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Viewing cable 08LONDON2970, Spending Sprees And Tax Hikes: The Highs And Lows Of The

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Reference ID Created Released Classification Origin
08LONDON2970 2008-11-28 16:47 2011-08-25 00:00 UNCLASSIFIED//FOR OFFICIAL USE ONLY Embassy London
VZCZCXRO1847
PP RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV RUEHSR
DE RUEHLO #2970/01 3331647
ZNR UUUUU ZZH
P 281647Z NOV 08
FM AMEMBASSY LONDON
TO RUEHC/SECSTATE WASHDC PRIORITY 0522
INFO RUCNMEM/EU MEMBER STATES COLLECTIVE PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RUEHBL/AMCONSUL BELFAST PRIORITY 1174
RUEHED/AMCONSUL EDINBURGH PRIORITY 1028
UNCLAS SECTION 01 OF 03 LONDON 002970 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD EINV UK
SUBJECT:  Spending Sprees And Tax Hikes: The Highs And Lows Of The 
UK Pre-Budget Report 
 
LONDON 00002970  001.2 OF 003 
 
 
1.  (SBU) Summary:  The November 24 2008 UK Pre-budget report (PBR) 
announces a GBP 20 billion stimulus package and deficit financing to 
respond to the recession brought on the global financial crisis. 
Government debt will double to GBP 1 trillion over the next few 
years before declining, and the budget will not be in balance again 
until 2016.  The PBR projects the stimulus will add approximately 
0.5 percent to the previously forecast negative growth for 2009 of 
-1.5 percent.  The stimulus package includes a 2.5 percent reduction 
in the Value Added Tax (VAT), advancing infrastructure projects, and 
spending to help individuals and companies most affected by the 
economic downturn.  The package will be paid for by future tax 
increases, including a 0.5 percent increase in the National 
Insurance levee.  In addition, it includes a new upper tax bracket 
of 45 percent for the wealthy, signaling a return to income 
redistribution and an end to the "New Labour" policy not to increase 
the maximum tax rate.  Politically, the PBR evidences Prime Minister 
Brown's transformation in the eyes of the public from an indecisive 
risk-averse ditherer who couldn't prevent a run on the Northern Rock 
bank to a decisive innovative thinker, willing to take bold action 
and lead the world's developed economies by example.  Brown's 
turnaround in the polls, narrowing the Tory lead to single digits, 
is largely due to his emergence over the last few months as a leader 
in responding to the financial crisis.  End Summary. 
 
Background: PM Brown On The International Stage 
--------------------------- ------------------- 
 
2.  (U) The first UK victim of the global financial crisis was the 
mortgage lender Northern Rock (NR).  It sought funding from the Bank 
of England in the fall of 2007 as wholesale credit markets seized 
up.  A run on the bank led ultimately to the government 
nationalizing NR in February.  The government's handling of the NR 
crisis evoked widespread criticism of both Prime Minister Brown and 
Chancellor Darling.  Their dithering was said to have made the NR 
crisis worse and was consistent with Brown's reputation for being 
highly risk averse and not wanting to make tough decisions.  The 
dithering moniker contributed significantly to Brown's declining 
poll data through the first half of 2008.  As the financial crisis 
worsened, Brown reversed his political fortunes by positioning 
himself and his government to appear as leaders in developing a 
global consensus on responding to the crisis and reforming the 
structure of the world's financial system.  At the G-7 meeting in 
Paris, Brown argued for aggressive coordinated monetary policy 
action among central banks and significant fiscal stimuli.  Brown 
continued these themes at the November G-20 meeting.  His aggressive 
handling of the UK response to the deepening global financial crisis 
not only reversed his declining poll numbers but has narrowed the 
Tory lead to single digits.  The 2008 PBR certainly reflects Brown's 
newly adopted preference for taking bold action. 
 
Strategy: A Fiscal Stimulus Package 
-------------- -------------------- 
 
3.  (U) To respond to global financial challenges, the PBR proposes 
a large immediate fiscal stimulus package plus borrowing to offset 
declining government revenue.  Without referencing Brown's "golden 
rule" that the government should only borrow to invest rather than 
to finance expenditure, and his "sustainable investment rule" that 
government borrowing should not exceed 40 percent of GDP, the PBR 
abandons them completely.  The objective is to keep people employed, 
restore consumer confidence, and get them spending again.  According 
to the PBR, the economy will turn around in the second half of 2009. 
 Future taxes and a recovering economy will pay for the program. 
Significantly, the government signaled it was abandoning a key tenet 
of Tony Blair's "New Labour" and returning to Labour's traditional 
philosophy of income redistribution by announcing a new higher tax 
bracket on the wealthy. 
 
The Key Elements 
---------------- 
 
4.  (U) The largest part of the Chancellor's GBP 20 billion fiscal 
stimulus package is a value-added tax rate cut of 2.5 percent to 15 
percent from December 1, 2008 to December 31, 2009.  This will ease 
the annual tax burden by GBP 12.4 billion.  A number of public 
infrastructure projects, totaling GBP 3 billion, are being brought 
forward to support jobs during the slump.  Increasing personal tax 
allowances will ease the tax burden a further GBP 3.6 billion, 
corporate tax measures will ease the burden on businesses by GBP 500 
million and delaying higher vehicle excise duty rates for more 
polluting cars will ease the burden by GBP 500 million. 
 
The Impact On Growth: Government Projections 
---------------------- --------------------- 
 
5.  (U) The Chancellor told MPs that the measures adopted were 
designed to limit the length and depth of the recession.  HM 
 
LONDON 00002970  002.2 OF 003 
 
 
Treasury forecasts a short, shallow downturn with output recovering 
quickly by mid-2009.  It forecasts GDP growth of 0.8 percent in 
2008, between -0.75 percent and -1.25 percent in 2009, and positive 
growth of between 1.5 percent and 2 percent in 2010.  These 
projections represent a marked change from those in the March 
Budget.  In March, Darling estimated growth of about 2 percent for 
this year and 2.5 percent in 2009.  These forecasts were based on 
the belief that the credit crunch would ease in the second half of 
this year and that financial market conditions would return to 
normal by 2009.  Despite these substantial downgrades, Darling's 
projections are still more optimistic than many independent 
forecasts, particularly with regard the timing of a recovery. 
 
Implications For Government Finance 
----------------------------------- 
 
6.  (U) An economic slowdown, combined with a GBP 20 billion 
stimulus package, will have a dramatic impact on the state of public 
finances.  The tough economic climate has significantly reduced tax 
revenue, with receipts from the financial sector alone expected to 
fall by 35 percent this year.  This will result in higher borrowing 
levels - with forecasts of GBP 78 billion this year and GBP 118 
billion in 2009, or 8 percent of GDP.  UK net debt, as a share of 
GDP, will increase from 41 percent this year, to 48 percent in 
2009/2010 and will peak at 57 percent in 2014.  If these fiscal 
projections are accurate, the budget will not balance until 
2015/2016. 
 
The Next Challenge: Repayment 
----------------------------- 
 
7.  (U) The record borrowing levels will be paid for via a 
tightening fiscal policy from 2011 (notably, this will occur after 
the next general election which must be held no later than 2010). 
National insurance contributions will increase for both employers 
and employees and a new 45 percent tax bracket will be introduced 
for those earning more than GBP 150,000 annually.  The Chancellor 
also announced increased government efficiency savings of GBP 5 
billion in 2010/2011. 
 
Policy Implications 
------------------- 
 
8.  (U) Environmental:  The Chancellor said he is determined that 
the present economic uncertainty should not undermine the priority 
of protecting the environment.  During his statement in the House of 
Commons, Darling announced that he has scrapped plans for a 
per-plane tax (introduced in the 2007 PBR) to replace air passenger 
duty (APD), despite cross-party support for the aircraft tax. 
Instead, a four-band APD will be introduced so those flying the 
furthest will pay the most.  The reformed APD will be implemented 
from November 1 2009, moving from two to four distance bands to 
improve environmental signals.  The policy u-turn was made, 
according to the Chancellor, in order to ensure greater stability 
and to protect competitiveness at a time of economic uncertainty, 
while also reducing emissions from aviation.  The PBR extends the 
Renewables Obligation for an additional ten years, to 2037.  (Note: 
The Renewables Obligation was developed as an incentive to encourage 
new renewables generation by placing a mandatory requirement for UK 
electricity suppliers to source a growing percentage of electricity 
from eligible renewable generation capacity.  End note.)  The 
Chancellor reconfirmed the UK's commitment to meeting its Kyoto 
targets, to legislation that sets binding commitments to cut 
emissions through the Climate Change Bill, and to the EU Emissions 
Trading Scheme. 
 
9.  (U) Business:  The PBR included measures to improve business 
access to credit and to ease cash flow problems.  The Chancellor 
announced that foreign dividends received by large and medium groups 
on ordinary shares and most non-ordinary shares will be exempt from 
UK tax.  Small businesses facing difficulties will be able to spread 
their payable tax over an affordable timetable.  HMG has also agreed 
a GBP 4 billion deal with the European Investment Bank to provide 
money to banks to pass on to SMEs.  HMG will offer credit through a 
temporary Small Business Finance Scheme, allowing small businesses 
to borrow up to a million pounds on flexible terms.  The Chancellor 
decided to defer the increase in the small companies rate of 
corporation tax.  The total package of measures for businesses, 
including the money from the EIB, comes to GBP 7 billion. 
 
Reactions: "Could Do Better" 
---------------------------- 
 
10.  (U) The Shadow Chancellor, George Osborne, said the PBR 
highlight the deception in PM Brown's claim to have abolished boom 
and bust.  He noted that the Chancellor announced the largest amount 
of borrowing ever undertaken by a British government.  Osborne said 
 
LONDON 00002970  003.2 OF 003 
 
 
HMG's decision to double the national debt to GBP 1 trillion is the 
bill for Labour's decade of irresponsibility, initiated by the Prime 
Minister.  He said the Chancellor has created a "huge unexploded tax 
bombshell", timed to detonate underneath the future economic 
recovery.  Osborne added that this is confirmation of the "time-old 
truth that in the end all Labour Chancellors run out of money and 
all Labour governments bring this country to the verge of 
bankruptcy."  He concluded that this PBR is all about the political, 
not the economic, cycle as the tax rises, planned for 2011, do not 
come until after the next general election. 
 
11.  (SBU) If the Chancellor had a report card, it would be marked 
"could do better" by the Director General of the British Chambers of 
Commerce, David Frost.  Frost said there are a few good 
announcements, including the deferment of the Small Business Rate of 
corporation tax and allowing businesses to spread out the payment of 
their tax bill, but he was very critical of the proposal to increase 
national insurance contributions.  He said that while the economy 
should be coming out of recession, businesses will face an 
additional tax.  David Kern, the BCC's Chief Economist, notes that 
while the PBR goes a long way towards acknowledging the UK is facing 
a serious recession, the forecasts are too optimistic.  He expects 
growth in 2009 to be worse than predicted and is doubtful that 
positive quarterly GDP growth would start as early as mid-2009. 
Professor David Miles, Morgan Stanley's Chief UK Economist, is more 
optimistic about HMT's growth forecasts and said the short term 
fiscal boost to the economy is substantial and will potentially 
generate a boost of 0.5 percent to 1 percent of GDP in 2009/10. 
However, Miles says the VAT cuts, while quick to implement, will 
likely not have as big a multiplier effect as other types of fiscal 
stimulus would have. 
 
TUTTLE