The emergency Budget was one of the most talked about and feared Budget statements in UK history.
Since the election early last month, the new coalition Government has been keen to manage expectations about the tough challenges that a record Budget deficit presents. From this perspective it probably succeeded in instilling the fear factor into the population.
In many respects, however, it was not as bad as it could have been.
For example, the anticipated rise in VAT to 20% is deferred until January 2011, the increase in capital gains tax was not as large as expected and there were no rises in fuel, alcohol or tobacco duties.
Furthermore, yesterday’s Budget was nowhere near as severe as the painful medicine that has been administered in the Republic.
Nevertheless, yesterday’s policy announcements overall are unambiguously negative for the Northern Ireland economy.
The local economy is a public expenditure-driven economy and is therefore more sensitive to changes in public expenditure than other UK regions. The decision to freeze public sector pay for two years, from next April, for those individuals earning more than £21,000 will affect a significant proportion of Northern Ireland’s 220,000 public sector workers.
In reality this amounts to a pay cut in real terms with inflation, using the retail prices index (RPI), expected to top 4% in 2011. A review into public sector pensions is already under way and it is anticipated that employees will have to increase their contributions through a pension levy.
Again, such a move would in effect represent a pay cut.
Declining public sector incomes will have a knock-on effect to consumer sensitive sectors such as retail, hotels and restaurants.
Northern Ireland’s retail sector has already begun to experience a tailing off in cross-border shoppers as falling prices in the Republic coupled with a strengthening in sterling relative to the euro has made Northern Ireland’s retail offering less attractive to RoI shoppers.
Consumer demand, both domestic and cross-border, will be further reduced with the rise in VAT to 20% in January 2011. This will increase the cost of goods and services outside of the zero-rated items such as food, children’s clothes, newspapers and books.
Meanwhile, the Chancellor wielded his axe with some welfare benefits squeezed. Child benefit payments are to be frozen for the next three years and working families’ tax credit will be reduced for families earning more than £40,000pa.
Low income families, however, will receive more tax credits. On a positive note, from next year the basic State pension will be linked to earnings and will rise by a minimum of 2.5% from next year. As a result pensioners are one of the few groups to see tangible benefits. In addition, those individuals under 65 on low incomes will benefit from a rise in the income tax threshold by £1,000 to £7,475. Up to this level no tax will be paid.
Finally, the business community will welcome the planned staged reductions in corporation tax over the next four years. However, Northern Ireland will be pinning its hopes on a more significant reduction in corporation tax and will be eager to learn what incentives a possible ‘Enterprise zone’ status could bring.
The Government has promised a consultation paper this autumn on how to rebalance the Northern Ireland economy away from the public sector to the private sector. In the meantime, the next round of fiscal austerity will take place on October 20 when the scale of the public expenditure cuts facing the UK and Northern Ireland will become clear. Overall, Northern Ireland is expected to experience cuts of around £1.5bn over the next four years. Unfortunately things are going to get worse before they get better with the human recession set to continue for some time yet.
Richard Ramsey is the chief economist of Ulster Bank