Warning: The pre-budget report means more pain to come, for little gain today

by The Investor on November 25, 2008

As a saver whose income is modestly into the higher tax bracket, yesterday’s pre-budget report wasn’t great. Here are the main measures designed to get Labour re-elected and stimulate the economy:

Spend now:

Temporary cut in VAT, from 17.5% to 15% (until December 2009)
Extra £60 to pensioners in January
Early increase in child tax credits
£120 basic rate tax rebate (introduced after the 10p farce) made permanent, which will increase to £145 in April
Proposed rise in tax for small businesses from 21p to 22p is deferred
£3 billion in government spending to be brought forward
Sundry other minor fiddling designed to get headlines (a green fund, phasing in changes on fuel duty)

Pay later:

Rise in income tax to 45% for those earning over £150,000 (April 2011)
National insurance increase of 0.5% for employers and employees (April 2011)
Cuts in the personal allowance for those earning over £100,000 (April 2010)
Government borrowing to rise to £118 billion in 2009 (8% of GDP!)
UK net debt as a share of GDP to rise to 57% by 2011

Why it’s a bad budget for me

Like many Monevator readers, I won’t benefit much from Gordon Brown’s giveaway:

I don’t benefit from the tax credit giveaways, since I don’t have kids and I’m not a pensioner.
Most years my income is modestly into the higher-rate tax bracket (around £40,000), which will mean higher taxes in a couple of years due to the National Insurance rise.
I save rather than spend, which means a VAT cut won’t help.
Long-term interest rates will rise because of all this borrowing, which means I’ll pay higher interest rates when it finally makes sense to buy a house rather than rent.
On a brighter note, I’ll see a small reduction in tax next year, due to the 10p rebate going permanent

Since I know my bills and expenses are going to rise in the future, the rational thing for me to do ahead of the downturn to save more today. This is the paradox of thrift, and it explains why I think the budget should have been aimed at getting money moving via infrastructural spending, rather than short-term VAT cuts.

Why it’s not the best budget for the country

I freely admit I’m not an economist, but the ‘big idea’ – the cut in VAT – doesn’t look like the best use of £12 billion from a national point of view, either.

Prices are already plunging in the shops, so who is going to notice a 2.5% reduction? Worse, retailers are going to have to spend money changing their signage and sticker prices. More likely most won’t, which means it’ll just bolster their margins. (Perhaps avoiding retail bankruptcies is the real motivation?)

I wrote before that I didn’t want the Government to cut my taxes, which is effectively what they’ve done with the VAT fiddling. Worse, Gordon Brown and Alistair Darling are actually putting taxes up for higher-rate earners, which might have some redistributive merit but isn’t going to raise much money and will only depress spending at the higher end.

On a more positive note, the Government is going to direct most money to the poor (who will spend it, which is what you want from a stimulus) and bring forward capital investment projects.

It should have done more such investment, targeting its spending to get lasting results as well as a stimulus.

President Elect Obama in the US is proposing to build thousands of wind turbines to create hundreds of thousands of jobs while reducing energy imports and carbon emmissions. Encouraging us to buy more tat in the shops with a VAT cut seems pretty pathetic in comparison.

For individuals, it’s best to ignore the VAT cuts. Instead, get out of debt, save more, and watch your mortgage, as I outlined in my four steps to tackling the credit crunch.