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Taxes to fall and then rise

• Robert Peston
• 21 Nov 08, 03:47 PM

On Monday, the chancellor will admit, by implication, that the government's industrial policy of the past decade has been something of a disaster.

Actually to call it an industrial policy is a bit misleading - but what I mean is the Treasury's celebration over many years of the UK's growing economic dependence on the City of London and financial services.

The City contributed around a third of our economic growth in the recent past and about 10% of total output.

It also generated a huge slug, directly and indirectly, of the tax revenues that flowed into the Exchequer.

So here's part of the horrible news we'll get on Monday in the pre-Budget report.

The slump in the City has knocked around 拢40bn - yes 拢40bn! - from annual tax revenues.

That's made up of lower corporation tax (our banks and other financial services provided about 拢10bn of this), lower income tax (those controversial fat City bonuses, now gone, yielded a fair chunk of tax), and lower stamp duty (on share trading and property deals).

And much of that tax revenue has probably gone forever, or at least for as long as the time horizon of most sensible forecasts (viz, up to five years).

How so?

Well, quite apart from the mess our banks are in, which has sent them tumbling into losses (no good for the tax man), the City in general is being forced by regulators to become a place where fewer risks are taken.

Such was the unambiguous message of last weekend's statement by the leaders of the G20 leading and most dynamic economies.

You may think it's a good thing that there'll be fewer risky deals by banks, hedge funds, private equity firms and so on.

But fewer risky deals, less risky lending, also means much smaller banks and City firms, much less employment, much smaller revenues, and much diminished tax payments.

So part of the hole in the government's revenues to be unveiled after the weekend should be seen as permanent.

Which is why the chancellor will have to announce that taxes are going to rise at a specified date in the future, to fill the structural hole in the public finances.

To be clear, I am not talking about immediate tax rises.

Quite the reverse.

I am certain that on Monday the chancellor will also announce a significant package of measures to stimulate the economy.

These will include tax cuts and spending increases funded by extra borrowing, equivalent perhaps to as much as 2% of GDP.

And the bulk of the tax cuts will be directed at those on lowest incomes, partly because they have the highest propensity to spend - for the good of the economy - and also for reasons of social justice.

Alistair Darling will describe such a giveaway as vital to lessen the sharp and painful economic contraction we're experiencing.

But he will also announce deferred tax rises and deferred cuts in public spending - to kick in when the economy has recovered a bit.

When would that be? Maybe 2010, maybe 2011.
If he fails to announce such debt-reduction measures, there could be very strong downward pressure on sterling and a corresponding damaging rise in the cost for the government of borrowing.

And, to be clear, the incremental sums he'll announce he has to borrow over the next couple of years will be colossal - equivalent to at least 8% of GDP, possibly more, or well over 拢110bn per annum.

You have to go back to at least the 1970's for a time when public borrowing was spiralling up at such an alarming rate.

Such a rise in public borrowing would be unsustainable.

Which is why, to repeat, there will have to be deferred tax rises and deferred public spending reductions inked into the public accounts and announced by the chancellor.

All of that is inevitable.

So which taxes will rise?

Well my prediction is VAT.

For the sake of transparency I should say that I don't know that there will be a VAT rise.

But a deferred increase from 17.5% to 22.5% in the VAT rate would raise around 拢20bn.

And it's one of the few future tax rises which might actually stimulate a bit of increased economic activity ahead of its implementation, rather than encouraging us to save

To use the economic cliche of the moment, it would give us all quite a "nudge" to spend now, before the swingeing increase in VAT would kick in.

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Paradox of bank bailout

• Robert Peston
• 21 Nov 08, 10:17 AM

In saying that there's a case for , John McFall - the chairman of Commons Treasury select committee - has shone a light on the paradox of the recent global rescue of the world's biggest banks ().

McFall and many others are exasperated that our banks remain deeply reluctant to lend to businesses and to individuals, even after so much taxpayers' money has been pumped into the banking system.

"What are the banks playing at?" many of you ask.

Well, funnily enough, part of the reason our banks are restricting the supply of credit actually stems from the official description of the bailout as "temporary".

Governments and central banks are saying that they want their (our) money back from banks within about five years.

That may seem a long time. But it's no time at all in the context of all the money that we've pumped into the banks.

The capital element of taxpayer support is only a small part of the problem.

Take the UK. Taxpayers are providing 拢37bn of capital to Royal Bank of Scotland, HBOS and Lloyds TSB.

Redeeming that will be enough of a headache in the coming few years, given the parlous state of capital markets.

But it's the tip of an enormous iceberg.

Special, additional taxpayer loans and guarantees to British banks are a further 拢600bn in total, or just under half the UK's total annual economic output.

All of that has to be paid back too. And since it can't be refinanced on wholesale markets (which are closed till who-knows-when), paying it back automatically requires our banks to lend less to all of us.

There's nothing the banks or we can do about this - unless we tell them that we don't want our money back. And I'll return to what that would mean in a moment.

Nor is this simply a UK problem.

As I've pointed out in earlier notes (see "The 拢5000bn bailout"), taxpayer support for banks across the world - from South Korea, to Australia, Germany, the US and so on - is around 拢5000bn in total.

Which is equivalent to a sixth of the entire output of the global economy.

And, again, the imperative of paying this back is a massive drag on banks' ability to lend and is therefore also a ball-and-chain on economic growth.

This, of course, is just one of the deadening weights on banks' ability and desire to lend.

The other severe constraints are:

1) regulators' very belated stipulation that banks and other financial institutions should hold much more capital and cash in their balance sheets relative to the value of their loans - which in a world where capital and cash is scarce and expensive is a massive disincentive to lend;
2) the devastating effect on credit creation of falling asset prices;
3) the relative dependence of British banks on funding from overseas institutions which are progressively calling in their loans;
4) the considerably increased risks of lending to individuals and companies when the economy shrinks.

Against that backdrop, the question is whether it is remotely sensible to put a deadline - implicitly or explicitly - on the repayment of all that taxpayer funding for banks.

But if we don't demand our money back, we'd be formalising that there's been a semi-permanent nationalisation of the entire banking system.

And that would massively encroach on the ability of our banks to operate as independent commercial entities.

There would be massive political pressure on them to become quasi-social utilities, providing loans at the behest of ministers and officials rather than on the basis of commercial criteria.

So here's what may turn out to be the choice: less lending for years or public ownership of the banks for the foreseeable future. It's not an easy choice, is it?

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