But war is likely to have more strategic implications for the Budget. The chancellor is likely to recognise that, given the very uncertain outlook that threat of war has created, now is not the time for any significant new macro policy initiatives.
Rather, he is likely to re-emphasise that his two fiscal rules (the ‘golden rule’ of only borrowing to fund investment, and the sustainable investment rule that limits public debt to 40% of GDP) and the inflation target given to the independent Bank of England are designed to protect the economy in just such circumstances. They provide, he may well say, the ‘prudent and sustainable’ basis for the operation of policy even if economic conditions deteriorate markedly, and should be allowed to do their work.
Not that he has much scope to announce any substantial fiscal measures in any case. The Institute for Fiscal Studies now shares ITEM’s long-held view that public borrowing this year would overshoot even the Treasury’s November forecast, reaching £22bn. And like ITEM, the IFS sees the public deficit widening further in 2003-04 to over £25bn. Given these borrowing projections, and the funding needed for war, the chancellor has almost no room for any give-aways on public spending. Inevitably, there will be some increases, but overall they are unlikely to add up to much.
Similarly, on the tax side, the chancellor is likely to feel boxed in given the risk that any significant further increases would exacerbate the danger of a sharp slowdown in growth. Moreover, he will not want to compound the impact of the nationalinsurance increases he announced in his March 2002 Budget, which will come into effect just days before his speech. Again, there will be some tinkering with the tax system, but war may even stay his hand on some widely expected changes, such as to air passenger duty.
The main emphasis of the chancellor’s speech is therefore likely to be on micro policy – most notably, on measures to encourage skills training. The difficult question of how to plug the hole in the government finances in the medium term will be put off until at least next year, with Treasury projections showing a strong – and in ITEM’s view implausible – recovery in tax revenues in the medium term. But ITEM accepts that, even though the chancellor will have to tackle this tax gap issue at some point, there are more important concerns that should take precedence right now, and any necessary tax increases can wait at least twelve months.
This is an update to the Winter 2003 issue of the Ernst & Young Item Club’s Economic Outlook for Business
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