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April 23, 2009 – 9:13AM
Chancellor of the Exchequer Alistair Darling raised taxes on British motorists, smokers and the rich to contain an unprecedented budget deficit as he forecast the worst recession since World War II.

The Treasury will borrow 269 billion pounds ($556 billion) more than estimated in November. It will raise taxes by 3.2 billion pounds on people earning above 100,000 pounds a year and 6 billion pounds through duties for alcohol, tobacco and gasoline, Darling said in his annual budget.

The moves left Prime Minister Gordon Brown’s government little room to stimulate the economy before the next election, which must be held by the middle of 2010. Darling’s expectation that growth will resume by the end of this year is too optimistic and suggests taxes will rise again, said Andrew Smith, chief economist at the accounting firm KPMG.

“Even though Darling insists that the end of the recession is in sight, we are still looking at eye-watering budget deficits,” Smith said. “Plans for repairing the public finances are long on ambition but short on detail. Significant additional tax hikes will ultimately be necessary.”

Gilts and the pound fell as the Debt Management Office said it will sell a record 220 billion pounds in bonds this year, 50% more than last year’s record. The pound lost 2 cents against the US dollar, trading at $1.4490.

Recession forecast

The Treasury expects the economy to shrink 3.5% this year and to rebound in 2010. Moments after he spoke, the International Monetary Fund forecast a contraction of 4.1% this year, with the recession continuing in 2010.

Deficits will total 703 billion pounds during five fiscal years through April 2014 compared with 434 billion pounds forecast in November. This year’s shortfall of 12.4% of gross domestic product would be the biggest peacetime deficit in more than a century, according to Citigroup Inc.

Darling said the Labour government is aiming to help businesses and people on low incomes to weather the recession while taking more from those who can afford to pay. He plans to cut the deficit in half in five years.

“It is fair that those who have gained the most should contribute more,” Darling told lawmakers in Parliament. “We are determined to support a fairer society.”

Taxes rising

Fuel duties will rise quicker than inflation for the next four years, starting with an increase of 2 pence a liter in September. Alcohol and tobacco levies will rise 2% from today.

People earning more than 150,000 pounds a year will pay 50% of their income in tax and lose tax breaks for pension contributions. The new rate is five points higher than suggested in November and will come in a year earlier. It unravels the decision in Margaret Thatcher’s Conservative budget in 1988, eliminating all tax rates over 40%.

“It’s a scorched earth policy,” said Doug McWilliams, head of the Centre for Economics & Business Research, a London- based consultant. He predicted “a huge amount of damage to the City of London, the straw that breaks the camel’s back.”

The UK’s financial services industry, which employs about 1 million, may lose 140,000 jobs, and about 25,000 of the richest taxpayers may flee the country, CEBR estimated. The Confederation of British Industry said businesses are concerned that taxes will rise to fund the deficit.

Business concerns

“The key question for this budget was whether it set out a credible and rigorous path for restoring the public finances to health,” said Richard Lambert, a former Bank of England policy maker now leading the CBI. “It does not.”

The budget paves the way for a squeeze on public spending after the election, putting pressure on the nation’s main opposition party to say how it would cut spending without eating into frontline services.

Current spending is forecast to grow an annual 0.7% more than inflation in the three years from April 2011 instead of the 1.2% forecast in November. Net investment will fall to 1.25% of gross domestic product by 2013-14 rather than 1.8%. Conservative leader David Cameron said the budget shows Labour has lost its ability to manage the economy.

Conservative view

“As of today, any claim they have made to economic competence is dead, over, finished,” Cameron told lawmakers in response to the chancellor’s statement. “This prime minister has certainly got himself into the history books. He has written an entire chapter in red ink.”

The government plans to help fund capital investment by raising 16 billion pounds from the sale of property and other assets in the three years from 2011-12. It also plans to save 15 billion pounds through efficiency and cost-cutting measures and another 1.2 billion pounds by curbing tax avoidance.

“The painful tax announcements have been deferred to the other side of the election,” said Peter Spencer, chief economic adviser to Ernst & Young’s Item Club, which makes forecasts for business based on the Treasury’s economic model.

For the first time, the government has conceded that it may not recover all of the money it has pledged to support the banking industry. The budget makes a provision for potential losses of between 20 billion pounds and 50 billion pounds, or as much as 3.5% of GDP.

Bank bailouts

The government has spent about 40 billion pounds buying stakes in Royal Bank of Scotland and Lloyds Banking Group and pledged hundreds of billions of pounds in guarantees and deposit protection.

“The provisional estimate is a caution judgment, made for fiscal policy purposes,” the budget document says. “It is not an estimate of the scheme-by-scheme losses over time as it is impossible to set out accurate overall costs for certain at this point.”

In all, the budget measures will give away 5.16 billion pounds this year and 100 million pounds in the fiscal year ending in April 2011. In fiscal 2012, the budget will raise 5.23 billion pounds more for the Treasury. The measures are have a broadly neutral impact on the public finances over three years.

The Trades Union Congress, which represents 6.5 million workers, praised the budget, saying it will make a “better balanced economy.” Derek Simpson of the Unite union said it will “position Labour as the party for jobs and social justice” in the minds of voters.

Record deficit

Economists said the Treasury’s deficit is so large, the biggest in the Group of 20 nations and above the shortfall expected this year in the US, that the government couldn’t act to stimulate the economy.

“When it is most needed, fiscal policy will not be able to act,” said Michael Saunders, chief western European economist at Citigroup. “This is a major policy failure.”

Darling today vowed more support for the jobless and home owners. The government will spend an additional 1.7 billion pounds for job creation and provide a 2,000-pound discount on new cars when they are traded in for ones that are more than 10 years old, he said.

He also promised to extend support to mortgage holders who have lost their jobs, to prolong a lower rate of stamp duty on home purchases and to keep guarantees for mortgage-backed securities.

“We will continue to do everything we can to help people into work and help people into jobs,” Brown told lawmakers in Parliament earlier today.


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