Economic Implications
by Andrew Smith, Chief Economist, KPMG LLP (UK)

The global credit crisis, a slowing domestic economy and tight public finances made the backdrop to Mr Darling’s first Budget the most difficult since Labour came to power. Faced with the dilemma that tax cuts might be desirable to support growth but would be dangerous on financial grounds, while tax increases might improve the public finances but could de-rail the economy in the process, the Chancellor opted for a broadly neutral Budget this year.

The increased spending which was announced over the next few years, mainly on child poverty relief, will be more than offset by higher alcohol and fuel duties, VED and anti-avoidance measures but the net increase in revenues is relatively small.

This, of course, comes on top of the reforms to personal and corporate taxation pre-announced in last year’s Budget, while the Chancellor also confirmed modifications to the changes in the capital gains tax and non-domicile regimes foreshadowed in October’s Pre-Budget Report.

The economy

The economic outlook is extraordinarily uncertain as no-one knows how long the credit crisis will last or how much damage it will do. Blaming it, the Chancellor downgraded this year’s growth forecast, but only to 2% and stuck to the view that 2008 will be the bottom, with growth picking up from 2009.

If the Chancellor is right, this will amount to no more than a mild slowdown. However, the risk is that high inflation, weak income growth and a correcting housing market depress consumer spending for an extended period, even if the credit crisis somehow evaporates magically overnight.

Public finances

Mr Darling acknowledged that slower growth means a lower tax take and higher borrowing in the short term, but maintained that the golden rule, that current spending must be covered by current revenue, would still be met over the cycle as a whole.

However, the fact that net government borrowing is approaching 3% of GDP this year after the past five years of buoyant growth – surely as good as it gets – suggests that the shortfall is not entirely cyclical. To the extent that there is a structural element, further tax rises or spending cuts will be necessary.