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.


8 Responses

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  1. Dominic Minghella said, on May 11, 2011 at 1:37 pm

    Thanks for picking up on this.

  2. jomiku said, on May 11, 2011 at 3:35 pm

    The problem is one can’t untangle the causes. Is it slowing because of tax increases, which argues for tax cuts? Is it slowing because of spending cuts (and the atmosphere that creates)? Or is it slowing because oil is expensive? Or is it slowing because the regional economy is too?

  3. Yonmei said, on May 12, 2011 at 8:47 am

    All you can really say is: Keynes was right. The last thing you want in a recession is for people to stop spending. Or for the government to stop spending.

    We have economic idiots running the country.

  4. Dave Holden said, on May 12, 2011 at 8:49 am

    Or is it slowing because we and much of the world still have a massive amount of deleveraging still to do and in reality there is no policy option available that can have much if any effect on this?

    As an aside – won’t inflation affect government spending on benefits further eroding the fiscal position?

    • duncanseconomicblog said, on May 12, 2011 at 8:58 am

      On the inflation point – normally inflation would increase govt spending yes, but also we’d see tax receipts increase (if wages rose).

      Given that real wages are falling though – we don’t get the same boast to income tax receipts.

  5. Luis Enrique said, on May 13, 2011 at 8:51 am

    well of course you are right about the role of growth, but the question of whether the government has the instruments at its disposal to generate growth is another matter. Specifically, if growth is to be achieved by government expenditure and your objective is to reduce the deficit via growth, you need £1 of additional expenditure to generate enough growth to raise taxes / cut welfare bills by at least £1

    everybody seems to agree (me too) that if the government hadn’t announced such aggressive cuts, businesses and households would be more confident and the economy would be stronger. I wonder, now that confidence is weak, whether announcing that cuts are being scaled back and spending increased here and there , would be enough to gee everybody up again?

    part of the problem is that because state led investment has been neglected for so long, we’re not really in a position to embark on big “shovel ready” infrastructure projects etc. that we need. Do we have the organisational capacity to do the “useful government spending” we can envisage?

  6. Luis Enrique said, on May 13, 2011 at 8:52 am

    I meant to link to Tim Hartford’s latest column which sounds a cautious note

  7. […] I said on Wednesday as the Bank of England downgraded it’s 2011 growth forecast, potentially adding another £12-14bn […]

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