Rathfinny Wine Estate

Budget Deficit and all that…

Forgive me, but with my ex-hedge fund manager’s hat on I can’t let the end of the tax year slip by without a comment on the recent budget and the march against cuts in London.

My son keeps asking me to try and explain “what’s going on in the world at the moment” because he’s at University and wants to be able to give the other side of the argument. He’s like that. He’s studying Philosophy and English, and he’ll make a good Barrister on day, as he’ll argue the other side on anything.

So here goes, and with a health warning, I’m not a politician. I studied economics and I hold no deep political views.

However, I am frankly shocked that Ed Balls can get away with saying that we can afford to stop or moderate the program of cuts announced by the coalition government last year. Step back and look at where we were in May last year. The dollar was hovering at $1.45 to the pound, having fallen from over $2 dollars to the pound in 2008 and the Euro, that battered currency, was heading towards €1 to the pound. We were on the brink of a currency crisis.

If the new government, whoever was chosen, had not instigated some radical cuts to expenditure then the international community, who buy our debt, could well have walked away from the UK, leaving the pound to collapse and the cost of our borrowing to rise.

So let’s talk about the deficit. Firstly, the deficit is not our government debt; it is the difference between our income (tax revenue) and expenditure. If you or I started spending 10% more than we earned, and we had already borrowed a substantial sum of money, the bank would probably come knocking on the door and asking when we would be rectifying this. It is the same with national governments. The banker is the global financial community who buy our government debt, gilts, treasury bonds, they are all names for the same thing. Our deficit is huge, it is forecast to rise to £163bn this year, and we are currently spending over 11% more than we earn in tax revenues.  Our deficit was over £10.8bn in the month of February alone, up £2bn on February 2010. That means we spent £10.8bn more that we generated in tax revenues in February.

So how do we compare to the basket cases of Europe? Ireland had a similar budget deficit of over 11% prior to its collapse; Portugal, whom the EU is bailing out this week had a budget deficit is nearer 8%. So what about our total debt?  How much do we owe? We currently owe £875bn. This is about 60% of our GDP and it is rising. Even with the cuts announced we would still have a budget deficit of £74bn next year.

When the global financial community lose confidence in your ability to pay back your debt then two things happen.  Government bond markets sell off, because less people are interested in buying them, that means that interest rates rise and the value of the currency will fall.

Without the cuts announced we could be facing a very difficult outlook. Interest rates in Portugal and Ireland are now around 8%, double those in the UK and the rest of Europe. Imagine what would happen to the UK economy if mortgage rates doubled. What would happen to house prices, and then the inevitable spiral of bad debts and a further collapse of the UK banks? We are a net importer of almost everything into this country, as the value of the pound falls all prices will rise causing a further squeeze on the economy.

This is why we have to cut government expenditure and reduce the deficit and start to reduce our national debt.

But surely we can raise taxes? Sadly, we have been doing that for the last ten years, but in rather stealthy ways, like congestion charges, stamp duty on housing and national insurance rates. We have to remember that even prior to the financial collapse in 2008, because government borrowing had almost doubled over the previous five years, we were still running a deficit at that time. Now our taxes are some of the highest in the world and we have already instigated emergency tax rises to try and stem the tide.

Unfortunately, raising tax rates often leads to lower tax revenues. A chap called Arthur Laffer proved that in the 1970s (the Laffer Curve) and that’s what led to the Reagan tax cuts in the 1980s. The problem is that we are part of the global economy where companies and increasingly individuals, are free to offer their services from any country in the world.  Often, companies and now individuals will move to base themselves in countries that offer lower tax rates, and it’s happening here.  I personally know of several companies and individuals who have done exactly that in recent years.

We need to encourage wealth creators to stay and work in the UK.  In fact you could, and we should, be arguing that we should be cutting taxes to encourage spending, rather than increasing taxes to fill a hole in the government deficit.

Now some might argue that the government should be spending more money to get us out of this hole. We should, but the government can’t.  They have no money.  They are already spending more than they earn and do we want them be spending more of our money?

However, the most important thing that our government can do is to maintain the support of the global financial community, because if they don’t then interest rates will rise significantly, the currency will fall and we will have one hell of a mess.

So there you have it. The British government is spending more than it earns and has one of the largest deficits in the world, government debt levels are still rising and we need to rein in expenditure, otherwise the global financial community will come knocking on the door and force us to do it, as they have in Greece, Portugal, Ireland and Spain.

It all argues for continued cuts in government expenditure as painful as they may be. However, where you cut is the political decision. Personally I am disappointed that so many young people will be put off going to university by fees of £9000 per annum and I think we need to offer more bursaries to help the poorest get to university.

I promise to write about wine later this week.

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