OUCH!

OUCH!

by The Economist | LONDON

FOR once the event lived up to the pre-launch publicity. George Osborne, the Conservative chancellor of the exchequer, promised before the election to deliver an “emergency” budget to tackle Britain’s deficit within 50 days of winning power. He did so on June 22nd as a member of a coalition government that includes the Liberal Democrats, and it more than lived up to expectations.

The budget set out tax rises and spending cuts worth an additional £40 billion ($59 billion) or 2.2% of GDP by 2014-15, the last year of the current parliament (assuming that the coalition government survives that long). Since Alistair Darling, the previous Labour chancellor, had already set out plans for a big tightening, that brings the overall fiscal consolidation to 6.3% of GDP.

Mr Osborne has long said that spending cuts rather than tax rises should do the bulk of the work, often mentioning a goal that 80% of the consolidation should come from reducing expenditure. He managed to achieve that for his own package by 2014-15. But taking the consolidation as a whole over that period, spending cuts will make up 74% and tax rises 26%, reflecting the fact that Mr Osborne has kept many tax rises planned by the previous Labour government.

On top of those he added his own. One long-expected rise was in VAT, a consumption tax. The main rate will go up in January from 17.5% on goods and services to 20%, raising a thumping £12.1 billion in 2011-12. The chancellor had some other important tax announcements, which taken together will reduce revenue, such that the overall package, including the big VAT increase, will raise taxes by around 0.5% of GDP by 2014-15. On personal taxation, one of the trickiest issues concerned capital-gains tax, where he had to square the Lib Dems’ demand to raise CGT sharply with strenuous opposition among many Tories. In the event, he left it at 18% on non-business assets for anyone who pays only the basic rate of income tax (20%) and raised it to 28% for those whose who pay higher rates. In a similar spirit, a rise of £1000 in the tax-free allowance for income tax next year will not benefit the better-off.

On business taxes, Mr Osborne had already said he would lower the main corporation tax from 28% to 25%. In the budget he went one step further by announcing that he would lower it to 24% by 2014-15. A new levy on banking liabilities is expected to bring in just over £1 billion next year, rising to over £2 billion a year from 2012-13.

Just as tax rises were a taboo during the election, so too was any discussion of cutting welfare (beyond a few token items), even though it makes up 28% of expenditure. It was always unrealistic to think that a big fiscal consolidation could exclude welfare spending and Mr Osborne announced an array of cuts which will total £11 billion by 2014-15. That sounds a lot, but in fact it will make up only a tenth of the overall retrenchment of 6.3% of GDP.

That means there will have to be deep cuts in spending on the main public services and administration, which make up over half of overall public expenditure. And since health, which alone constitutes nearly a fifth of public spending, will be spared real cuts, that augurs a very tough time for the unprotected services.

Whether the implied scale of cuts is feasible is one shadow over Mr Osborne’s Budget. That will become clear once the spending review, which will determine where precisely the reductions will be made, is published on October 20th. Another is whether the economy will be able to deal with such a sharp fiscal retrenchment. The new Office for Budget Responsibility, which is now responsible for official economic and fiscal forecasts, thinks it can. It has lowered its GDP growth forecast for 2010 from 1.3% to 1.2% and for 2011 from 2.6% to 2.3%, but raised it a bit for both 2013 and 2014. The third issue is fairness. Mr Osborne made much of his claim that the tax measures in the budget were fair. But once the spending cuts are identified, others may take a different view.