ECONOMIC ANALYSIS – Brown has his eyes on the election, so it won’t be a Budget for business

This March, Gordon Brown will unveil his fifth Budget. Despite his rhetoric about the need to avoid boom and bust and focus on the long-term health of the economy, this will be a political Budget – the third instalment in a loosening of fiscal policy in the run-up to the General Election.

The first instalment came in the summer, with the announcement of significant increases in public spending over the next three years. The government plans to take advantage of the current surplus in the public finances to target areas such as transport, education and health.

The second instalment came in the autumn, with the pre-Budget report. The original purpose of this was to highlight the measures which the government was considering for the Budget, to allow interested parties to comment. But last year it took the form of a mini-Budget, with the Chancellor announcing a spending and tax boost worth £4bn next year and £6bn the year after. Some of these measures, such as the proposals aimed at defusing the fuel protests, are the subject of consultation, but they are still very likely to be confirmed in this month’s statement.

The forthcoming Budget is therefore the icing on the cake of a giveaway bonanza. Analysis by the Institute for Fiscal Studies suggests that the Chancellor can afford to make a further £3-4bn of tax reductions and still keep within the borrowing targets set out last year. However, little of this largesse is likely to benefit the business community.

There are three ways in which the Chancellor could help business, but in all three the best we can hope for is damage limitation. The first step the Chancellor could take is to limit his tax and spending boost to the economy, supporting the task of the Bank of England in controlling inflation. Though the bank has reduced interest rates in response to concerns about the weakness of the US economy, higher public spending and borrowing raises borrowing costs over the long-term. The less money the Chancellor pumps into the economy, the less the Bank has to take out by raising interest rates.

Though the Chancellor will present his Budget as financially responsible, he is in fact spending a war-chest that was built up over the early years of the government. Even if he limits his additional Budget tax giveaway to the lower end of expectations – say, around £2bn – the spending and tax measures he has already announced will still exert considerable upward pressure on interest rates over the years ahead.

The second area where corporates might look to the Chancellor for some support is through a reduction in the business tax burden. Once again the omens are not good. Though he has talked of the need to encourage investment and has introduced a raft of measures to help small businesses, Gordon Brown has not in general been particularly kind to the corporate sector in his Budgets.

Recent “reforms” to the corporate tax system, such as the early changes to Advance Corporation Tax, have generally been designed to raise extra cash. He has cut the corporation tax rate, but the benefits of this reduction have been more than offset by measures to expand the tax base on which profits are paid. The restriction of double tax relief introduced in the last Budget is a recent example of this approach. In a pre-election Budget, the Chancellor is likely to be even less disposed to help business with the focus of the coming Budget likely to be on personal tax reductions.

The final way in which this Budget could be helpful to business is through a simplification of the tax system. Gordon Brown has talked a lot about tax reform, but he has continued along the path of his Conservative predecessors, John Major, Norman Lamont and Ken Clarke, of adding complexity. We have to look back to Nigel Lawson to find the last Chancellor who simplified the tax system.

The Chancellor has been prone to introducing special incentives for certain forms of saving and investment, often targeted at small companies. In this way, the tax system has become a tool of government intervention, encouraging companies to undertake certain activities. The danger of this approach is that investment and savings decisions are shaped by the desire to achieve the most favourable tax treatment rather than by the need to achieve the best economic return. This is precisely the approach to taxation which Nigel Lawson sought to dismantle in the mid-1980s.

When the Chancellor stands up to deliver his Budget in March, therefore, expectations in the business community are likely to be low. Of course, Chancellors often spring a few Budget surprises. But this year’s rabbits from the hat will be designed to appeal to voters, not wealth-creators.

In the short-term, the risks to the world economy from a US slowdown might seem to justify this giveaway. However, over the long-term there is likely to be a price to pay in the form of higher interest rates and an increasingly complex tax system.

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