Why the real Budget pain is still to come
John Stepek Jun 23, 2010
Well, that's the easy part over with.
After the emergency Budget, no one can doubt that George Osborne really does want to slash the deficit. Labour had hoped to halve our annual overspend within the next five years. He wants to pretty much wipe it out.
So as far as the LibCons are concerned, 'stimulus' packages are out of the window. The government is focused on cutting back borrowing. And it's going to do it mainly by cutting spending (77%) rather than raising taxes (23%).
On paper it all sounds good. The markets certainly liked it. And the broad consensus from the credit ratings agencies is that Britain has protected its AAA credit rating – assuming it can stick to the plan.
And that's the hard part…
Reaction was polarised - but who's right?
Osborne's slasher budget was a "courageous move", said the OECD. Rubbish, said Labour's Harriett Harman. It was "a reckless Budget that pulls the rug out from under the recovery".
Of course, she would say that. But it pretty much sums up the reaction to the Budget. The pundits line up on two sides. One side reckons that cutting spending will be a disaster and plunge us into another depression. The other side reckons that by keeping interest rates low, and allowing the private sector the space to flourish, we'll end up with a much healthier economy, rather than a currency crisis on our hands.
The fact is, we'll never know who's right. In 60 years' time, whatever the outcome, economists will still be arguing the merits of their own pet theories. Each camp will point to the Great Recession of the early 2000s and be able to come up with arguments that justify their own particular political viewpoint.
Cutting public spending is the right way to go
Our instinct would be to back the cuts. Keeping the bond vigilantes happy is one reason. But it's also about confidence. That might sound odd when we're talking about a budget "bloodbath". But people don't like uncertainty. At least now we know what we're facing - a big squeeze. It might be painful, but it's also much easier to quantify, rather than an open-ended commitment to spend "whatever it takes", with no idea how we'll pay the bill in the end.
And we can't ignore that the threat of sovereign debt default is going to be a big issue in the coming months and perhaps even years. The last thing we want is for Britain to come under the microscope after the markets have exhausted the possible disasters waiting in the eurozone periphery.
Special FREE report from MoneyWeek magazine: When will house prices bottom out - and how will you know?
- Why UK property prices are going to fall 50%
- When it will be time to get back in and buy up half price property
On top of that, businesses will like the fact that corporation tax is being steadily reduced in the years to come. As a statement of intent, it should encourage businesses to invest, and allay concerns that they might face a much more hostile political environment up ahead.
The banking levy also came in lower than the banks had feared. And they can hardly complain about being taxed effectively on how risky their balance sheets are. So for now at least, it's highly unlikely to lead to a mass exodus to Zurich.
For the average person, the Budget wasn't all that bad
And in fact, the average person could have been forgiven for coming away from the Budget thinking it wasn't that bad. You can read more of the details in my colleague Merryn Somerset Webb's piece here. But in short, beyond the VAT hike – painful, but delayed until January – and the removal of some tax credits which were hard to justify in the first place, there's not a lot of immediate pain in here.
And it was all quite cleverly implemented. The VAT rise from 17.5% to 20% should be a nightmare for retailers. But in fact, retail stocks went up. Why? Because it doesn't come in until a couple of days after New Year 2011. So if anything, sales will get an artificial boost for the rest of the year as people rush to order their big-ticket items for Christmas.
It also deals nicely with the concerns about how hiking VAT would affect inflation. Because frankly, if inflation hasn't started to dip by the end of this year, then the Bank of England will have to revisit its whole argument about there being too much slack in the economy in any case, regardless of what happens to VAT.
But this was just a start - the really tough choices lie ahead
But despite all the headlines about hacking and slashing, we haven't seen the details of where the real pain will hit yet. And that's when the government's job will get hard. All the toughest choices have still to be made.
All the moves that will cause real unrest – such as public sector pension reform, massive 25% cuts to most departmental budgets, and proper reform of benefit programmes – will come in the spending review in autumn.
As Nicholas Timmins points out in the FT this morning, "with health and overseas aid protected, all other departments face an average 25% spending reduction over just four years."
That means that all the reforms to housing benefit and the like are just for starters. "If we can find any additional savings to social security and welfare… then that will relieve the pressure on these departments, and that 25% figure," as the chancellor put it.
These reforms are needed, as are the cuts. There's no doubt that over the past decade, the government has expanded into areas where we simply can't afford it to be. But it's these reform decisions that will cause the biggest political upheaval. They're also the ones that are the most important to get right.
So all in all, it's not a bad start for Osborne. But the real test for the government – and for the UK economy - is still to come.
Our recommended article for today
Don't think a stock is too expensive just because it's hitting new highs. This fashion group is up 34% since its flotation, but there's plenty more to come, says Bengt Saelensminde.
FREE - MoneyWeek's daily investment email
Our free daily email, Money Morning, is an informative and enjoyable analysis of what's going on in the markets. Written by our Editor, John Stepek, and guest contributors.
Sign up FREE to Money Morning here.