Andrew Lilico: A healthily underwhelming Budget - but one that the financial markets should like

Andrew Lilico is an economist and a Director and Principal of Europe Economics. Click here to read his Budget preview.

Some of my likes and dislikes about the Budget.

Likes

Osborne stuck to Plan A on deficit reduction.  He quite rightly refused to be deflected from what needed to be done by a bit of snow, an oil price spike, and the attacks of Ed Balls.  Many commentators worry that the OBR forecasts for 2011 and 2012 are overly optimistic.  I don’t — I worry that the forecasts for 2013 and 2014 are too optimistic.  But if growth isn’t as good as we hope, that will mean more spending cuts, not less.

He introduced a price-stabilising fuel duty, as I had long proposed, albeit in a much less fine-grained form than I had called for and in combination with a new kind of quasi-royalty on North Sea oil.  (Many commentators ask why the oil companies won’t simply pass this tax increase on, negating the effects of the stabiliser.  The reason is that their marginal costs of production are not increased by it.  What it does is to reduce the upside opportunity of investment when oil prices are below $75/barrel, with the consequence that future investment would be reduced, relative to counterfactual.  But at $100+/barrel, investment in North Sea oil is going to be increased anyway, and at the time of initial investments in current North Sea capacity, the probability of oil prices being consistently above $100/barrel was so low that a quasi-royalty being introduced now is virtually irrelevant compared to the vastly increased returns on investment relative to expectations.  They won’t pass it on.)

He raised the personal allowance.  That was the right first use of any “spare” money.

Though he tinkered elsewhere, he didn’t tinker that much.  He aspired to simplify the tax code, taking 100 pages off this time, and to seek simplifying measures elsewhere.

Dislikes

He renewed the Bank of England’s inflation target in the same, broken form.  That is a serious mistake that he may live to regret, albeit not one that he has faced or will face any political pressure over.

Connected to this, he didn’t dwell enough on the dangers of inflation.  This will be the key political issue over the next eighteen months (alongside rising interest rates next year).  By not openly worrying enough about this, he exposes us to the charge that, when it comes, we weren’t prepared for it.

He continued the war on banks, making a point of insisting that banks were not permitted to be net beneficiaries from any of his other corporate tax reductions.  Britain may be open to some kinds of business, but the political environment is actively hostile to banking business.

He gave us little sense of where he is going on corporate sector taxes.  What happened to taxing debt interest?  Has that aspiration gone, or are we waiting for another couple of budgets?  Does he want to equalise the treatment of debt and equity, or distributed and recycled profits?

He gave us relatively little sense of where he is going on personal taxes in the medium term.  He mentioned that the 50p rate is temporary, and of course the personal allowance was to be raised.  But he didn’t tell us whether he envisages future tax cuts, when they become possible, to focus upon reductions in income tax rates or further rises in the income tax threshold or other places such as NI or VAT.  And he didn’t tell us how many rates he thinks there should be (two, three, one?).  (P.S. Contrary to some reports, I don’t believe he proposed merging income tax and NI — merely merging the operation of them.  The document explicitly envisages NI continuing out to 2015/6 (the whole of the forecast period).  I’m opposed to the merging of income tax and NI, but merging their operations is potentially sensible.)

Overall I found it healthily underwhelming.  Steady as she goes, with a limited fuel tax rabbit from the hat at the end.  Just enough politics to be pragmatic, but the key thing was sticking to the plan.  I expect the financial markets to like it.