When the sums just won't add up

Anthony Hilton12 April 2012

THE Institute for Fiscal Studies has acquired a reputation in recent years for gently pointing out the gap between political rhetoric and economic reality. Chancellors grab headlines with promises to spend. The IFS then does its own sums on how much it will cost.

It was at it again today, but in truth it let the Government off rather lightly. Its main conclusion was that £5bn extra will be needed from somewhere to pay for new measures announced by the Government but not yet costed. There are, of course, only two places it can come from - borrowing or tax increases.

This may provoke the Opposition to claim there is a black hole in the Government finances, but given how much we pay in tax anyway, £5bn extra is a trivial sum. It could be a bit worse, but not much. The IFS assumes spending will rise with national income - meaning-that tax will be a constant proportion of the total economy.

However, in recent times the Government has been grabbing rather more than its share, increasing spending in real terms by 2.75% a year. Doing that again, which seems likely, could require a further £2bn and push the total requirement for extra tax or borrowing up to £7bn.

It is almost exactly what it gets in a year from tobacco duties alone. Raising it entirely through extra income tax would require a 6% across-the-board increase; raising it through national insurance would mean a 12% rise. But of course it will be spread, if it happens at all, much more thinly than that.

How thinly? Well, this year the Government will take £400bn in tax, so for every 100p the nation currently pays to the Exchequer, we will in future have to hand over closer to 102p. Given the public-support for extra spending on health, education and transport, voters may think this a remarkably low price to pay.

But there is a catch. The IFS assumes, as does Chancellor Gordon Brown, that economic growth will continue - growth which has given him a windfall since 1987 of on average £20bn a year. But if this growth tails off then the sums very quickly look awful - as John Major and Norman Lamont found to their cost 10 years ago.

Once unemployment starts to rise, hundreds of thousands of people who were paying taxes become claimants. That is when the sums quickly look sick, and when the Government has to make the tough decisions on where to spend, where to tax and where to cut. Thus far Tony Blair and Brown have had it easy.

Wrong course

PRESIDENT George Bush's State of the Union speech on Tuesday night was well crafted to build global support for the war on terrorism but it failed in one key area - assuring the world this White House will not ambush the US economy.

Bush spent the first 40 minutes of his speech on America's international obligations and defence before outlining his 'third' priority, an economic agenda that would set the US on the wrong track.

Despite Federal Reserve chairman Alan Greenspan's warnings that further stimulus is not needed for America to shake off recession, the President asked Congress to speed up tax cuts, increase spending for a host of programmes, double the so-called homeland security budget and boost military spending by the largest amount in decades. And all this on top of an additional $1bn (£708m) a month in war-related spending.

Some people on Wall Street reckon the speech killed any chance that the Fed will cut interest rates by another notch when it concludes its policy meeting today.

Some of Bush's desired outlays are unavoidable and necessary for global safety but with a projected budget deficit this year of at least $106bn, America must show fiscal restraint. In Ronald Reagan's day, the threat from the Eastern bloc nations led to massive increases in US spending and a soaring deficit that took years to unwind, forcing global interest rates to stay higher for longer than necessary.

Normally, the President's annual speech does not rock Wall Street's financial markets because everyone knows there is a huge divide between his wish list and what Congress will approve. However, Bush is riding a wave of unusually strong public support - his job approval ratings are above 80% - and Congressional elections loom in November. His legislative agenda has a much better chance than we typically expect from America's divided system of government.

Bush has already managed to achieve big victories that eluded the past President, including passing a giant tax cut in record time. He outlined a dozen extra spending initiatives last night, though he did not reveal the amounts he will request for each programme. That will come next week when the 2003 budget blueprint is released.

'We will prevail in war and we will defeat this recession,' he said at the start of his speech. For the next 45 minutes, he outlined a programme to spend his way out of both. It was more Reagan than George Bush Senior in delivery and detail.

Clearing out

AS Deutsche Bourse moves to buy the half of Clearstream it does not already own, some of the Luxembourg-based settlement agency's customers seem less than happy with the prospect.

JP Morgan Chase, said to be the second-largest provider of business, is switching its accounts to Clearstream's major rival, Brussels-based Euroclear. The decision was made just before Christmas and the process should be completed by Easter.

No one will say why the American bank is moving its business, but there must be at least a suspicion that it does not like the idea of Clearstream becoming an integral part of the Frankfurt operation. One wonders if it is alone. Its departure might well lead to other significant defections, which must undermine the value of what Deutsche Bourse is buying.

The interesting twist to this is the impact on industry consolidation. There was widespread disappointment that Euroclear failed to buy Clearstream because that would have opened the door to cost savings and rationalisation. However, if enough customers move to Euroclear, the industry will have achieved the same thing by voting with its feet.

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