Philosophers" among the Christmas presents you give.

No free lunch for you Gordon!


As the Pre Budget report approaches, Gordon must come to understand that “there ain't no such thing as a free lunch". Whatever the possible catering policy in Number 10 and the Palace of Westminster, the world of economics unfortunately does not quite work like that. This is an unfortunate common sense principle of economics: somebody always has to foot the bill.

Gordon wishes to draw an election battle line, arguing Labour is the party of growth, whilst others are anti growth. He makes occasional gestures to our debt crisis, but the strategy is primarily tax and spend focused rather than spending cut driven (to maintain consistency and his core vote).

His argument is that government must keep investing, so we can grow our way to prosperity. GDP= C(onsumption)+G(overnment spending)+I(nvestmnent)+X(net exports). Therefore, the logic is that if we increase G, we will increase GDP.

Unfortunately there is no such thing as a free lunch. Where does government get its money? You and I, the taxpayers must foot the bill. As we pay the bill, we have less money to spend on our own consumption and investment. This policy of stimulus is a road to hell.

Government is worse at spending money than its people are. For every government multiplier, there will be a negative multiplier of an equal or greater size, so the policy at best will not do very much, and at worst will have a negative effect on growth. Of course, people may not immediately spend all their money as the government might, but private saving, private investment, paying off debts, and fixing balance sheets are essential to restructuring and economic recovery.

Rather than maintain and expand government spending and uncompetitive taxes (to fund this spending), a policy of growth should slash taxes , cut expenditure, whilst understanding we are severely restricted by the debt straight jacket imposed on us by Gordon’s historic spending binge.

To make one exception to the rule: Gordon, Darling and the rest of the Labour apparatchiks, if you disband your government now I would gladly host a celebratory lunch, this one's on me.