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Monday March 27, 2006 - 11:21:56 GMT
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Economics Weekly: Analysis of the 2006 UK Budget

Analysis of the 2006 UK Budget
This was a budget with few surprises, in which The Chancellor had little room for manoeuvre and little scope for changes to tax or spending. As a result, Gordon Brown made very few adjustments in the 2006 Budget, his 10th, relative to the figures announced in the 2005 Pre- Budget Report. It was in this report that he downgraded his economic forecasts, raised borrowing and increased taxes, mainly on companies. However, that is not to say that there were not any changes announced – there were many small announcements – or that the official forecasts for the economy and public spending and revenue projections are not interesting – they are. There were no changes to personal income tax rates, VAT or major changes to corporate taxation. But there was a small net giveaway next year of around £400m compared 2 years.

Many small announcements were made, and more detail on earlier proposals
Air passenger duty and corporation tax were left unchanged. The exemption on stamp duty for buying a home was raised slightly to £125,000 for 2006/7; while the inheritance tax exemption over the next four years was to be increased from £275,000 this year to £325,000. The Chancellor also announced that the tax free limit on ISAs will remain at £3,000 in cash and £7,000 in total. More detail was given about real estate investment trusts, or REITS, seen as encouraging for investment in the UK property market.

The future is one of high levels of government borrowing and tax
If there was one clear signal for the future it was that the Government’s fiscal approach will remain unchanged over the next few years, with borrowing remaining high at around £36 billion for the next financial year and only falling to £24bn by 2009/10, see chart a - though it will decline as a share of the economy. Although the Chancellor expects tax revenue to remain buoyant, he may find that in the end taxes and borrowing will have to rise to keep up with his public spending plans for health and education. The reason is that the economic assumptions that underpin the government’s revenue and spending are likely to be viewed as very optimistic compared with latest independent forecasts. Indeed, chart b shows that the tax share of the economy is set to rise further in the next few years, before stabilising at just under 40%. That is well up from a tax take of around 33% of the economy in 1993/4.

Is the Chancellor taking risks with debt?
Great store was placed on stability and on the success of the UK economy since 1997, but it had been growing since 1992 under the previous Conservative administration so all the benefits cannot be claimed by one political party. The fiscal rules are met on the government’s assumptions, but the risk is that if economic growth undershoots its projections then taxes will have to go up or borrowing will have to rise. It is in order to help keep down future borrowing and tax increases, that the government also announced plans to raise some £30bn by 2010 from selling the public stake in British Energy, the Tote and radio spectrums. It is very prudent to do this as the 1 year ahead error on forecasts of net public sector borrowing (PSNB) is 1% of gdp or £12bn at todays prices.

Not a boring Budget – there are many hostages to fortune
It could be argued that because there were no major changes in the Budget that it was boring, but this would be wrong in our view. It is anything but boring in the sense that there is a fundamental tension and contradiction between some of the stated aims of the government - to lock in stability, to be prudent - and the risks being taken with these by the continued high level of government debt, tax take of the economy and spending based on optimistic economic assumptions. Should theses assumptions prove to be wrong, there will need to be a further rise in borrowing and or tax increases. Either way, the Budget is a big gamble that there will be no major economic shocks, in the UK or world economy, in the years ahead. Chart c shows that reaction to the Budget was very muted. The currency markets have not reacted, nor has the sterling interbank cash market. Bond markets have reacted slightly more, but the 10-year rate has ended the week pretty much where it closed on Wednesday. Equity markets have reacted more positively, perhaps due to speculation about investment flows into property from REITS. However, the muted financial market reaction overall does reflect the well flagged nature of what was in Budget 2006.

Trevor Williams, Chief Economist
[email protected]
Lloyds TSB Bank,
Financial Markets
Faryners House,
25 Monument,
London EC3R 8BQ
0207 283 - 1000

Any documentation, reports, correspondence or other material or information in whatever form be it electronic, textual or otherwise is based on sources believed to be reliable, however neither the Bank nor its directors, officers or employees warrant accuracy, completeness or otherwise, or accept responsibility for any error, omission or other inaccuracy, or for any consequences arising from any reliance upon such information. The facts and data contained are not, and should under no circumstances be treated as an offer or solicitation to offer, to buy or sell any product, nor are they intended to be a substitute for commercial judgement or professional or legal advice, and you should not act in reliance upon any of the facts and data contained, without first obtaining professional advice relevant to your circumstances. Expressions of opinion may be subject to change without notice. Although warrants and/or derivative instruments can be utilised for the management of investment risk, some of these products are unsuitable for many investors. The facts and data contained are therefore not intended for the use of private customers (as defined by the FSA Handbook) of Lloyds TSB Bank plc. Lloyds TSB Bank plc is authorised and regulated by the Financial Services Authority and is a signatory to the Banking Codes, and represents only the Scottish Widows and Lloyds TSB Marketing Group for life assurance, pension and investment business.


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