Taxes to fall and then rise

On Monday, the chancellor will admit, by implication, that the government's industrial policy of the past decade has been something of a disaster.

Actually to call it an industrial policy is a bit misleading - but what I mean is the Treasury's celebration over many years of the UK's growing economic dependence on the City of London and financial services.

The City contributed around a third of our economic growth in the recent past and about 10% of total output.

It also generated a huge slug, directly and indirectly, of the tax revenues that flowed into the Exchequer.

So here's part of the horrible news we'll get on Monday in the pre-Budget report.

The slump in the City has knocked around £40bn - yes £40bn! - from annual tax revenues.

That's made up of lower corporation tax (our banks and other financial services provided about £10bn of this), lower income tax (those controversial fat City bonuses, now gone, yielded a fair chunk of tax), and lower stamp duty (on share trading and property deals).

And much of that tax revenue has probably gone forever, or at least for as long as the time horizon of most sensible forecasts (viz, up to five years).

How so?

Well, quite apart from the mess our banks are in, which has sent them tumbling into losses (no good for the tax man), the City in general is being forced by regulators to become a place where fewer risks are taken.

Such was the unambiguous message of last weekend's statement by the leaders of the G20 leading and most dynamic economies.

You may think it's a good thing that there'll be fewer risky deals by banks, hedge funds, private equity firms and so on.

But fewer risky deals, less risky lending, also means much smaller banks and City firms, much less employment, much smaller revenues, and much diminished tax payments.

So part of the hole in the government's revenues to be unveiled after the weekend should be seen as permanent.

Which is why the chancellor will have to announce that taxes are going to rise at a specified date in the future, to fill the structural hole in the public finances.

To be clear, I am not talking about immediate tax rises.

Quite the reverse.

I am certain that on Monday the chancellor will also announce a significant package of measures to stimulate the economy.

These will include tax cuts and spending increases funded by extra borrowing, equivalent perhaps to as much as 2% of GDP.

And the bulk of the tax cuts will be directed at those on lowest incomes, partly because they have the highest propensity to spend - for the good of the economy - and also for reasons of social justice.

Alistair Darling will describe such a giveaway as vital to lessen the sharp and painful economic contraction we're experiencing.

But he will also announce deferred tax rises and deferred cuts in public spending - to kick in when the economy has recovered a bit.

When would that be? Maybe 2010, maybe 2011.
If he fails to announce such debt-reduction measures, there could be very strong downward pressure on sterling and a corresponding damaging rise in the cost for the government of borrowing.

And, to be clear, the incremental sums he'll announce he has to borrow over the next couple of years will be colossal - equivalent to at least 8% of GDP, possibly more, or well over £110bn per annum.

You have to go back to at least the 1970's for a time when public borrowing was spiralling up at such an alarming rate.

Such a rise in public borrowing would be unsustainable.

Which is why, to repeat, there will have to be deferred tax rises and deferred public spending reductions inked into the public accounts and announced by the chancellor.

All of that is inevitable.

So which taxes will rise?

Well my prediction is VAT.

For the sake of transparency I should say that I don't know that there will be a VAT rise.

But a deferred increase from 17.5% to 22.5% in the VAT rate would raise around £20bn.

And it's one of the few future tax rises which might actually stimulate a bit of increased economic activity ahead of its implementation, rather than encouraging us to save

To use the economic cliche of the moment, it would give us all quite a "nudge" to spend now, before the swingeing increase in VAT would kick in.