UK Needs to Address the Budget Deficit

Source: The Sunday Times
By: David Smith, Economics Editor
2010/02/14

Leading economists say the government lacks a credible plan to cut Britain’s budget deficit and that action to reduce the country’s borrowing should start immediately after the election.

In an endorsement of the Conservatives’ position and an attack on Labour — although the economists insist they are non-partisan — they warn that a failure to act could trigger a loss of confidence that could push up interest rates, undermine the pound and threaten the recovery.

Signatories of a letter, published today in The Sunday Times, include the former chief economist of the International Monetary Fund, a former deputy governor of the Bank of England and head of the Financial Services Authority, and a former permanent secretary to the Treasury and cabinet secretary.

Britain entered the financial crisis with a big underlying or “structural” budget deficit, the letter adds, which has widened sharply as a result of the recession.

The next government should seek to eliminate the bulk of that deficit within a parliament.

There is “a compelling case” for the first measures to cut the deficit to begin in the 2010-11 fiscal year, the economists say, implying action immediately after the election.

The Conservatives have promised, if elected, to deliver a budget within 50 days, although David Cameron has played down the prospect of “swingeing cuts” early on.

Most of the deficit reduction should come from spending cuts, the letter says, rather than tax increases. Any tax hikes “should minimise damaging increases in marginal tax rates on employment and investment”.

Labour has already announced a new 50% tax rate, to take effect in April, and increases in National Insurance, the “tax on jobs”.

The international list of signatories also includes four former members of the Bank of England’s monetary policy committee (MPC), a Labour peer, the former chief economists of the Bank of England, HSBC and the Greater London Authority, the head of the economics department at the London School of Economics (LSE) and the presidents of both the Royal Economic Society and the European Economic Association.

It was organised by Tim Besley, a professor of economics at the LSE, who left the MPC last year. The names include Lord Turnbull, Sir Howard Davies, Lord Desai, Ken Rogoff, Thomas Sargent and Sir John Vickers.

“This is a decisive moment in the economic debate in Britain — a moment when Gordon Brown’s argument on the deficit has collapsed and a new consensus for more decisive action emerges,” said George Osborne, the shadow chancellor.

“An impressive array of top economists, not just from Britain but around the world, are clearly warning that the government does not have a credible plan to deal with the deficit and that this threatens the recovery with higher interest rates.

“Crucially, these economic experts also say there is a compelling case for starting in 2010 and that there should be independent oversight of the forecasts — two arguments we Conservatives have been making with force for months now.

“It is clear today that the Conservative party is now speaking with the consensus of expert economic opinion and it is Gordon Brown who is threatening the British recovery.”

The Treasury insisted that Alistair Darling, the chancellor, had set out a credible plan to halve the deficit over four years in his pre-budget report in December and that he would provide further details in his budget next month. They also pointed to the government’s Fiscal Responsibility Bill, which enshrines the deficit reduction plan in law.

The chancellor insisted on Friday that he would present a budget for growth next month alongside “the most ambitious deficit reduction plan of any G7 country”. But he repeated his warning against withdrawing the stimulus too soon.

“The case for maintaining public spending until recovery is established is overwhelming,” he said. “Most countries are taking the same approach, because to cut now would be extremely risky and dangerous.”

Labour had claimed the Conservatives were backtracking on cutting spending immediately on taking office, for fear of losing votes because of the party’s “austerity” message. The economists’ letter is likely to embolden Osborne, who has insisted that tackling the deficit early is the right thing to do.

Besley said the letter was intended to demonstrate that there was a significant consensus among economists on how to address Britain’s record government borrowing. “I don’t want this to be seen as us siding with anyone,” he said. “But it does suggest that the Conservatives are where majority opinion lies.”

The Tories have proposed an independent Office of Budget Responsibility, chaired by Sir Alan Budd, a former chief economic adviser to the Treasury. In their letter, the economists call for something similar: independence in fiscal forecasting and scrutiny of the government’s performance.

The budget warning comes as an investigation by The Sunday Times has discovered that half of Britain’s 30 biggest firms have studied shifting their tax base offshore, with some saying they are actively considering a move.

The findings, which suggest the threat of a corporate tax exodus is real, come a week before a meeting at the Treasury where reforms to the taxation of foreign profits — which is of intense concern to multinational companies — will be thrashed out.

Of the top 30 companies in the FTSE 100 index, 15 said they were keeping their tax domicile under review. Three said they were actively considering a move. Last week Unilever and Diageo said they could move if tax and red tape were not reduced.

Kenneth Clarke, the shadow business secretary, warned yesterday that the next government would have to introduce tougher spending cuts than any recent administration.

“The level of cuts we are contemplating will probably exceed those of any modern government,” he said. “We are going to have to be much tougher on public spending than Margaret Thatcher ever was.”

—James Purnell, the former work and pensions secretary, will tomorrow call for the creation of a new public fund providing loans to low-income workers.

In a speech, Purnell will also call for the government to create a statutory maximum interest rate as a way of putting loan sharks out of business.

He claims that if 1% of the money spent on bailing out banks were set aside, a loan fund of £1.3 billion could be created.