Weighing up the cost to the economy.

Darling's difficult pre-Budget gamble

Published:  08 December, 2009

LONDON: Tomorrow's pre-Budget report is the most difficult one faced by a Chancellor since the 1940s, according to...

BDO, the UK member firm of BDO International, the world's fifth largest accountancy network. In its report, issued today, the firm said: "We consider that the projected fiscal deficits for both 2009-10 and 2010-11 will both have to be revised upwards from £175bn to well in excess of £200bn.

"The economic position is precarious whether or not the UK emerges from the technical definitions of a recession or not. Current projected levels of economic growth are too anaemic to reduce the level of unemployment with its adverse effects upon both public expenditure and tax receipts," it stated.

BDO predicts that the Chancellor will comment on medium-term plan to close the fiscal deficit.

Most of the measures, it stated, will be delayed until after the General Election, not only for electoral reasons but also to attempt to protect any fragile economic recovery.

"The international debt rating agencies have already indicated that the outlook for UK government finances is negative and Mr Darling will need to provide a sufficient level of assurance to the markets."

In terms of potential tax rises from 2010-11, or possibly the following year, the Chancellor will need to focus on those taxes which already collect the largest sums. This means income tax, national insurance, VAT and customs duties, said BDO.

"Corporation tax revenues have collapsed in 2009-10 and the prognosis for their speedy recovery is very poor. The UK's corporation tax rate at 28% is already higher than many of our European competitors for in-bound investment, so the Chancellor will be unable to increase this rate and may well feel obliged to reduce it to 25%.

"We would be surprised to see major tax technical changes to corporation tax announced in the pre-Budget report and we consider that any tax reduction or new relief will be 'balanced' by restricting or removing existing reliefs."

BDO's report added that "the debt cap rules included in the Finance Act 2009 are an example of excessively complex tax legislation which has created economic distortions."

One area where the Chancellor may consider he has room for manoeuvre in corporation tax terms is the UK's relatively generous rules for the carry forward of tax losses against future trading profits.

The UK has no fixed time restriction for the carry forward of tax losses while many countries fix the carry forward at, for example, six years.

The Chancellor may be tempted to align the UK with other jurisdictions from April 2010, but BDO urged him to permit the tax losses accumulated up to March 2010 to be exempted from any additional restriction, recognising the ongoing effects of the credit crunch.

To support the financially challenged construction sector, BDO suggested that the Chancellor could reduce the VAT paid upon the repair and refurbishment of residential property to the lower rate of VAT – currently 5% or to the nil rate.

"The Chancellor may use the green agenda to justify supposedly 'targeted' tax increases.

"For instance, he could target the polluter and increase taxes on air travel and high polluting cars.  This might include an extension of the recently announced levy on energy to pay for Carbon Capture and Storage and the tariff supporting biogas and micro generation," BDO added.

"As well as wielding this stick, the Chancellor may offer some carrots such as increased tax credits available for capital investment in projects considered environmentally-friendly, such as waste-to-energy projects."

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