New British Coalition Governments Policy On Deficit Reduction - Example

Running head: NEW BRITISH COALITION GOVERNMENT’S POLICY ON DEFICIT REDUCTION New British Coalition Government’s Policy On Deficit Reduction Insert Name Institution Date: Introduction Britain held its national elections on 6th May 2010 to vote in new House of Commons representatives for the 650 constituencies following the dissolution of parliament by Gordon brown, the then British prime minister. Three main parties were contesting in the elections, namely the Labor Party, the Conservative Party and the Liberal Democratic Party. The winning party is expected to have a majority 326 seats in the house in order to form the next government. The conservative party had the most number of votes as well as seats in the house, 307, but failed to reach the required majority number of seats in order to form the new government. The Labor Party had 258 seats while the Liberal Democratic Party had 57 seats. This resulted in a hung parliament, as no party was able to garner the required majority in the house. This resulted in coalition talks between the conservative party and the liberal democratic party leading to the formation of a coalition government. An important task at hand for the new government was economic recovery following a downturn during the recent global recession lasting six consecutive quarters. Britain had the largest deficit in 2009 standing at 11% of the gross domestic product with expenditure being four times more than receipts. As such, the coalition government took over a rather challenging fiscal position that needed remedy. The government therefore embarked on a policy of trying to reduce the government budget deficit and to eliminate the structural deficit within the lifetime of a single parliament. The reasons behind the adoption of this policy The reasons behind the adoption of the new policy by the coalition government arise from the failures of the fiscal policies that were adopted by the former labor government that took over office in 1997 resulting in an ailing economy, increased unemployment and loss of jobs, and massive bailouts. The former labor government promised a new approach towards fiscal policy with radical changes envisioned for the main policy making institutions in order to command public trust as well as market credibility. These changes were adopted on a backdrop of transparency, openness, as well as the accountable distribution of responsibility. The government developed two major fiscal rules: The golden rule; which required the government to borrow funds in order to invest rather than funding current expenditure. The sustainable investment rule; that required the public sector debt, represented as a percentage of the gross domestic product, be held at a prudent and stable level (Budd, 2010). The major fiscal objectives of the fiscal policy adopted by the government were centered on the short-term and on the medium-term. In the short-term, the government hoped to support monetary policy through the adoption of favorable fiscal positions according to the economic trends. It also hoped to allow the automatic economic stabilizers to play their functions in order to allow the economy to grow despite variations in demand. In the medium-term, the government hoped to adopt sound public taxation and expenditure frameworks that impacted fairly across the generations. This was to be achieved through establishing taxation and expenditure priorities that would avoid an unstable rise in public debt. A code for fiscal stability was adopted that had the following provisions: Fiscal and debt management. Adoption of best-practice accounting techniques in the creation of public accounts. Pre-budget debates on the various suggestions under consideration for inclusion in the budget. Fiscal and economic strategy reports that outlined long-term goals to be adopted by the government. Audit reports from the national audit office on the changes undertaken as a result of changes in fiscal projections (Treasury, 1998). With these policies in place, the labour government was able to ensure continued economic growth. For instance, Gordon Brown, the then British prime minister, announced a five year deficit cutback plan during the 1997-98 fiscal year budget reading in accordance with the golden and prudent investment rules. This was to be achieved through the eradication of advanced corporation tax that was being paid by pension funds and companies and a windfall tax cut on profits from privatized utilities (Sawyer, 2007). This would help in reducing financial borrowing by almost 4 billion pounds. This was followed by further fiscal tightening in consequent years that resulted in additional revenue for the government. This revenue was acquired through a further reduction in corporate taxation, a reduction in the married couple’s allowance, increased duties on cigarettes and motor fuel, as well as stamp duty increases for property transfers. This increase in revenue was forecasted to increase resulting in a surplus in current accounts by the year 2000. By 2000, the economy had grown by 2%, surpassing the forecasted 1.5% growth figures (Beetsma, Giuliodori, & Klaassen, 2006). Current expenditure was forecasted to increase by 2.5% per annum for three years from 2001 with net public investments of gross domestic product increasing from 0.9% to 1.8% during the similar phase. In addition, the lowest inflation rate in thirty years was recorded in 2001, with unemployment being at its lowest since 1975 and interest rates at their lowest since 1966. Following the elections held in 2001, the fiscal position was reported to have worsened compared to forecasted estimates (Balls & O’Donnell, 2002). Receipts declined by 7.6 billion pounds in the 2001-02 financial year and further by 9 billion pounds in the 2002-03 financial year as a result of declining equity prices, weaker growth in the world economy, and a decline in financial profits of companies. The government announced increases in expenditure in the National Health Service that would be supported by additional revenue obtained through an increase in the national insurance contributions as well as freeze in the national insurance threshold. Despite these measures, the increase in revenue was less than the NHS expenditure. By 2005, the fall in revenue as compared in NHS expenditure was short by 6 billion pounds (Treasury, 2005). The forecasted budgetary surplus from 2002 to 2004 fell short of the government’s projections underlining further underachievement of the set out fiscal objectives of the government (IMF World Economic Outlook, 2010). Instead, deficits were recorded with cyclical deficit being 1% of the gross domestic product. Net borrowing increased in the 2003-04 financial year to 37.5 billion pounds from 27.3 billion pounds in the 2002-03 financial year. Deficits in the 2005 budget were projected to reach 16.1 billion pounds as compared to the forecasted 10.5 billion pound deficit in the 2004 budget. This reflected a 0.6% increase in the cyclical deficit. Income from selected range of taxes for the UK government 1999-00 2004-05   £ billion £ billion Income tax 95.7 127.2 National Insurance contributions 56.1 78.1 VAT 56.4 73.0 Corporation tax 34.3 34.1 Fuel duties 22.5 23.3 Council Tax 13.1 20.1 Business rates 15.4 18.7 Other taxes 8.1 11.7 Stamp duties 6.9 9.0 Tobacco duty 5.7 8.1 Vehicle excise duty 4.9 4.7 Beer & cider duties 3.0 3.3 Inheritance tax 2.1 2.9 Spirits duties 1.8 2.4 Capital gains tax 2.1 2.3 Wine duties 1.7 2.2 Customs Duties & levies 2.0 2.2 Betting & Gaming duties 1.5 1.4 Petroleum revenue tax 0.9 1.3 Air Passenger duty 0.9 0.9 Source: HM Treasury Public Finance Statistics Discretionary changes were introduced that resulted in an increase in net borrowing with non-discretionary changes resulting in a deteriorating fiscal outlook (Monacelli & Perotti, 2010). Further deficits were reported in 2006 and 2007 with an estimated deficit of 7.1 billion pounds in 2006 and 9.5 billion pounds in 2007 (Barrell & Kirby, 2010b). The cyclical-adjusted surplus of 0.4% of the gross domestic product for the 2006-07 financial year was adjusted to a 0.5% of GDP deficit. New tax measures introduced had little effect on revenue with current budget as well as net borrowing figures being projected to worsen due to the reduction in revenues from the North Sea. Instability in the international markets in 2007 became more apparent with a revision being done on the forecasted growth in gross domestic product to 2.5% in 2008 despite a projected 1.9% increase in current expenditure per annum accompanied by a 2.5% of the gross domestic product increase in net investments. Despite this forecasted growth in the economy, the effects of the ailing world economy were felt in the 2007-08 financial year with projected figures in the 2007 budget not being achieved (Barrell & Kirby, 2010a). This was coupled by a further reduction in returns from the North Sea oil. By 2008, gross domestic product had already started to decline with estimates standing at 0.75% for 2008 and 1.5% the following year. Expansionary measures were adopted in the 2008-09 financial year with little effect on the gross domestic product. Public spending and the national debt had been consistently less than 40% of the gross domestic product for the last 20 years before the recession hit the economy in 2008 (Ramos & Roca-Sagales, 2008). This drastically changed with public expenditure reaching a historic 48% of the gross domestic product in the 2009-10 financial year. Moreover, the public sector debt stood at 36% of the gross domestic product in 2007 but rose in 2008 because of the ensuing bailout made in favor of major banks in the economy (OECD Economic Outlook, 2010). In addition, the government injected in excess of 375 billion pounds in bailouts to the banking system yet only a small amount of this money returned into the actual economy. Advantages of this policy This new policies has several advantages. First of all, this policy will reduce the exposure to a additional economic shock as well as any additional loss in the market confidence of major economic players within the United Kingdom. This is very important as it will enable the economy to shield against further economic shock. Secondly, it supports the growth as well as creation of jobs both in the short and medium term (Treasury, 2010). This is as a result of the increased confidence in the market by the private sector which constitutes a major part in overall employment figures. The policy also offers protection to the existing businesses from the proposed jobs tax adopted by the former Labour government. Thirdly, the policy will assist in keeping interest rates down in the long term which directly helps both households and businesses as they are able to acquire capital in the form of mortgages and loans at rather lower costs. This is a very important aspect as it will enable businesses and households to increase demand for goods and services which in turn increases aggregate demand resulting in the growth of the economy. Fourthly, the policy will help in keeping both debt as well as interest payments on debt that is to be paid by the Government. This in turn reduces the amount of tax to be paid by the taxpayers ensuring that money within the economy is used for job creation and expansion of businesses. More importantly, it protects low income households from public debt constraints. Lastly, the policy aids in avoiding the accumulation of substantial debts that are used in the funding of recurrent expenditure that profits the current generation which would rather be unfair to future generations that would be required to pay for this expenditure (Treasury, 2010). Disadvantage of this policy This policy leads to reduced expenditure as the government tries to reduce public debt and increased borrowing. As such, some of the essential services end up not being provided to the people as the government ends up prioritizing some services over others (Cavallo, 2007). For instance, the revival of the financial sector, a key sector in the economy, requires large amounts of money which will result in the reduced expenditure in some essential services such as education and social services. Conclusion The government’s policy of trying to reduce the government budget deficit and to eliminate the structural deficit within the lifetime of a single parliament is justified as it will help the United Kingdom to recover from the economic decline that it has undergone in the recent years. The policy adopts feasible measures that enable the government to reduce the current deficit while at the same time ensuring growth in the economy by fostering market confidence so that economic players are able to conduct their activities effectively. It also assist in keeping interest rates down in the long term which directly helps both households and businesses as they are able to acquire capital in the form of mortgages and loans at rather lower costs. References Balls, E. & O’Donnell, G. (2002). Reforming Britain’s Economic and Financial Policy: Towards Greater Economic Stability, Basingstoke: Palgrave. Barrell, R., & Kirby, S. (2010a). 'UK Fiscal Prospects’. National Institute Economic Review. Barrell, R., & Kirby, S. (2010b). 'Fiscal Policy and Government Spending’. National Institute Economic Review. Beetsma, R., Giuliodori, M., & Klaassen, F. (2006). Trade spill-overs of fiscal policy in the European Union: a panel analysis. Econ Pol 21(48):639-687. Budd, A. (2010). 'Fiscal Policy under Labour’. National Institute Economic Review, 212:R34-R48. Cavallo, M. (2007). ‘Government consumption expenditure and the current account’. PFM 7:73-115. IMF World Economic Outlook. (2010). Chapter 3 'Will it hurt? Macroeconomic Effects of Fiscal Consolidation’. Retrieved March 14, 2011 from http://www.imf.org/external/pubs/ft/weo/2010/02/pdf/c3.pdf Monacelli, T., & Perotti, R. (2010) Fiscal policy, the real exchange rate and traded goods. Economic J 120(544):437-461 OECD Economic Outlook. (2010). Chapter 4 'Fiscal Consolidation: Requirements, Timing, Instruments and Institutional Arrangements’. Retrieved March 14, 2011 from http://www.oecd.org/dataoecd/63/57/46435606.pdf Ramos, X., & Roca-Sagales, O. (2008). ‘Long-term effects of fiscal policy on the size and distribution of the pie in the UK’. Fisc stud 29(3):387-411 Sawyer, M. (2007). 'Fiscal Policy under New Labour’. Cambridge J Econ 31:885-899 Treasury. (1998). Code for Fiscal Stability, Retrieved March 14, 2011 from http://www.hmtreasury.gov.uk./documents/uk_economy/fiscal_policy/ukecon_fis c_code98.cfm Treasury. (2005). Britain meeting the global challenge: Enterprise, fairness and responsibility, Pre-Budget Report Cm 6701. Treasury. (2010). 'Spending Review 2010’. Retrieved March 14, 2011 from http://cdn.hm-treasury.gov.uk/sr2010_completereport.pdf Read More