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25.03.2001

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Andy Lindley sifts through this year's budget and details the consequences for you and your business.

BUDGET 2001 - Analyst's Report.

YET MORE, TAX, TAX and SPEND, SPEND, SPEND

This final installment of pre-election budgeting is full of avoided tax increases.
In consequence the usual boost to inflation from tax hikes in April will be muted this year so published inflation figures should fall sharply. It is also full of increased social benefits aimed at women with children and pensioners, and further increases in expenditure on top of existing growth. In consequence inflation will be stronger in later years.

Significant risks are now being taken with the economy, but they will not kick in this year. They come from sharply rising expenditure and a move into deficit in the face of increased risk of recession. No doubt the judgement is these risks can be tackled later; which means borrowing, and or increased taxes and trimmed expenditure next year and thereafter. Interest rates will fall less as a result and then rise more, or rise earlier.

There continues to be the sharp contrast between the announced measures and the ever rising tax take due to stealth taxes, and fiscal drag from inflation and real growth. The standard misrepresentations are indulged in and there are the usual mass of measures, 83 so far counted. Many pre-budget consultation measures are implemented and there are significant effects from phased measures.

Once again middle income, home owning, Mondeo man bears the brunt, but the announcement of few tax increases may relieve him, until he receives his council tax bill. Pensioners, women with children and the poor are the winners, if they can jump through the bureaucratic hoops and do not trip on the exceptions.

Since the Budget the situation has become distinctly darker, with the world-wide stockmarket crash, the USA moving closer to recession, Australia in recession, Japan once more stalled with other Asian countries slowing, the German economy slowing markedly, and the foot and mouth epidemic here.

A recession in 2002, if it comes, will make nonsense of both tax and expenditure projections. Sharply slowing growth this year may strain them.
This expansionary Budget already seems out of tune with the times.

Tax Measures:

• As a result of the Budget and earlier measures, in 2001/02; taxation of personal incomes is reduced by £3.54 billion, but is projected to actually rise by £6.0 billion.

• Taxation of personal savings and assets is to rise by a modest £280mn in line with projected actual tax take.

• Indirect taxation is to reduce by £1.88billion, but is still projected to actually rise by £2.3billion.

• Business taxation is to reduce by £285mn, however again the actual tax take is projected to rise by a sharp £7.75billion largely from corporation tax yield.

• In all there are 42 measures reducing tax take, but total tax receipts are still projected to rise by £13.6billion.

Expenditure Measures:

• Social security expenditure continues to grow exponentially, with the start of the Children's Tax Credit, real increases in the Working Families Tax Credit, and especially in Pensions plus a host of other benefits. Total expenditure in this area is projected to rise by £8.23billion in 2001/02 to £112.23billion. Expenditure in the following year seems likely to rise by ca. £7billion from existing commitments and inflation.

• This Budget has the usual topping up of Health, Education and fighting crime. They add a total of £720 mn in 2001/02 rising to £795 mn in the following year. Together total Health and Education spending are projected to rise by ca. £5.6billion in 2001/02.

• Earlier commitments to increased capital spending are coming through with the total capital budgets planned to rise by £3.4billion to £25.3 billion before depreciation in 2001/02 followed by further rises of £4.1 billion and £5billion in the following two years. By 2003/04 the total is planned to be £34.4billion.

• Total expenditure rises dramatically by £25.4 billion or 6.9% in 2001/02 to £393.7 billion and by £24.1 billion to £417.8 billion in the following year. These totals include tax credits, payments to the EU, debt interest, civil service pensions and a wide variety of adjustments.

The Budget Balance:

• In this Budget and the last one, expenditure was sharply increased with commitments to further increases in years ahead. Now the fast growth of tax revenue is being trimmed. In consequence the projections of tax revenue and other receipts and public expenditure show a pattern of low and falling surpluses turning just into a deficit in 2002/03. The figures provided are as follows.

A diagram with cyclically adjusted projections shows the cautious case dipping to a deficit of 1% of GDP in 2003/04. These projections are very subject to error and just one year ahead have been wrong by almost £10 billion, on average. In recent years the error has always been favourable.

·• The economy reviewed below indicates a likely change of direction. The financial situation can quickly reverse with expenditure growing even faster and revenue growth slowing or even a fall in revenue. This change from virtuous circle to vicious circle happens in every recession. A recession could increase the 2003/04 deficit to £30billion, 3% of GDP. This is not yet in prospect, but the Government is clearly taking quite a chance. A public sector deficit is normal counter-cyclical policy in recession, but not piling deficit on deficit because of the inflation risk and in particular risk to the currency. A severe limit to deficits is placed on members of the Euro block. Ireland was admonished recently for its excesses.

The Economy:

• The economy performed extremely well in 2000 and exactly fitted into the middle of the Treasury forecast of a year ago with 3% GDP growth. The passing of the peak of economic growth with lower than expected interest rates has allowed the housing boom to continue into 2001 and coincide with historically low levels of unemployment, defined narrowly as those receiving benefit.

• There is a distinct feeling of change in the air which is only partly reflected in the forecast for growth this year, of a range of 2.25% to 2.75%, still retained from Budget 2000. The Treasury would have checked this forecast before the foot and mouth epidemic with its knock on effects on tourism and perhaps other sectors, such as transport or retailing. Such factors may reduce growth to the bottom of the range or even just below at 2.0%. Then the recent even harsher than expected situation in other countries and the various knock on effects, psychological as well as direct, on the UK have to be allowed for. The Treasury has not done this in the Red Book where they rely on public expenditure growth and continued private sector confidence.

• A short and shallow US recession might reduce growth here by ca. 0.5%-1.0% through the effect on exports, but this is only the beginning; there is the position in other countries and the reactions here to our stockmarket crash and redundancies.

• Altogether there is the potential for a sharp slowing of growth to around zero for a few quarters. The UK annual growth rate depends on exactly when these occur. If the fourth quarter this year was zero, growth through the year would be only 1% and year on year growth ca. 1.75% for 2001. However these zero quarters are more likely next year. The stockmarket is forecasting a recession, but they do not always get it right. In this situation we may expect short-term interest rates to fall to 5% this year. Some expect a lower rate. Overall therefore the Treasury forecast of growth in 2002 in line with productive potential at 2.25% to 2.75% is clearly at risk and we could end up with a flat year with 1.0% to 1.5% instead.

• A sharper US recession is not yet expected but if it occurs the outlook for us in 2002 is worse. The UK is quite vulnerable because of its world status finance industry, low savings ratio, growing current account deficit, and our tendency to be as over-sensitive to economic weather as we are to the weather. The rest of the EU would also be vulnerable with a weak Euro coming into general use.

Construction:

• Construction receives the usual mixed message from this Budget, good news now with bad news already built in from previous measures. Private housing continues to benefit from the economic growth and prosperity in the Southeast. The tax changes last year seemed to only have an adverse effect in cool spots in the market. At some point demand will go quiet as buyers become concerned about prospects; at present that seems likely in the autumn. Contracting is benefiting from the expansion of public capital expenditure, which will continue unless there is a recession. Public capital expenditure usually becomes the first victim of a financial crisis. The PFI however shows a sharper decline in new projects expected to coming to contract over the next 2 years than in previous projections.

• Demand should benefit in small ways from reduction of VAT on conversions and renovations, stamp duty exemption on property in disadvantaged areas, and tax relief on cleaning contaminated sites. Costs are eased by the changes to VED and Fuel Duty, but will be raised by company car tax. Three measures Climate Change Levy, the Landfill Tax £1 increase, and the Aggregates Levy starting 2002/03 together give a sharp little boost to construction costs of 0.5% to 1%.

The Measures

This time there are 83 measures that flow from the Budget process 42 of which reduce tax take. 46 were announced in this Budget, of which 13 are pre-budget consultation measures, 16 are from the last budget or before, 19 from the PBR plus also Council Tax. They are grouped, listed and assessed below.

Personal Taxation: Incomes

1. Personal Allowances are indexed in line with rpi or marginally above, e.g. the single persons allowance rises by £150 to £4,535, or 3.42% worth £33 per year at basic rate. Allowances include the Children's Tax Credit for the first time of £5,200 worth £520 per year. In all these increased reliefs reduce tax by £2,450 mn in 2001/02.

2. The Lower Rate Band is increased by £360 to £1,880, 23.7% worth £43.20 per year; other bands are indexed for rpi. The Higher Rate Band begins at £29,400 plus allowances, a £1,000 or 3.5% increase, worth £180 per year. These changes reduce tax by £1,300mn in 2001/02.

3. Employee NICS have their lower limit aligned with tax allowances reducing tax take by £1,200 mn in 2001/02 but the upper limit rises to £29,900, £575 per week with an increase of £200 per year for those affected, raising an extra £560mn. They are also indexed reducing, tax take by £430mn. The overall change is a reduction of £1,070mn.

4. Company car fuel scale charge increased, tax take rises by £50 mn per year.

These direct personal tax changes reduce overall tax take by £3,540 mn in 2001/02. However actual income tax paid is projected to rise by £4,800 mn and total social security, including employers, rises by £2,500 mn in 2001/02 from previous changes, growth and inflation.

Personal Taxation: Savings and Assets

5. Council Tax increases by an average of 5.76%, £800mn to a projected £14.7 billion in 2001/02. Projections underestimated CT, by £300mn in 2000/01 and £200mn in the prior year. Also average increases have been reported in the press as above 7% this year.

6. Stakeholder Pensions are to begin with tax relief of £600mn in 2001/02 projected to rise to £2,150mn by 2003/04.

7. The ISA £7,000 tax-free limit is for 5 years reducing tax take by £20mn in 2001/02.

8. The Capital Gains Tax exempt limit is indexed rising by £300, 4.2% to £7,500, if you make any.

9. The Inheritance Tax exempt limit is indexed rising by £8,000 to £242,000, tax take reduced by £40mn in 2001/02.

10. Stamp Duty will be removed from property transactions in disadvantaged areas, reducing tax take by £60mn in 2001/02.

11. Unapproved share options, tax take rises by £200mn in 2001/02.

12. Employee Share Ownership is given stamp duty exemption, no tax reduction in 2001/02.

Total tax on personal assets and savings rises by £280mn in 2001/02 as a result of these measures. Total tax in this sector is estimated at £27.2 billion in 2000/01 and is projected at £27.5 billion in 2001/02, a rise of only £300mn. However last tax year the projection was underestimated by £800mn.

Indirect Taxation

13. VED on cars is reduced by increasing the lower rate to 1549cc with the rates frozen the tax take is reduced by £430mn in 2001/02.

14. Reformed VED on lorries, a complex system, reduces tax take by £105mn in 2001/02, plus the VED rebate reducing tax take by £160mn.

15. VED on tractors, and various other vehicles is removed, tax take reduced by £15mn in 2001/02.

16. Fuel Duty is cut by, u-low sulphur petrol 2p litre, u-low sulphur diesel 3p litre and various other adjustments, so tax take is reduced by £1,140mn in 2001/02.

17. The reform of General Betting Duty operating from January 2002 reduces tax take by £45mn in 2001/02 rising to £145mn in the following year.

18. Alcohol Duties are frozen, tax take to rise by ca. £100mn in 2001/02 with rising wine consumption.

19. Tobacco Duties are indexed at 1.8% adding ca. 5.8p to a packet of cigarettes. This is to raise an additional tax take of £125mn in 2001/02. However it has been estimated that a fifth to a third of cigarettes in the UK are not tax paid, with a loss of duty of ca. £3.75billion per year. As a counter measure it will become a criminal offence to trade in tobacco without a duty paid pack mark from July 2001.

20. A variety of changes are made to VAT. They include raising the registration level by £2000 to £54,000, further widening of Zero rating on vehicles for disabled people and on children's clothing, VAT recovery for museums with free admissions, the rate on children's car seats reduced to 5%, a grant scheme to reduce the rate to 5% for repairs to listed buildings that are used for worship, and simplified collection for SME's. There is also to be a reduced rate for renovation of housing empty for 3 years or more, and extended scope for reduced rate on conversions. Together they reduce tax take by £140mn in 2001/02.

21. The increased in Landfill Tax of £1 to £11 per tonne starts in 2001/02 raising an extra £30mn as reported in Budget 2000.

22. Air Passenger Duty restructuring begins reducing tax take by £80mn in 2001/02.

Total indirect tax changes reduce tax take by £1,880mn in 2001/02 including item 21 above. Actual tax take is however projected to rise by £2.3billion.

Business Taxation

Four significant changes from previous Budgets begin. They are listed below.

23. The Climate Change Levy begins raising £1,000mn in 2001/02.

24. The repayment of the Climate Change Levy via reduced Employer NIC's begins reducing the rate by 0.3% and lowering tax take by £1,050mn in 2001/02. However this reduction is 0.1 %, or £350mn less than earlier stated due to changes to the CCL. A further reduction of the NIC rate by 0.1% is due in 2002/03 unrelated to CCL.

25. Abolition of Withholding Tax on international bonds and foreign dividends begins reducing tax take by £400mn in 2001/02.

26. Enhanced Capital Allowances for Energy Saving Technologies begin reducing tax take by £70mn in 2001/02.

27. Additionally Business Rates rise by £300mn, 1.74% to £17.5billion in 2001/02.

There were some further 10 minor measures, 8 from this Budget, which reduce tax take by £65mn in 2001/02. Two relate to relief for cleaning contaminated sites they reduce tax take by £50mn in 2001/02.
Despite these reductions Business Taxes are projected to actually rise by £7.75billion in 2001/02 to £89.6billion due mostly to a sharp increase in Corporation Tax yield.

Expenditure - Social Benefits

28. Child Benefit stops and is succeeded by Children's Tax Credit, which is in turn increased by £1.50 to £10 per week. The net additional cost over Child Benefit is ca. £650mn in 2001/02. Further changes increase the net additional cost to ca. £910mn in 2002/03.

29. Working Families Tax Credit is increased and extended in several ways, cost £290mn in 2001/02, rising to £345mn in the following year.

30. Child Premia for various benefits increased by £1.50 per week, cost £120mn in 2001/02 rising to £245mn in the following year.

31. A Maternity Benefits Package including 6 items is introduced with nil cost in 2001/02. By 2003/04 the cost is £490mn. There is a minor adjustment to another maternity benefit, cost only £10mn in 2001/02.

32. The Disability and Carers Package begins, substantially up-rating 3 benefits, cost £195mn in 2001/02.

33. The Pensioner's Package consisting of £5 per week on the State Pension for single pensioners, an up-rating of the minimum income to £92.15p for single pensioners and pro-rata for pensioner couples. These apparently modest increases cost £1,790mn in 2001.02 rising with further real increases to £2,440mn in the following year.

The total cost of these measures is an increase in expenditure of £3.1billion in 2001/02 rising, to £4.0billion in 2002/03. Total expenditure on Social Security, as stated in the Budget, plus various tax credits, continues to bound upwards, as follows, 2000/01 plus £3.6billion to £104billion, 2001/02 plus £8.23billion to £112.23billion, 2002/03 plus ca. £6billion to above £118billion with inflation adjustment on top. These figures also substantially understate total expenditure as defined in the National Accounts pub. ONS.

Other Expenditure Measures

34. Health is to receive another £1billion spread over three years as topping up of rapid growth. This falls £360mn in 2001/02 with £355mn and £290mn in the following years. In the context of total health spending of around £50billion this is small beer.

35. Education receives an identical amount but spread, £290mn in 2001/02, followed by £330mn and £380mn.

36. The Home Office also gets a top-up of £70mn for crime and drugs rising to £110mn and then £155mn.

37. Two other interesting changes are the carry forward of £1billon under-spent in the last financial year and a reduction of £1.73billion in the contingency margin together allowing this extra to be spent in 2001/02.

Sources: The Budget Speech, The Red Book and associated papers. Note ca. is used wherever exact figures are not given in the sources and some estimation is used.

A. Lindley 25.3.2001

Andrew Lindley is an analyst for the construction industry.

See previous year's report: click here