A radical budget: now let's pray

By Martin Lewis, June 24, 2010

Behind every budget there is a hidden hand.

In the case of Labour's last Chancellor Alistair Darling it was Gordon Brown who would keep officials up into the early hours of budget day fiddling with the numbers.

In new Chancellor George Osborne's very first budget - an action-packed affair in which almost all major taxes were adjusted - the hidden force was not at the Treasury at all.

Much of the thinking, if not the detail, which influenced Osborne's key decisions to tackle budget deficits and borrowing head on, was formulated on Threadneedle Street rather than Downing Street.

The governor of the Bank of England, Mervyn King, made it clear before the election - much to the chagrin of New Labour which appointed him - that the key to stabilising the economy and avoiding a Greek-style crisis for Britain was to set out a credible plan for reducing the annual deficit and bringing down accumulated debt.

If the next government were to adopt such an approach then the Monetary Policy Committee (MPC), which sets the direction of interest rates and monetary policy, would do all in its power to support recovery. As fiscal policy, tax and spending are tightened, monetary policy would take up the slack.

The sheer size of the proposed tightening of policy is astonishing

There can be no doubt that the Chancellor, at 39 years old, some 23 years younger than the Governor, has extraordinary trust in the Old Lady of Threadneedle Street. It is no surprise that in the week before the budget, in his Mansion House speech in the City, Osborne proposed an extraordinary transfer of power to the Bank from the Financial Services Authority and the Treasury.

In line with proposals first drawn up by former SG Warburg banker Lord (James) Sassoon in opposition, policing of the banks passes from the FSA and Treasury to the Bank, significantly enhancing King's power. Indeed, he will become the most powerful governor in the Bank's history, with independent authority to set interest rates and enforce financial stability.

What is perhaps as remarkable is that in delivering the most radical budget in three decades, Osborne has set huge store by King's comments. The budget red book - where the secrets of the public finances are revealed - unusually quoted the Governor.

"Monetary policy must be set in the light of fiscal tightening over the coming year. If prospects for growth were to weaken, the outlook for inflation would be lower and monetary policy could respond."

In simple words, if Osborne kept his part of the bargain and made a real run at cutting the fiscal deficit, then King and the MPC would play their part in supporting recovery by keeping interest rates low.

So has Osborne done enough?

The sheer size of the proposed tightening of policy is astonishing. In the current year, Osborne proposes removing £8bn by means of spending changes and tax increases. This is a figure that surges to £40bn by 2014-15, a squeeze of unprecedented proportions.

The scale of the proposed changes is impressive, with the middle income Britons, the main group of taxpayers, taking on most of tax burden.

Higher-income taxpayers will lose £2,700 alone over the next three years as a result of frozen tax free allowances alone. They, of course, will also be hit by higher VAT and a freezing of benefits such as tax allowances.

Indeed, in the effort to keep the speculators at bay, the most savage cuts in government expenditure in more than a generation are proposed. Because the Tories decided before the election to ringfence the NHS, foreign aid and parts of the education budget, the rest of government spending has to be cut by 25 per cent. It is a hugely ambitious target and bigger than anything tried anywhere else in the world.

If it works, and it is a big if, the so called structural deficit - the budget red ink caused by the ups and downs of the economic cycle - will be eliminated. But we should not kid ourselves that will be the end of the nation's troubles.

The national debt - the accumulated amount of deficit over the decades - stands at £900bn and will rise to £1,300bn despite all the cuts made.

The interest rate bill at the end of the forecast period will still be an alarming £66.5 billion and debt will stand at 69.4 per cent of total output.

Despite all of New Labour's talk of prudence and fiscal discipline, the profligacy of its policies will still be felt midway through this decade.

Normally, after a period of severe austerity and adjustment, the taxpayer can look forward to some goodies in the shape of lower headline tax rates or more generous allowances.

The best that can be hoped for is that the shrinkage in the size of the state, a traditional Tory tenet, will allow the Bank of England to keep interest rates low and create room for the private sector - in the shape of business and entrepreneurs - to power a recovery.

Clearly, Osborne with the assistance of the Bank, thinks he can reshape and rebalance the UK economy.

But with our European partners struggling with many of the same kind of problems as Britain, the export markets required are going to be in very short supply.

The saving grace, amid the myriad of new taxes, is that the Chancellor has spared us another duty assault on the Kiddush whiskey.

Alex Brummer is City Editor of the Daily Mail

Last updated: 11:47am, June 24 2010