Duncan’s Economic Blog

There goes the VAT rise, or what the today’s numbers say about the deficit.

Posted in Uncategorized by duncanseconomicblog on May 11, 2011

The Bank of England released its quarterly Inflation Report today, updating projections last made in February.

It makes for fairly grim reading.

For me, the big news is that growth forecasts have been revised down again and risks are apparently ‘skewed to the downside’.

Which raises the question of – what impact will this have on the deficit?

Let’s take an example; the Bank has revised down its forecast for 2012 growth to 2.2% from an earlier estimate of closer to 3%. That’s quite a large revision.

The OBR by contrast (which is already looking out of line with other forecasters one and which has been over-estimating growth for a year now) is going for 2.5%.

0.3% might not sound like much. But growth 0.3% lower in 2012 could add about £12bn-£14bn* to the deficit (split between fiscal years 2011/12 and 2012/13).

£13bn is coincidentally rough what the government raised by increasing VAT from 17.5% to 20% in January.

In other words the slowing of the economy could totally erase the fiscal effects of a regressive tax increase. There can be no more vivid illustration of the importance of growth to reducing the deficit.

* I obviously don’t have access to the OBR’s model but looking at the most recent ‘Economic and Fiscal Outlook’ we can see that a total downward revision of -0.3% to growth for 2011/12 and 2012/13 growth (compared to the outlook in November) increased the borrowing forecast for those years by £13.9bn.