Britons are already planning to cut back on their spending even before the increase in VAT scheduled for January 1st 2011. The government wants to limit state spending which is fair enough, as it is out of all control, and threatens the country’s long-term financial standing. But limiting consumption at a time when it is already falling fast is undoubtedly a mistake. The government would do better to rely less on tax increases, which will help to reduce tax revenues by slowing growth, and depend more on cuts in state spending, which will ensure the government can borrow for much less than they are expecting.
Long-term borrowing rates are tumbling, and could yet see 2% in the UK, down from the 4% which the government is planning on. That is the prize which comes from fiscal responsibility. Once British 10year gilts hit rates under 2%, the government can take up the slack by launching badly needed infrastructure projects, which will raise long-tern growth potential.
The news on Britons’ planned consumption is not so good, as reported by the WSJ.
In response to their concerns about the economic outlook, Britons appear likely to cut back on spending. Some 46% of those surveyed said they will spend less on new furniture, while 45% intend to spend less on large electrical items. Some 42% intend to spend less on drinking alcohol outside the home, while 39% plan to spend less on eating out.
There is already evidence that the big cutbacks in spending announced in the budget have hit business confidence. A survey of purchasing managers in the dominant services sector published July 5 found that following the budget, sentiment plummeted by the largest amount in a single month since records began in January 1997.
The government and the Bank of England would like to see a rebalancing of the U.K. economy, so that growth is driven more by exports and business investment than consumer and public-sector spending, which were the main contributors to growth in the decade leading up to the financial crisis in 2007.
But an abrupt slowdown in consumer spending before exports pick up could plunge the U.K. economy back into a recession from which it only emerged in the final three months of last year, following six straight quarters of contraction.
“It is ironic that a reduction in consumer spending driven by economic uncertainty — could in fact bring about the thing people are most concerned about: a dip back into recession,” said Ivan Browne, consumer products and retail expert at GfK NOP.
The increase in VAT to 20% is a mistake. There is still time to unwind it.