The boom in our living standards is over - and now it's payback time

By the standards of the past, this is not austerity, but slower growth for all will mean little or no increase for some
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The Independent Online

Higher taxes in the Budget to pay for the war or just higher taxes anyway? Actually it will be a bit of both. The first question is how much taxes and/or government borrowing will have to go up. The second question is the extent to which increased military spending will be responsible. And the third question is whether the combination of falling house prices and the forthcoming tax increases will end the great consumer boom that has kept us out of recession.

Higher taxes in the Budget to pay for the war or just higher taxes anyway? Actually it will be a bit of both. The first question is how much taxes and/or government borrowing will have to go up. The second question is the extent to which increased military spending will be responsible. And the third question is whether the combination of falling house prices and the forthcoming tax increases will end the great consumer boom that has kept us out of recession.

We will have to wait another few weeks for the Budget (which may now be pushed back into early April) before we know how far this year's finances have deteriorated since last November. Then, Gordon Brown admitted that the amount the Government would need to borrow this year had doubled to £20bn. Soon we will know the extent to which there has been further deterioration since then. My own guess is that unless they somehow massage the figures, that £20bn will have risen to about £27bn, which would be pushing towards 3 per cent of GDP.

That is this fiscal year, the one that ends a month from now. It is in effect water under the bridge because nothing much can be done about it now. The focus now is on next year. On Monday, the International Monetary Fund produced its annual report on our economy. It was reasonably complimentary, understandably so in view of the fact that several other developed countries are in worse nick than we are. But it did warn about two aspects of British economic policy. One was this rising fiscal deficit; the other, the unsustainable nature of our housing bubble.

The problem with any estimate of the deficit before the fiscal year starts is that revenue forecasts have to be an act of faith. The Government can, up to a point, know how much it has to spend and there is a contingency allowance for unpredictable expenses such as, er, a war.

But the revenue side is different. This year the tax take has been hard hit by the fall in City bonuses: in January income tax revenue was running more than 6 per cent down on last year. The total number of people in jobs has continued to rise but the new jobs being created are relatively low-paid, while many of those lost, in the City at least, are at the top of the market. And of course every pound less in revenue is one more pound that has to be borrowed.

The Chancellor hopes to recoup some of this shortfall by the increases in national insurance contributions (NICs) that have already been announced and that come into effect next month. But that may not be enough. There are already rumours that there will be further tax increases.

In addition there must be a concern that NICs – which are a tax on employment – may cut the number of jobs. Were unemployment to start rising he – well, actually we – could be in serious trouble. Into this equation comes the war.

Yesterday the Chancellor acknowledged that he was making more funds available to the military. That is common sense. What he cannot know is the longer-term bill. But if this follows the pattern of the Gulf War, the military cost could be some £45bn, of which something like £7bn would be down to us. That may not sound so much in the context of a deficit approaching £30bn, but it is coming at a fiscally unfortunate time. Were this country to become involved in a longer conflict or even a long-term policing action, the costs would be higher still. In the Gulf War a very large part of the bill was shared among the allies. I can't see the French and the Germans wanting to stump up too much for this one.

Let's accept that £7bn figure. In November the Chancellor expected the deficit to narrow a bit in the coming year. If that estimate of the costs of war turns out to be more or less right, it could be enough to push the deficit up instead of down. Indeed if revenues really do badly we would be above the £30bn level, equivalent to 3 per cent of GDP, the EU Stability and Growth Pact's ceiling. Suddenly instead of being one of the good boys of Europe, we would join the naughty ones at the back.

Then we could really find ourselves in a bind. If the Government is living above its means, it joins the millions of consumers who have been borrowing against the security of their houses to maintain their living standards. If houses have become seriously over-priced, and it is not just the IMF that thinks they have, then we will no longer be able to use them to the same extent to borrow for consumption. Currently this form of borrowing is adding about 6 per cent to our household incomes. You don't need to predict a housing crash to see that equity take-out will have to stop. A modest fall would be enough to change people's willingness to borrow – and just as important, the banks' willingness to lend.

To say all this is not to predict economic catastrophe. There was growth last year – 1.6 per cent, which while not great was not too bad by European standards. There will be some growth this year, though the tax increases will blunt it. All the forecasts I have seen expect growth this year

What will surely come to an end is the rapid and relentless rise in consumption to which we have become accustomed. Year in, year out for a decade our living standards have risen by some 4-5 per cent a year. Meanwhile the economy has grown at about half that. This boom in living standards has been possible because we have consumed an increasing proportion of GDP each year.

Now comes payback time. Instead of consumption rising at double the rate of growth of the economy, it is going to rise at perhaps half. The Government is bound to take more of our money, in part to help pay for improved public services (assuming they really do improve) but also to cover the increased cost of national security at home and abroad. These civil defence preparations in the event of a terrorist attack in London are not just a one-off exercise. No responsible government has any choice but to set aside more money for security for the foreseeable future. The money has to come from somewhere and the only somewhere is consumption.

We are not going to like this. By the standards of the past, this is not austerity by any means. But slower growth in consumption for all will inevitably mean little or no increase for some. Being human we will seek people to blame, and the people in this case will be the Chancellor of the day. This will be a huge test of political attitudes.

I don't think most people realise the extent to which the relative popularity of the Government during its first term of office was a function of the economic feel-good factor. If you want a date when that feel-good factor finally disappears, it will be the Budget. And the bad news then that won't just be the impact of the war.

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