Churchill Knight Blog

The economy contracted by 6% during the recession, but is forecast to grow by about 1.25% in 2010 and about 3.25% in 2011. It might be argued that these remain somewhat ambitious targets, in view of the need to take money out of the economy to reduce national borrowing. On the other hand, past experience suggests that the economy can prove highly resilient. Even if a new administration (of whatever complexion) comes in after the forthcoming election and slashes government spending – which everyone says is essential, although not everyone agrees over timing – it is by no means certain that this will hamper the recovery because the chances are that, provided spending cuts are carefully targeted, the private sector will expand to fill the gap in public spending.

What is essential is that, while protecting essential public services, maximum effort is invested in cutting not just obvious forms of waste, but the millions of pounds spent on quangos, Whitehall consultants, unnecessary administration and needless targets that have to be reported on, but seldom improve the quality of service.

Doubling the Entrepreneurs’ relief against capital gains tax that will now see qualifying lifetime gains up to £2 million taxed at 10%, rather than the usual 18%, will please many. It is unlikely in the short term, however, to do much towards helping the economy. In any event the Treasury’s own figures suggest that the saving will only be £5 million in 2010/11 and £75 million the following year.

What will be of more immediate benefit is that ISA investment limits will increase in line with inflation from next year, with everyone now gaining from the £10,200 limit, not just the over 50s. Unfortunately, this is offset by a freezing of personal allowances and tax thresholds which means that, thanks to inelegantly-named fiscal drag, we will all effectively end up paying more tax; not just those earning over £100,000, who gradually lose their personal allowances, or over £150,000, who also now have to pay 50% tax and also stand to lose higher rate tax relief on pension contributions.

The net effect of this could be to damage net investment levels at a time when the savings ratio has only recently recovered from negative territory. Individual investment is an essential part of keeping the economy going, as is spending, which will also be hit by consumers having less disposable income.

The business rate relief scheme and doubling of the annual investment allowance are likely to help many businesses – along with the requirement that the partly state-owned banks must boost lending to small firms in particular. However, it may be that the immediate 2.2% increase in national minimum wage and a steadfast refusal to reverse – or at least delay – the 1% rise in national insurance contributions due next April will combine to reduce the ability of the SME sector to grow sufficiently to help the economy recover its strength.

It is generally understood that everyone needs to contribute towards a return to economic stability and that this involves paying higher taxes overall. If, however, the burden falls disproportionately on those businesses that have previously formed the engine room of economic growth, then the growth of tax revenues associated with business success – through increased corporation tax payments and higher income tax associated with greater earning potential amongst employees – then the recovery could be short lived.

It was vital to our national interests that the government should be seen clearly to address the size of its borrowing. Failure to do so could have resulted in rating agencies reducing our credit worthiness ranking as well as institutional investors around the world seeking a higher interest rate for our borrowings.

The extent to which the Chancellor succeeded has yet to be seen but at least sterling appears to have survived the day with just a 0.9% fall against the dollar. His updated forecasts suggest that public sector net borrowing, predicted in the Pre-Budget Report to reach £178bn this year, will actually undershoot by £11bn at £167bn, falling to £163bn next year despite a 2.2% real-terms increase in spending.