See V for victory or U for unworkable

ANY government budget is a balancing act and this is no more true than with that announced by Alistair Darling, the Chancellor, yesterday.

There are two key questions: Has he given away enough to provide the kind of stimulus that will get the economy back to growth by next summer? And has he signalled enough by way of tax rises in the years ahead to get the public finances back on an even keel? Neither question has an easy answer.

The stimulus to the economy is about £20 billion, which equates to about 2 per cent of GDP or the amount of wealth annually created in the economy.

Since most economic forecasts predicted that the UK economy would suffer about a 1.5 per cent fall in output next year, Mr Darling looks to have taken the right action to prevent a recession.

But economies don't work like that.

By far the biggest giveaway is the VAT reduction to 15 per cent. Assuming that consumers buy as much next year as they did last year, then they will spend £12.5 billion less to buy the same amount from shops.

Spending in the shops, however, is on the slide. An upward spike in food costs has meant household food bills shot up in the second half of this year, leaving less to spend on non-food items any-way, even before recession-prompted thoughts of spending less kicked in.

Because of this, the VAT giveaway will probably be less than forecast.

Then there is the question of what consumers will do with what they have saved on their purchases which, according to government estimates, should be about £250 a household. The problem here is that households are labouring under an unprecedented burden of debt – currently about £10,000 of credit card and loan debt each. And since everyone knows a job-destroying recession has set in, any fuel efficiency or VAT savings made are much more likely to be spent on reducing debt rather than going out to spend.

If this becomes the case, the second question's answer is a definite "no".

Mr Darling has signalled these tax rises for two purposes. Firstly, to tell us we are going to have to bear some financial grief in the future to pay for the pain relief today. Secondly, to tell the international sources he intends to tap for vast levels of borrowing that he is prepared to raise taxes to pay them back.

Without that assurance, the cost of borrowing would go up and the pound sterling would be devalued still further. But where the sums do not add up is in his belief that the recession will end by next summer and in autumn the UK economy will return to a growth track.

Economists call this a v-shaped downturn – a sharp fall in output followed by an equally sharp rise. But much more likely, given the probability that the £20 billion "stimulus" will not have the hoped-for effect, is a u-shape – a sharp fall, followed by a period of no growth and then eventually an upturn. In that case, the tax increases will not produce the predicted revenue and, even worse, they may kick in while the economy is still in recession.

Inflation, or rather the lack of it, also causes a problem for Mr Darling.

Governments often increase their tax revenues by doing nothing. If inflation is running at 3 per cent and pay awards are at the same level, governments can raise their revenue from income tax by keeping rates and allowances at the same cash levels.

Although inflation is now relatively high at 4.5 per cent, it is falling fast and some believe it may even hit zero or turn negative into a period of falling prices or deflation. And if that happens, Mr Darling's sums certainly won't add up.


GOVERNMENT SPENDING

Changes in personal tax allowances announced since March £2,830m
Reduction in VAT £12,400m
Raising personal tax allowances by inflation £6,240m
£130 increase in personal tax allowances £1,400
Deferral of small business corporation tax £480m
Temporary exemption on empty business properties £175m
Child benefit £170m
Child tax credit £190m
Jobcentre Plus funding £800m
Pension credit £560m
Extra money for pensioners £900m
Air passenger duty £220m
Vehicle excise duty cut/freeze for "green" cars and vans £980m
Fuel duty reduction £180m
Additional spending on Home Front insulation scheme £100m
Other assorted measures £790m

COST OF MAIN CHANGES: £28.415bn


GOVERNMENT INCOME

Increase in alcohol duty £1,445m
Increase in tobacco duty £815m
Restricting personal allowances for people earning £100,000-plus £830m
Government efficiencies £5,000m
Freeze in pension allowances £325m

INCOME FROM MAIN CHANGES: £8.415bn


OVERALL COST (by March 2011): £20bn

The Chancellor will receive an extra £4.7bn from April 2011 once National Insurance contributions are increased by 0.5 per cent for employees and employers, plus £670m from the 45 per cent tax rate. But this will be partially counterbalanced by giving back £3.27bn to taxpayers as a result of basic tax thresholds continuing to increase by inflation.


ANALYSIS

THE government's VAT cut was last night branded "reckless and very expensive bait" by financial experts.

With high street retailers already offering huge savings in an attempt to cure ailing sales, the 2.5 per cent cut was unlikely to have much impact, it was claimed.

Patrick King, Tax Principal at MacIntyre Hudson, said: "This is an odd move given Mr Darling's aim of stimulating consumer spending.

"Poorer households are the very group for whom a VAT cut will make the least difference. At a cost to the Exchequer of an estimated £12.5 billion per annum, this VAT rate cut is reckless and very expensive bait."

Meanwhile, most Britons will pocket tax cuts rather than spend them, a poll showed yesterday.

The ComRes survey found 54 per cent of people would save any extra cash in their pocket – although 43 per cent said they would increase their purchasing.


THE PRE-BUDGET REPORT: FULL COVERAGE