Boring Budget, but wait for '96

Economics

THAT BUDGET was boring - though economic columnists are not supposed to admit it. But a year from now, we might be saying something altogether more interesting - for we will have seen the full line-up of goodies that this Budget has been designed to create. Perhaps we will be writing something like this:

Has he done it? The Tory backbenches think so, though the pollsters say that the Conservatives are still a clear seven points behind Labour in the polls. But he has made an interesting, even exciting stab at creating a Budget that clearly differentiates the two parties and will therefore put a clear choice before the voters next spring. And he has done it against a mixture of good and bad luck, which has led to some modification of the original plan.

So we have our pounds 4bn of tax cuts; the basic tax rate of 20 per cent; the abolition of inheritance tax; and - the big surprise - we seem to have got these against a background of a recovery in house prices. More about the tax cuts, or as the Labour press (though not the party leadership) has called them "the bribes", in a moment. First, how has it happened?

The plan that the Chancellor drew up in outline back in autumn 1995 aimed to engineer the return of the feel-good factor before spring 1997. But the slowdown in the economy last spring means that he is delivering the goods exceedingly late. That is why he abandoned his earlier plan to introduce the income tax cuts to straddle the election, giving us the 22 per cent rate in this year's Budget and the cut to 20 per cent next. Instead, he is giving us the whole 20 per cent now.

But to do that he has to raise revenue, and he has been clever to have balanced the income-tax cuts with the one new tax that the Treasury could think of which might even be popular.

Indeed the whole strategy is clever in a rather different way than the Chancellor would have expected back in November 1995. That is because of two surprises. First, the economy has performed rather differently from the Treasury forecast: remember that it expected 3 per cent growth this year, with both exports and consumers pulling up the economy.

Now it looks as if that growth will be closer to 2 per cent, with a very slow start to the year but now picking up quite fast. Some mid-term pause in the recovery had been expected by the Treasury, for it was evident a year ago. But it proved longer and more stubborn than expected as consumers hesitated and exports were hit by the even greater slowdown across continental Europe. The dip is shown in the charts. (I have cheated here, using the current Goldman Sachs forecasts, chosen because they show a very sharp slow-down in the first half; actually an even sharper one than I expect.)

The second surprise was lower-than-expected inflation this year. Hardly anyone a year ago predicted that inflation would be running below 2 per cent and tending to fall further, a decline helped by the sharp fall in the oil price early this year and by continued moderate wage increases.

Together these have been enough to create an opportunity for Mr Clarke to push down interest rates three times in the last 12 months. Result? House prices are now between 5 and 7 per cent higher than they were in autumn 1995. That is not enough to eliminate the scourge of negative equity, but it does mean that three-quarters of the population who a year ago had houses worth less than their mortgages can at last move home. Not entirely the Chancellor's doing by any means, but a justification for his cautious Budget a year ago, for had he started the tax-cutting programme earlier, the chances of getting those interest-rate cuts would have been much reduced.

This recovery in house prices has reinforced a recovery in disposable income and in consumer spending (See the second graph.) People are getting richer and increasing their spending, just about as fast as at any time since the late 1980s. But because of the slowdown in the first part of the year, and thanks to a very tight curb on public spending, the latest tax cuts in theory at least should not lead to an excessive surge in demand. They can - just about - be billed as "responsible".

And the cuts themselves? The commitment to a basic 20 pence rate of income tax has been so strong that, somehow or other, the Chancellor had to deliver it. The commitment to abolishing inheritance tax was taken up by the backbenches as a vote-winner, following the positive reaction to the rise in the IHT threshold last year. So these had to be in the package. The question was how to find the money, for the cost was far beyond the available net "give away" of about pounds 4bn.

Increasing excise duties was impracticable, given the leakage of revenue across the Channel; increasing VAT was out of the question. Windfall taxes on the public utilities would not have been credible, given that what was needed was a continuing stream of revenue, rather than a one-off payment.

In any case, Mr Clarke needed to have some weapon to damp down the additional consumer demand that his income tax cuts will generate. He also needs to continue to encourage savings. So his new consumer credit levy - a tax that adds 10 per cent to the interest charge on all consumer credit, now over pounds 100bn - is a clever way of taking back a little of the benefit of lower interest rates. It also puts pressure on the lenders (banks have never been the most popular of our great institutions) to absorb as much of this tax as they can. As he said in his speech, the Chancellor was merely bringing in the plan developed but never introduced by Nigel Lawson.

The main political question mark over the Government's economic strategy has been the failure of unemployment to decline much in the first part of the year. (See the right-hand graph; actually I think Goldman is a touch pessimistic in expecting a rise in unemployment in the first half of next year - little change is likely if the slow-down is less marked than Goldman expects.) But as the rise in consumption passed through the economy, the last three months have seen the downward path in unemployment resume.

So, with this Budget, the election campaign has begun in earnest. It is quite clear that it is a campaign that will be fought over tax. Lab- our's immediate response suggests that it will oppose the income tax cuts and fight the election on the basis of a 24p basic rate and a cut in VAT to 15 per cent - though for the moment that is only speculation. The really interesting thing, surely, is that both parties are presenting themselves as tax-cutters. The difference is which taxes they will cut. We really will have a choice, come May.

Maybe it won't be like that after all. Maybe the idea of a new tax to help finance the 20p basic rate is too clever by half, and the original plan of tax cuts straddling the elction will hold. Maybe the Tories will not make it to next November anyway. Maybe we will all want a change. But you must admit it is more interesting that crawling over last Tuesday's effort yet again.