In the City
Second thoughts on Budget
Jock Bruce-Gardyne
It takes time to digest the sort of meal that Mr Lawson laid before us ten days ago. But by now the City and its analysts in- house run their first simulations through their n- house computers, and the message of the print-outs has been consistent and pretty unsurprising. It has been 'sell' for gilts and banks, and 'buy' for almost any other equities in sight. Which seems hard to fault. On the surface the response of the gilt- edged market might look something less than generous. A cut of £3 billion in the weight of government borrowip, coupled with the prospect of the business sector un- winding its dependence on the banks and looking to additional retentions and medium-term CGT-exempt debentures, and hence the promise of less need for over- funding; what more could the punters in government stocks be asking for? However, when allowance has been made for the con- tribution due to come from asset sales, which the City tends to look upon as more akin to a fancy form of funding, and the latest indications that borrowing in 1983-4 may turn out to be up to £1 billion less than the Chancellor told us to expect, the pro- mise of a shrinking deficit ahead has almost disappeared. That in itself would hardly have given the markets pause, in a week when the Chancellor was the toast of every City b. oardroom (outside Lombard Street, that Is). As usual it was what was going on on Wall Street which sent gilts scurrying for cover. On Budget night Mr Lawson left no one in any doubt that he expected an im- mediate cut in bank base rates to be part of the response to his performance: and the banks duly obliged — through gritted teeth, no doubt. But he had also singled out the US budget deficit and consequential in- terest rates as one of the 'inevitable risks and uncertainties' which mortal flesh is heir to (the other being oil prices). Wall Street came in right on cue. Vastly unimpressed by President Reagan's perfunctory gesture to the concern out on the hustings about his massive deficit, it signalled higher interest rates, and by Monday the US banks had duly responded. `UK . . rates are now lower than American . . .' the Chancellor pointed out on Budget day and added: 'As long as American rates remain near their current level, it is highly desirable that this advantage be maintained.' Maybe. But the proviso is going to need close watching. If the 'advantage' looks overdone then the skids get under sterling. The London market clearly thinks the trans-Atlantic gap is now as wide as it can get with comfort or any modicum of safety. Will Mr Lawson be Prepared, if need be, to acknowledge that, in a sensible world, base rates move up as well as down? That is going to be the real test of the depth of his conversion to 'supp- ly side economics'.
For on closer inspection it seems to me that Mr David Howell, the former Energy and Transport Minister, probably came as near as anyone to summing up the distilled essence of Mr Lawson's first offering: it did indeed mark a distinct shift in the direction of Reaganomics. Over the whole course of Mrs Thatcher's first administration a real growth of public spending, in substantial part the inevitable consequence of the reces- sion, was paid for from additional taxation: for all the promises of cut taxation back in 1979, the share of taxes in the national out- put rose from 34 to 39 per cent. And as a result, Sir Geoffrey Howe's Budget deficits shrank — not as fast as originally intended in Nigel Lawson's first issue of the Medium Term Financial Strategy, but still quite fast. From here on out, however, despite strik- ingly confident (some might say optimistic) projections of growth and revenues, the Budget deficit — in money terms — is to stay unchanged. Since the Chancellor also plans — again some might say optimistical- ly — to keep the rise in total public spen- ding to the rate of inflation, this year's effective tax cuts are scheduled to be the first of many. By 1988-9 the tax take is planned to come back to 36 per cent: and this is done by taking the whole of the `fiscal adjustment' — the equivalent of what the army used to call 'the unexpired portion of the day's rations' — in the form of tax reductions. Mr Howell was delighted. No more of all that stuffy nonsense about reducing bor- rowing to get down interest rates. Instead, like Mr Reagan, we were going to look to the Taller curve' — of lower taxes generating activity and hence higher revenues — to keep us out of trouble. Well, it has not exactly kept Mr Reagan out of trouble, as this week's rise in US prime rates reminded us. But of course the circumstances are vastly different. A steady £7 billion a year deficit is a different thing from one of $200 billion (plus 'off-Budget' trifles), even allowing for the different magnitudes of the two economies. Never- theless one would — as Mr Enoch Powell pointed out — be rather glad to know precisely how the Chancellor intends to borrow it. If he is thinking in terms of bor- rowing from the non-bank public, then a rise in interest rates, an increase in govern- ment funding, and perhaps a rise in sterling must be on the cards in time. If, on the other hand, he doesn't want that, then we could — we just could — find ourselves heading back to the bad old days when the Treasury borrowed directly from the banks, with all the consequences that we know about.
At any rate the euphoria of the equity markets is every bit as understandable as the caution shown by gilts. Inevitably a lot of anxious figuring has been going on about what the switch from investment allowances to a lower corporation tax will mean for individual companies, and the Financial Times has carried some predictably furious letters from the industrial heartlands. It is bound to come as a shock for a lot of com- panies to find they are going to have to pay Corporation Tax after all these years, and my withers were — almost — wrung by the tale I heard from the chairman of one such company on Budget night. Ten days before the Budget, he recounted, the finance direc- tor had come shamefaced before his col- leagues: 'It looks as though we're going to have to pay some Corporation Tax. I wonder whether we oughtn't to have a look at leasing some machinery.' Almost too late. But no doubt he's now closeted with his bankers.
Before we leave the Budget some marginalia seem worth looking at. First, the decision to put VAT on house repairs and renovations. Clearly there are going to be some howls of rage about the Chancellor encouraging owners to pull their buildings down and start again from scratch — if they are allowed to. But the moral of that, sure- ly, is not to return the VAT tax frontier to the shambles that it was before the Chancellor acted, but to extend it to cover all the building sector. It already looks as though Mr Lawson has got that message. Will he also include newspapers and finan- cial services next year?
Then the vexed matter of American 'unitary taxation' — the system by which certain States, led by California, have begun to calculate the local tax liability of multinationals by assessing the ratio of local operations to their global activities. I don't know whether Mr Lawson's cryptic reminder that `US firms operating in this country are not of course taxed on a unitary basis' had anything to do with it, but I note that Massachusetts has dropped its plans to go over to this ingenious device. For my part I can't help thinking that unitary taxa- tion may have something to commend it. At least it seems to be the only effective answer yet devised to the use of transfer pricing to reduce the tax exposure of the multi- nationals.
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