Britain's going down the toilet...

I have given myself a couple of days to fully digest the contents of Alistair Darling's Pre-Budget Report released on Monday. At the time, watching his speech sitting at my desk at work, I really couldn't believe what was coming out of the Chancellor of the Exchequer's mouth! But I thought, no, give him the benefit of the doubt, wait to see what commentators have to say and see how the markets react before passing judgement.

Well the FTSE had it's best ever day ending up nearly 10%. Unfortunately this was not in reaction to Darling's speech. Rather it coincided with the announcement of the Citigroup bailout in the States which gave confidence back to the markets. For the markets to appreciate and price in the information will probably take until the results of the proposals start to show effect.

So, having had time to read up and mull it over, my conclusion is that Darling's actions could well end up in the bankruptcy of the UK. Might sound a bit extreme, so let me explain.

First, let me summarise the main points. Borrowing is going to increase to record levels, £78bn this year and £188bn next year (8% of GDP). It is expected that borrowing will fall from 2010 so that by 2016 Britain would only be borrowing to invest. VAT is to be cut by 2.5% from December 1st for 13 months. Government spending plans for 2010/11 are to be brought forward in an attempt to create jobs. There will be a new 45% income tax bracket for those who earn above £150k a year from April 2011. Also from 2011, National Insurance contributions are to be increased by 0.5% for everyone earning above £20k a year. In business, small firms are to get a temporary increase in threshold for empty property relief. Also struggling businesses will be able to spread their VAT, corporation tax and NI contribution payments over a longer period. Rise in corporation tax for small firms from 21p to 22p - planned for April 2009 - will be deferred. There is a lot more related to housing, employment, travel and the environment.

The outstanding proposal is obviously the increase in national debt between now and 2015. As I have mentioned in previous entries, such an increase in debt will be a burden on future generations - higher taxes in the future. Add this to the income tax proposals and we are seeing a huge shift in policy for "New Labour" which specifically contradicts Tony Blair's pledge at the beginning of his Premiership that Labour would not be a high tax party.

Aside from the politics, the implications could be horrific. The major assumption made by Darling in his proposals was that by the end of 2009 the UK would be entering into a recovery. This could well be the case. Looking back through history, negative growth has lasted for about 5 consecutive quarters (we have had one quarter so far) - but have we ever had a global slowdown as big as this one? This recession had been built on more credit than any other period and was preceded by the longest period of economic prosperity.

It is also being assumed that the proposals will actually work as they intended. I hate to break it to Mr.Darling but they almost certainly will not! The cut in VAT - irrelevant. Essential goods, such as food, do not have VAT added anyway so day-to-day spending is not affected. For other purchases, I fail to see how a fall of 2.5% will encourage an individual to spend money they wouldn't otherwise have spent. If a TV costs £117.50 today and £115 tomorrow and you were thinking "My existing TV could last me another year so I won't bother," would that £2.50 saving change your mind? M&S recently had a 20% one off sale which had consumers squeezing through their doors. Many other retailers have vouchers all over the net offering similar discounts. My point is 2.5% is nothing - consumer spending will not increase enough to help to stimulate growth. So immediately, the end of 2009 looks optimistic.

So let's say things take longer to get better. Consumer spending remains low, unemployment continues to increase and growth is stagnant. The only option for the government is to cut taxes and increase government spending once more to try to stimulate the economy. But this will need more funding - which means borrowing more money. The government will raise money - increase their debt - by selling bonds in the debt markets. The government will be responsible for paying coupons on these bonds - like interest payments on a loan - to who ever holds them. If the governments income from taxes is less than the coupon payments on all the bonds it has issued so they default we get a situation where the country could face bankruptcy.

This is real possibility - tax revenues are likely to fall significantly. Already the slump in the City has knocked £40bn off annual tax revenues. In addition to the loss in revenue supplied by VAT, businesses have been given longer to repay taxes, lower employment and lower city bonuses means less income tax, fewer houses getting sold means less stamp duty revenue - and all of these examples have further implications downstream. Hence, the government have planned to raise taxes in the future to ensure they can afford to repay the debt. But if people are in no better of a position than they are now, increasing taxes will cause havoc.

The crux of my argument is that in this current unique situation we have been met by a solution which is exactly the same as when we were enjoying a boom but on a much larger scale - more borrowing, more public spending, and more taxes. Without any real debt reduction plan in place if a recovery by the end of 2009 is not apparent, there will be extreme downward pressures on the pound and a rise in the cost of borrowing for the government.

I have recently read a forecast that suggested that the UK's global political influence is diminishing. Sterling is weakening and the country has a massive current account deficit. GDP is massively reliant upon the ailing FS industry. The well off who contribute vital tax revenue and who are largely responsible for job creation are leaving because of the prospect of higher taxes.

The question is - do you really want to be in the UK in a few years time?