Want to know how painful it will be to get the U.S. budget deficit under control? Take a look at the new austerity budget in the UK

06/23/2010 2:00 pm EST


Jim Jubak

Founder and Editor, JubakPicks.com

Maybe it’s their weather. But for whatever reason the Brits are really good at creating dystopias, those worst of all possible worlds.

1984. A Clockwork Orange. And now finance minister George Osborne’s austerity budget.

The plan announced yesterday projects roughly $170 billion a year in budget cuts and new taxes that are projected to reducethe United Kingdom’s budget deficit from 10% of GDP this year to roughly 2% of GDP by 2015.

The cuts and taxes--$60 billion from the new Conservative-Liberal coalition government plus $110 billion from the Labor government defeated in May elections—amount to roughly 6% of the country’s GDP. (That’s roughly equal to cuts and taxes of $840 billion in the much bigger U.S. economy.)

Wall Street projections suggest that the U.S. needs budget cuts and taxes that range from 3% to 6% of GDP to get its financial house back into something like order.

If you want to know what that would feel like, take a look at Osborne’s budget. That’s what dystopias are for, after all.

Some of the highlights:

  • An acceleration of the planned increase in the age to qualify for a government pension to 66.

  • An increase in the Value Added Tax (VAT) to 20% from 17.5%.

  • A two-year pay freeze for government workers

  • A 28% capital gains tax for high income taxpayers

  • A three-year freeze on child benefits

  • A 25% cut in the budget for all government departments except for foreign aid and health care spending

One potential horror that the plan doesn’t include is the possibility that it won’t work.

Osborne has said that the cuts and taxes are necessary if the United Kingdom is to avoid the fiscal crisis that has engulfed Greece, Ireland, Portugal, and Spain.

True enough. And if the United Kingdom can convince the bond market that it is serious about tackling its budget deficit, then the country will escape the worst of the huge surge in interest rates that the crisis has set off in other countries and the United Kingdom’s banks will avoid being frozen out of international markets for short and long-term funds.

The plan envisions that, after a very short-term hit to economic growth—growth will be 1.2% this year—putting the country on a sound financial footing will yield enough dividends to push the economic growth rate up to 2.3% in 2011 and 2.8% in 2012 and 2.9% in 2013.

Could be.

But these projections seem, well, utopian.

The plan projects that cuts and taxes of 6% of GDP won’t actually push a weak UK economy off a cliff in 2010. In the first quarter of 2010 the UK economy grew by just 0.3%. That was low enough so that the government had to issue soothing words saying that it still expected growth of 1% to 1.5% in 2010.

That was before the cuts and taxes in the most recent budget plan.

If growth in the near term comes in lower than projected, and that then leads to a slower recovery in the out years and lower tax revenues, then the plan for all its pain won’t reduce the government’s budget deficit to the 2% of GDP target by 2015.

And instead the United Kingdom will be looking at still more cuts to balance its account.

That’s the trouble with dystopias. It’s almost always possible to imagine an even darker future. (For my own vision of a long-term global dystopia see my post http://jubakpicks.com/2010/05/25/get-used-to-it-the-global-debt-crisis-will-play-out-over-and-over-again-in-the-next-decades/ )
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