Alistair Darling is hamstrung by circumstance – the real pain for UK will come after the election

Published on Saturday 13 March 2010 14:19

AS ALISTAIR Darling counts down the days to what could be his last Budget on 25 March, he would be forgiven if a few cracks began to appear in his usually steely demeanour. With the general election now less than two months away, the weight of expectation riding on the Chancellor's shoulders has never been higher.

• Alistair Darling

Gordon Brown last week made it clear that the economy and his personal ability to guide Britain through the "stormy waters of the economic crisis" will be one of the linchpins of his general election campaign. And the Prime Minister is leaning hard on his Downing Street neighbour to deliver a performance at the dispatch box later this month that will finally silence the concerns around Britain's 1 trillion debt.

Although the government is no stranger to jeers from across the floor of the House about ballooning public-sector debt, influential business groups – including the Confederation of British Industry, Institute of Directors and British Chambers of Commerce – last week joined the chorus of voices urging the government to lay out a more detailed timetable to tackle the UK's growing debt mountain, or face serious consequences at the hands of international credit rating agencies.

Foreign currency traders were again flexing their muscles last week, reminding the Chancellor how easily they could be persuaded to dump the pound and seek safety in more stable currencies. On Wednesday, sterling hit an 11-month low against a basket of currencies after disappointing industrial output figures reawakened fears over the sustainability of Britain's recovery and the possibility the UK could soon lose its prized triple A credit rating.

With so much at stake, it would be easy to imagine the Chancellor is struggling to stay afloat under the multiple demands being placed upon him. But those close to the MP for Edinburgh South West say he has been in remarkably good humour over the past few months, despite the magnitude of the challenge he faces in the next ten days.

Perhaps the Chancellor has resorted to gallows humour as he and his Treasury mandarins desperately juggle numbers within the confines of one of the tightest Budgets in recent history. Economists are already warning that most of what will be contained in the Chancellor's speech is likely to be nothing more than rhetorical and numerical trickery.

Martin Bell, a tax partner at BDO in Scotland, says: "It's going to be the phoney Budget. It'll be the usual political manoeuvring from the incumbents and then (shadow chancellor] George Osborne will stand up and slag it off. It'll be hard for Darling to say anything of any substance that will be treated with any confidence by the public."

Bell points out that the markets are already focusing more energy on the first Budget after the General Election, which the Conservatives have said they would hold within 50 days of a Tory victory. With polling day expected to fall on 6 May, markets are factoring in a "real Budget" before 25 June.

Rhona Irving, head of tax at PricewaterhouseCoopers (PwC) in Scotland, suggests that 25 March could, therefore, mark the Chancellor's shortest ever Budget speech as Darling finds himself with almost no room to manoeuvre. "There's not a lot of scope for election giveaways," she says.

While the odds are on that the vast majority of his speech will read like a history book of Labour's economic record over the past 13 years, economists are expecting that the government will desperately seek to include one or two headline-grabbing policies designed to convince the British electorate not to throw its weight behind the Conservatives on polling day.

With the public debt mounting and fears growing day by day over the UK's credit rating, what limited tools remain at the Chancellor's disposal?

Mike McCusker of PwC points out that it will be difficult for Darling to hide the harsh and politically unpopular reality that taxes on both individuals and corporates will have to rise dramatically over the coming years in order to make a dent in the Budget deficit. He says: "The basic message is effectively this: the tax level is going to rise and it's going to rise relentlessly."

However, Darling has already indicated that, contrary to the cynicism of the City, he intends to set out a Budget "for growth". He told an audience of business leaders in Edinburgh last month that while private sector output remains subdued, the government must continue with measures to stimulate activity.

"At a time of low private-sector activity, continued government spending provides vital demand. Pull that support too soon or too rapidly, and you hurt growth, reduce the tax take, push up benefit spending and eventually make borrowing worse," Darling said at the time.

Economists insist that with currency and bond traders all keeping an eagle eye on the UK, the March Budget will have to be a balanced one as Britain simply cannot afford any further increases in public spending.

Against this, Bell of BDO suggests Darling may consider politically popular but relatively inexpensive moves such as cutting the headline rate of corporation tax.

"From a headline grabbing perspective, you could see him cutting the headline corporation tax rate to say he is supporting business and encouraging more firms to set up in the UK," Bell says. He suggests there would be scope for a cut in the rate of corporation tax for large companies from 28 per cent to 25 per cent without hitting the Treasury too hard in the pocket. "Twenty-five per cent is not a bad headline rate for companies but is not drastically different from other European countries either. The problem with that, though, is employee taxes are still very expensive."

Tax experts point out that, even with some movement in the rate of corporation tax, foreign firms remain likely to be put off by the 1 per cent increase in National Insurance for both employers and employees, which is due to come into force from April next year. The rise was branded a "tax on jobs" when it was set out last year and is one of the factors which has prompted a raft of large corporates to recently consider relocating their headquarters abroad.

Bell suggests the Chancellor may also opt to extend further support to the UK's army of small businesses. Business secretary Lord Mandelson and shadow chancellor Osborne will go head-to-head in Aberdeen on Friday to win the business vote at the Federation of Small Businesses' national conference.

But even if Darling does manage to pull a few white rabbits out of the hat, Bell says the whole country knows that it will only be window dressing until the June budget, when painful and sweeping cuts will need to be made. He says that the next Chancellor, whoever that may be, will be forced to resort to significant changes to the "big three" taxes: VAT, National Insurance and income tax as other methods are unlikely to raise the vast sums needed to replenish the Treasury's depleted coffers.

"I'd be surprised if we are sitting here in 12 months and don't have a VAT rate of at least 20 per cent," Bell says.

However, others argue that the Chancellor may be reluctant to pin this month's Budget on corporation tax given that the Conservatives have already made this the cornerstone of their economic policy. On the first day of the Tories' spring conference in Brighton last month, Osborne said he would adjust the headline rate of corporation tax to 25 per cent although aides admitted the change was unlikely to come into effect until next April.

Irving of PwC suggests that Darling would be much more likely to make headlines around personal savings and tax, given that he is trying to persuade individuals to throw their weight behind the Labour government on election day.

Rumours have been circulating in the City that Labour could opt for a politically savvy "super tax" on the very highest earners to quell ongoing anger among the majority of the electorate around banking bonuses. Although most believe it is a long shot, some tax experts say there is scope for a new 60 per cent super tax rate although most believe the Chancellor would be far more likely to lower the threshold for the 50 per cent income tax, which is due to come in from 6 April. Those earning 150,000 or above will be covered by the 50 per cent rate.

Neil Whyte, tax partner at PKF, suggests the wealthy are also likely to be hit through changes to capital gains tax (CGT) and inheritance tax. He suggests CGT could be raised to as much as 40 per cent in order to close the gap between income tax and CGT.

"Although Gordon Brown and Alistair Darling may not always see eye to eye on tax issues, I expect the Chancellor to stick to the traditional Labour party line with his Budget announcements – financial 'fairness' is likely to mean tax rises for the wealthy," says Whyte.

"With the 50 per cent rate of income tax due to take effect from 6 April, many are expecting the current rate of CGT – just 18 per cent – to rise to counter tax avoidance by switching investments to generate capital gains instead of income. A CGT rate as high as 25 per cent or 40 per cent could be announced, so realising capital gains before the Budget could be a good idea."

No doubt the speculation over what the Chancellor may or may not plump for in the Budget will continue over the next ten days as he enters a series of frenzied negotiations with the Prime Minister and other Cabinet colleagues. But as Derek Henderson, head of tax in Scotland for Deloitte points out, if there's one certainty corporates, the markets and individuals can count on, 25 March won't ease any of the concerns about the inevitable pain to come further down the line.

"The Chancellor doesn't have many levers to pull at the moment," Henderson says.