UK Treasury chief juggles budget as outlook dims

LONDON (AP) -- Britain's Treasury chief George Osborne said Wednesday that the recovery of the U.K. economy is taking longer than he had hoped and warned more spending cuts will be needed to get public finances under control.

With official growth forecasts cut, Osborne had little room for maneuver but said he was trimming departmental spending to generate more investment in infrastructure.

"It has taken time, but the British economy is healing," Osborne told the House of Commons, though the latest estimate from the independent Office for Budget Responsibility forecasts a 0.2 percent contraction in the economy this year.

In his scheduled update to budget policies, Osborne essentially stuck to his plan of cutting government deficits to promote recovery. But he did accept to increase investments to stimulate employment and demand, as called for by the opposition Labour Party.

Osborne said the paltry recovery in the U.K. and a recession in the 17 European Union countries that use the euro will mean Britain's economy would only grow by 1.2 percent next year, down from the 2 percent it predicted in March.

"It's not the rest of the world's fault, it is your policies which have failed," said Ed Balls, speaking for the Labour Party.

Osborne confirmed that his target for public sector debt to start dropping as a percentage of GDP by 2015-2016 has also been pushed back a year.

Fitch, the U.S. rating agency, said Wednesday that the missed debt target would weaken "the credibility of the U.K.'s framework" and warned that the country's cherished AAA rating could be under threat of a downgrade. The agency will conduct a further review of the rating after the chancellor's spring budget in 2013.

"Today was the day (Osborne) started to acknowledge that this is a long-tail recovery rather than a trampoline bounce back to good times," said Scott Corfe, senior economist at the Center for Economic and Business Research.

As a result of the revised forecasts, government spending will be cut a further 1 percent next year and 2 percent the year after. As well as spending cuts, Osborne also announced a cut in tax relief on the pensions of higher-rate tax payers and a cap on welfare payments.

The taxation and spending measures announced Wednesday were forecast to yield an additional 3.9 billion pounds ($6.3 billion) to government income this year. Some 3.5 billion pounds of that sum is expected from a one-time auction of 4G mobile telecoms licenses.

Osborne announced that the government would crack down on tax avoidance, increase infrastructure investment by 17 percent, raise tax deductions for capital investment by businesses 10-fold and cut corporation tax to from the current 22 percent to 21 percent in 2014-15. Osborne said this compares with corporation tax of 40 percent in the U.S., 33 percent in France and 29 percent in Germany.

Economists noted the investment projects would help to create jobs, though some suggested the overall impact on the economy would be negligible.

Toby Ryland at HW Fisher & Co. chartered accountants said Osborne was supporting the corporate sector at the expense of ordinary taxpayers. "The reduction in corporation tax is being funded through below-inflation increases in (personal) tax bands and the restriction of pension tax relief," he said.

Households were promised an increase in the personal exemption from income tax and, for the elderly, a 2.5 percent boost in the basic state pension to 110.15 pounds a week.

Banks were excluded from the lower corporation tax, and the government is increasing the Bank Levy — a tax on the balance sheets of banks — to 0.13 percent to keep annual revenue at 2.5 billion pounds.

The Treasury also estimates that it will be able to recoup up to 5 billion pounds in lost tax by 2015-16 thanks to a new agreement with Swiss banking authorities.

Osborne also announced several capital investment projects including tax incentives to promote the production of shale gas. At the same time, the Department of Energy and Climate Change announced plans to build more gas-fired generating plants to replace aging coal, nuclear and gas plants. A 1 billion pound loan was also announced to extend the London tube network.

"While the U.K.'s safe-haven status still looks secure, today's statement does nothing to alter the poor fiscal and economic outlook," said Vicky Redwood, chief U.K. economist at Capital Economics.

Osborne said the government was considering allowing stocks and shares ISA (tax-deferred individual savings accounts) in smaller stock markets such as AIM, which lists smaller companies with less traded shares.

Flora Maudsley-Barton, director of Parsonage Financial Planning, called the idea "borderline crazy."

"The vast majority of investors don't understand 'illiquid,' but they will do so very quickly if they go down this route," she said.

Coming days will tell whether any parts of the budget plans backfire against the government, as happened with the budget announced in May.

Osborne then presented a series of unpopular measures that not only gave a tax cut to the wealthiest taxpayers, but eventually led to embarrassing reversals on his plans to raise taxes on hot meat pies, reduce tax relief for charitable donations, and to go ahead with a hike in the tax on auto fuels.