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What explanations can you offer for suggestions that the budget is likely to move into substantial deficit over the coming years?

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Introduction

Economic Environment. What explanations can you offer for suggestions that the budget is likely to move into substantial deficit over the coming years? The UK national budget is based on so-called economic cycles. Which in theory mirrors the 5-year term of a Government. In the event of a shorter government term then the 5-year cycle would need to be shortened accordingly. The article in the Times of October 25th 2002 refers to the growing belief that the model for the economic cycle 2002 - 2007 based upon predictions formed during the 1997 - 2001 economic cycle are no longer likely to be realised, thus plunging the hitherto projected budget into deficit. The current government committed its self to manage the economy according to the Maastricht criteria for fiscal convergence; also in 1998 it adopted two more important fiscal rules: 1. 'The Golden Rule' - over the economic cycle the government will only borrow to invest and will not borrow to fund current expenditure. 2. The 'Public Debt Rule' - the ratio of public debt to national income will be held over the economic cycle at a 'stable and prudent' level. ...read more.

Middle

For the Government spending less is not an option given its election pledge to improve public services. For the short term it seems that borrowing is the way the Chancellor plans to go, as he is relatively free to increase borrowing. The Government has paid back more than �50billion of its debt over recent years and it is easy to build it up again without any difficulties. However if money markets believe that Britain is heading into debt then it is likely that the government will have to pay more for its borrowings, which as a result could lead to rising interest rates across the economy, causing the housing market to take a fall, bringing recession closer which in turn will hit tax revenue. If you split the economy into four parts - investment, exports, consumer spending and government spending, it's the first two components that have failed to meet expectations. Businesses are still reluctant to buy new machinery or invest in new technology given the uncertain outlook, lack of finances and the excess capacity left over from the dotcom boom. Exports have also suffered because of the global downturn and the high pound - a serious blow to the economy since they contribute to around a third of GDP growth. ...read more.

Conclusion

Secondly, consumer pressure will create a market for cheaper imported goods, overall this may equalise tax income from the consumer sector, but it will undoubtedly further damage the demand for domestic manufactured goods and further reduce the tax revenue from this sector of the economy. Further, any reduction in output within the domestic economy will have associated job losses leading to lower levels of employment or increased levels of unemployment, in turn leading to higher social service costs and again lower individual tax income. The impact of increased taxation on manufacturing output and employment in the economy could be summarised as follows: 1. Increased corporation taxation will reduce competitiveness and hence low tax revenue, ultimately leading to reduced output, increased levels of unemployment and higher social services costs. 2. Increased personal taxation will reduce personal spending power, leading to lower demand on domestic production and/or an increased demand for cheaper imports, both of which will lead to lower tax revenues and ultimately increased levels of unemployment which in turn will reduce personal tax revenues and increase the social security budget. In other words, a self-fuelling phenomenon whereby increasing taxation outside of the levels that can be met by the national gross income will result in the need for further taxation to meet spending limits based outside the current national gross income capability. ...read more.

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