TAX NEWS - June 2010

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UK budget deficit lower than feared

Britain's budget deficit came in lower than feared last month, the latest indication that the public finances are over the worst of the financial crisis.

The government borrowed £16bn in May, below last year's £17.4bn and less than the £18bn expected by City economists.

Excluding bank bailouts, borrowing for the whole of last year was £154.7bn, which is better than the £156.1bn predicted by the Office for Budget Responsibility on Monday. The government expects borrowing to hit £155bn for this year, down from the £163bn forecast by Labour.

However, the nation's debt has now reached £903bn - equivalent to 62.2% of GDP, the highest since records began in 1993, underlining the task faced by the coalition government in cutting the debt burden.

The news comes as chancellor George Osborne prepares to deliver his first budget next Tuesday, which is expected to contain a package of wide-ranging spending cuts and tax increases, possibly including a rise in VAT.

"The big picture of course is that borrowing remains extremely high and additional measures to reduce the deficit will be required in next week's budget," said Vicky Redwood at Capital Economics. "Indeed, the government appears keen to act sooner rather than later, yesterday announcing additional spending cuts from the cancellation of pending projects. We expect tax rises and spending cuts adding up to perhaps £20bn per annum to be announced next Tuesday."

Earlier this week, deputy prime minister Nick Clegg said far-reaching action is needed to tackle Britain's deficit, as the newly formed OBR revised economic growth predictions for next year down to 2.6% from Labour's figure of 3 to 3.5%. He singled out a soaring bill for "unreformed gold-plated" public sector pension schemes as an area facing urgent cutbacks.

The OBR did not have today's public finance figures when it compiled its forecasts. Marc Oswald of Monument Securities said the picture painted by May's data "to a certain extent looks rather better" than the OBR had assumed. However, analysts do not believe it will deter Osborne from announcing hefty cuts next week.

"The public finances are still dire so May's improved data will not deflect Mr Osborne from pressing ahead with his plans to step up the pace of fiscal consolidation in Tuesday's emergency budget," said Howard Archer of IHS Global Insight.

"Pressure for accelerated fiscal tightening in the UK is being maintained by countries across the eurozone stepping up their austerity measures in reaction to the region's sovereign debt crisis," Archer added.

'Fiscal Drag' boosts tax revenue

The better number in May stems from an improved tax take, with income tax receipts up nearly 11% in April and May this year compared with the same period last year. This reflects "fiscal drag" - as incomes rise, individuals are pushed into higher income tax brackets - and the higher 50% tax rate for high earners, while VAT receipts are up 25% thanks to stronger spending and the return to the 17.5% rate from 15% at the start of the year, said James Knightley at ING.

"We should see further improvements, relative to last year, over coming months given the gradual upward trend in growth. However, next week's budget is likely to set in motion £100bn-plus of fiscal austerity over the next five years, which should accelerate this process," Knightley said.

"Today's numbers therefore should boost optimism that the UK can resolve its fiscal problems, but it is going to be painful as the government continues to point out. Indeed, our key concern is that private sector employment gains may be more than fully offset by public sector job losses."

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