ITEM Club Foresees Tough Taxation Decisions

by Robert Lee, Tax-News.com, London

29 April 2005

The Ernst & Young ITEM Club spring forecast shows that the UK economy is looking strong, with growth back on track for the next twelve months. However, at the same time, the future government faces some difficult issues regarding taxation, with Chancellor Gordon Brown likely to breach his self-imposed 'Golden Rule' of borrowing only to fund investment.

According to the ITEM Club (Independent Treasury Economic Model), which is the only economic forecasting group to use the HM Treasury’s model of the UK economy, growth is now being buoyed by manufacturing and services and continued expansion in investment and employment, with earnings set to grow by nearly 5% by the end of the year.

“It is very hard to see a major weakening in either the housing market or the high street against the background of such a stable economy," observed Professor Peter Spencer, chief economic advisor to the Ernst & Young ITEM Club.

Nevertheless, Spencer believes that the Chancellor now has very little room for manoeuvre on fiscal policy. ITEM is forecasting a deficit of £12bn in 2005-06.

“The Golden Rule will yet be breached, despite the extra £3 billion leeway provided by the new treatment of spending on road maintenance,” suggested Spencer.

The ITEM Club forecast notes that the Treasury is relying heavily on corporate recovery and fiscal drag to boost its tax take by £6 billion in 2005-06. Moreover, this forecast is reliant upon hefty increases in company tax payments, which are under pressure following the recent judgment by the European Court of Justice on Marks & Spencer.

What's more, Spencer points to "a cold blast of tax competition" emanating from the newly acceded EU states, which could limit the government’s ability to boost its deficit.

Poland and Slovakia are both introducing low flat-tax systems and the German government is already planning to cut corporate tax and reform its tax system in response.

“The City is not going to decamp en masse to Bratislava overnight, but they could start by taking more of their profits in Frankfurt,” noted Spencer.

“The government approaches an election with the economy in pretty good shape. From May 6, however, there will be come real challenges that have to be addressed quickly and competently, or the UK faces longer term economic stagnation," he concluded.

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