Comment: City all at sea over Gordon Brown's Budget

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The Independent Online
With less than a week to go before Labour's first Budget, the City is still all at sea over what to expect. Is this going to be a Budget which merely implements the windfall profits tax and welfare to work proposals, or will it go further to take in a whole raft of other measures? Will it be a limited, boring and predictable Budget which changes very little, or will Gordon Brown go for a bold and radical mix of measures that establish his credentials as a reforming Chancellor determined to make his mark and sweep away the past?

The Treasury is being more than usually coy about it all this time round, but judging by the way officials are burning the midnight oil and by Mr Brown's liking for headlines, the betting has to be that he's going to have a fair old go at the latter. If he confines himself to the manifesto promises of a windfall profits tax, welfare to work, and VAT on fuel, he's going to be accused not only of having no ideas but also of failing to cool Britain's overheated economy to boot.

So he's almost bound to go further, if only by way of announcing his intention to do certain things after a suitable period of consultation and review. What the markets can look forward to, therefore, is probably a set of measures that lie somewhere between the originally conceived "mini" Budget and the traditional "maxi" Budget - a "mini-maxi" Budget infact.

Rather than second guess what he is actually going to do - and nearly all the apparently inspired leaks of the Budget so far right down to the one about abolishing tax credits on dividends are no more than that - let's look at what the markets and business think realistic, and how far he might be prepared to go in meeting these wishes.

The general consensus is that there needs to be a sharp fiscal tightening that dampens growing signs of soar away consumer demand in the economy. Without it, interest rates will rise that much more strongly than they are already destined to, the pound will maintain its present overvaluation in foreign exchange markets, and the economy will suffer accordingly. Anything that Mr Brown might do directly to address Britain's perceived investment deficit would in these circumstances be pretty much pointless.

Whatever he does, then, Mr Brown is almost certain to present his Budget as a fiscal tightening. To do this credibly he's going to have to go further than merely announcing the windfall tax and the abolition of the tax credit on dividends. Though these two measures alone might be expected to raise pounds 10bn in a full year, their impact on consumer demand would be marginal.

So how to hit the consumer? Here Labour has considerably boxed itself in by promising not to raise personal taxes. While it is true that the Chancellor could mess around with tax reliefs and allowances in a way that had the effect of raising personal taxes but stayed within the letter of Labour's election promises, any such jiggery pokery would be seen as dishonest. There is, however, plenty of scope for fiscal tightening outside personal taxation. The most obvious targets here are MIRAS, stamp duty, excise duty, and VAT. The first two would both hit house prices hard, but since this is where the economy is at its most inflationary, that may be no bad thing.

Even taking into account these "extra" measures, the Chancellor won't be prepared to settle for such a conventional package. We already know there's going to be a package of green measures. Another priority, given the way Mr Brown used to bat on about this while in opposition, must be under investment, particularly in manufacturing.

Publication today of the Department of Trade and Industry's seventh annual research and development score board only serves to underline the point. For all the talk from the last Government of creating an enterprise culture, an entrepreneurial economy, there is little sign of a sustained commitment to investing in the future.

Measures to help investment neatly dovetail with the whole area of tax and savings. This is a mess, unfairly favouring certain forms of saving over others and failing to provide adequate incentive to save to all but the well off middle classes. If Mr Brown is not going to tax people into spending less, another way to dampen demand in the economy and boost investment at the same time would be to provide extra fiscal incentive for long term savings.

Mr Brown has so far barely put a foot wrong, despite an action packed two months of reform on a scale not attempted since the days of Geoffrey Howe and Nigel Lawson. He's not about to upset the apple cart now. A radical, but credible first Budget must be the one he's aiming for.

Will Ionica prove an exception to the rule

It was Eurotunnel and its then financial financial adviser S G Warburg that first introduced investors big time to the dubious delights of the discounted cashflow valuation. As a way of turning base metal into gold with a sleight of financial hand, this methodology has shown itself to be pretty much unbeatable. A godsend it may be to clever merchant banks selling companies with huge outgoings and nothing in the way of revenues, much less profits. But for investors it has more often than not proved a curse.

The Channel Tunnel was turned overnight from an unsaleable proposition into a goldmine using DCF valuation. After that came the cable companies, which though not as disastrous as the tunnel have nonetheless been a dissappointment in investment terms.

Eurotunnel faces its nemesis on 10 July should shareholders decide that enough is enough and vote down the latest refinancing plan. All of which makes SBC Warburg's timing immaculate - or perhaps unfortunate - as it seeks to send another business on its stock market way with the use of DCF.

Will Ionica, the telephone operator, prove to be one of the exceptions to the rule, the flotation that restores respectability to the DCF valuation? Weary investors have heard the story many times before. The technology is proven, the market is ripe for exploitation and the returns will be magnificent. We may have a track record of nothing but loses but the future is golden, perhaps even Orange.

Perhaps, however, Ionica actually is the one to break the mould. Unlike Eurotunnel and the cable operators, it does not have to do a lot of digging before it can sign up a single customer. Because it incurs most of its costs only when it connects a customer to its radio-based phone network, the cost per-home passed is a fraction of cable, or indeed BT.

The theory, then, is that the savings are passed onto customers in the shape of bills that are permanently 15 per cent below anything the opposition can offer.

Ionica's problem is that, however many bells and whistles it adds to the basic telephony service, it will always be reduced to competing on price since it neither intends to go interactive nor launch entertainment services over the radio waves.

That means it will need the support of a strong regulator who is not inclined to let BT price in a predatory manner when controls are lifted in four years time. When he started the business in 1991, Nigel Playford, Ionica's chief executive, had no money, no staff, no technology and no customers. He still does not have many of the latter, but for those that like a flutter, it could be worth a punt.

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