Will the emergency budget support growth

When George Osborne was photographed with Gladstone’s famous red briefcase, few would have envisaged that the new chancellor would deliver the most radical budget in a generation.

The conservative-liberal coalition had two factors to consider on how to slash Britain’s enormous public debt in such a way not to jeopardise the delicate economic recovery. Will this emergency budget stifle the recovery or help Britain prosper in the future?

Before the election, the Conservatives promised to have an emergency budget within 50 days, in an attempt to bring the UK’s spiralling deficit under control. George Osborne’s budget strategy was to cut spending by 77% and raise taxes by 23%, as he believes that this ratio will best support future economic growth. The main headline of this budget is a substantial increase of 2.5% in VAT to be implemented on the 4th of January 2011. On a personal level it is expected to cost the average UK household £500 a year as the general cost of living will rise. However, it is dependant on how much of the tax is absorbed by the businesses compared with the amount that will be passed on to the consumer. Nevertheless, this tax is likely to hurt businesses and consumers alike but unfortunately due to the regressive nature of the tax it affects the lowest earners disproportionately. On the positive side for the government, it is expected that the rise in VAT will raise £13 billion during the parliament and will make some serious steps in plugging the dangerous hole in the country's finances.

Since the formation of the government it has been anticipated that capital gains tax would rise for the high earners but by how much was the key question. For individuals, the rate of CGT remains at 18%, where their net taxable gains and taxable income are less than the income tax basic rate limit, currently £37,400. The 28% rate applies to gains or parts of gains that exceed that limit. Many experts are suggesting that 250,000 people will be liable for this increase in taxation and it is expected to raise almost a billion in revenue over the term of the government. This will especially hit the middle class buy to let owners, who might find themselves with a large tax bill when they choose to sell their second home.

In the run up to the election the Liberal Democrats were campaigning to increase the personal tax free allowance from £6475 to £10,000, with the view of eliminating income tax for the lowest earners in the economy. With the formation of the coalition government and in the name of compromise, George Osborne raised the threshold by £1000, which lifted 880,000 above the income tax threshold, giving basic rate tax earners an additional £170 a year in their pocket. This focused reduction will definitely benefit the lower earners in society and help to offset the rise in VAT. Furthermore, the additional money will be spent directly in the economy as lower earners spend a higher proportion of their income than the middle and higher classes. Moreover, the raising of the threshold acts as an incentive to low-income earners as they are more rewarded for their work and more willing to work supplementary hours.

The conservative government have been a consistent advocate of the importance of the free market forces and aim to provide a low tax environment that businesses require to grow. With this in mind they have laid out a 5-year plan to reduce the corporation tax by 1% each year. By reducing the tax burden on businesses this will increase profitability of the firms, which the government is hoping will spur entrepreneurialism. Furthermore, by 2015, the UK will have the lowest rate of corporation tax within the G7, which will make the UK economy a prime location for multinational companies to operate in. With this in mind, Mr Osborne raised the limit for entrepreneur’s discounted rate of taxation to £5 million in an effort to make business owners more willing to expand their businesses.

George Osborne described his first budget as ‘the unavoidable Budget’ designed to reduce the long-term debt the UK faces. In this budget he lays down plans for some of the biggest cuts in public spending since the end of World War 2. He planned to shave £6.2 billion off spending this year and left the door open for further cuts in the future. These cuts include a reduction in child tax credits, a public sector pay freeze, housing benefits and the abolishment of various new spending programmes launched by the previous government. However, these cuts in public spending will have a negative effect on the rate of economic growth in the country, as government spending is a key component in gross domestic product (GDP - a measurement of production of the whole economy). This idea is echoed by the newly-formed Office for Budget Responsibility (OBR), which has downgraded the economic growth projections in light of the new budget from 2.6% to 2.3% over 2011 -2012. Furthermore, the OBR predicts that the new budget will be worse for jobs over the next five years, as the heavy cuts in public services will lead to redundancies across the public sector workforce.

Overall, this budget has improved investors’ confidence in the country’s ability to repay its debt, with the rating agency suggesting that the UK will continue to maintain its prized triple A rating. Only time will tell whether or not the George Osborne’s first budget will successfully lead the UK economy out of recession.