Goldman Sachs Says Joining The Euro May Cost 3p On UK Income Tax

by Jason Gorringe, Tax-News.com, London

25 February 2003

A report out today by investment bank Goldman Sachs has concluded that a significant tax increase may be necessary should the UK decide to adopt the euro in the next year. The bank has warned this could be as much as the equivalent of 3p on the basic rate of income tax.

According to the report, the pound would be effectively devalued in order to meet the entry criteria for joining the euro, and this could have serious implications for fiscal policy, which may require tightening to the tune of 1% of GDP. This equates to the Treasury having to find an extra £10 billion in tax revenue.

Though the pound has fallen considerably against the euro in recent months, reaching a near four year low of £0.6828 last week, Goldman says that the rate would have to reach £0.73 before sustainable convergence could be achieved. Consequently, the bank says, there is a risk of an inflationary boom (assuming a deeper recession is avoided) and considerable fiscal tightening will have to be used to curb potential demand. The UK will be unable to utilise interest rates as a counter-inflationary tool once it has entered the single currency.

Given that an acceptable exchange rate differential is among Chancellor Gordon Brown's five key economic tests, it is likely to fuel speculation that, for now, the government will be reluctant to fully commit to joining the euro, at least in the short term. A source from the bank confirmed "our central expectation is that the Treasury will conclude that the timing is not yet right, in part because of concerns about transitional economic issues."

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