The Best Things In Life Are Three?

Justin mentioned the Three Chancellors last week. This reminded me that many good things come in threes. For instance there are the Three Wise Men, the Three Tenors, the Three Musketeers, the Three Degrees and of course the Three Wise Monkeys. The Three Wise Monkeys could see no evil, speak no evil and hear no evil, which takes me back to some of the traits demonstrated by our Three Chancellors in their TV debate a few weeks ago.

As Justin mentioned last week, we, as a nation, are in the ‘poo’ financially, but this seemed to have passed the Three Chancellors by, as they promised to be able to reverse increases in National Insurance, increase benefits for pensioners and pay for all this, and repay the accumulated deficit, by cutting wasteful spending. I am sorry, but I do not think there is that much wasteful spending to go around.

Ahead of the election spending promises like this are not a great surprise, but it is certainly not honest, and is the sort of behaviour that that makes the electorate cynical about self serving politicians. If we get the politicians we deserve, we must have been very naughty in the past.

The deficit this year is projected to increase by around £167Bn, but it is due to decline over the next few years as increases in National Insurance kick in and as the economy recovers. The government projects that the annual difference between tax raised and government spending will be a £74Bn deficit by the fiscal year 2014/15.

Now there are some economists who are slightly incredulous about this decline in the deficit as it assumes that the economy will grow by 16% over the next 5 years and it also assumes that tax revenues, including the coming increase in National Insurance, will increase by 34%. Well maybe the Treasury forecasters will be correct, but I suspect that all they will do is to make Mystic Meg look good.

However, let’s take a leap of faith and assume the Treasury economists are correct and we have a £74Bn deficit in 2014/15. I think we all know that it is a lot of zeros and commas, but I also think that we are so used to the television news talking in billions and trillions that we can lose sight of just how big a number £74Bn is.

Well in short, and going back to the theme of the threes, it is the amount we spend on Defence, Justice and the Home Office every year. Together these 3 departments’ spending adds up to around the £74Bn deficit we are projected to have in 2015.

If world peace suddenly broke out and we laid-off all our defence forces and ceased all our spending on buying tanks, ships, jets and limousines for army generals we would save around £50bn a year. If we could all settle our disputes without going to court and if all our criminals stayed on the straight and narrow and we closed down our justice system - our prisons, courts and probation services - we could save a further £10Bn a year. Finally, as we are such a Utopian society, if we laid-off everyone in the police, the UK Border Agency, counter-terrorism, the Passport Office, and related services we could save another £10Bn.

These three government departments will not disappear of course but it does illustrate just how large the cuts will have to be. The new government will clearly not be able to cut the deficit by cutting wasteful spending alone as was suggested during the Three Chancellors debate.

What will probably happen is that there will be large cuts in spending and large tax rises as well. As education and healthcare spending is going to be largely protected, the spending cuts will fall very heavily on the remaining big spending departments like Defence and Local Government.

It is perhaps interesting to consider what taxes might rise over the next few years. This is not pretty reading and I advise readers of a squeamish disposition to go on holiday to a suitable tax haven.

If the new government could double the rate of VAT it would raise about £70Bn a year, which might be enough to deal with the deficit, assuming no marginal diminishing returns and that the imposition of a 35% VAT rate does not plunge us into a second Dark Age.

More sensibly, raising the standard rate of VAT to 20% would raise around £11Bn a year, which could well make it a part of a combination of steps to address the deficit.

Slapping VAT on food would raise another £10Bn a year, but would be political suicide for whoever imposed the tax. I am not a headline writer, but I can imagine the headlines along the lines of ‘Chancellor puts tax on children’s food’. It seems to me that this is unlikely to happen. Our food is already expensive enough paying for French farmers.

Income tax may have to be raised. A penny on the basic rate of income tax would raise £4Bn a year, a very considerable sum, but pretty shabby in addressing the deficit, unless tax goes up a lot. Yet another penny on the higher rate of income tax would raise only £1Bn, but they may have to be hit again to mollify the vast majority of basic rate tax payers if the basic rate goes up.

The other often discussed tax increase is a change in Capital Gains Tax (CGT). A change is as possible here as so much else, but the sums that might be raised are very small relative to the size of the problem. A 1% change in the rate of CGT would raise only about £110 million a year. CGT would have to go up a lot to have any sort of impact.

Churchill was candid when he offered three things - ‘blood, sweat and tears’, but I am afraid the Three Chancellors are not statesmen of the same calibre and they, understandably perhaps, pulled their punches in their debate a few weeks ago. After the election it will be a different story.

***

And finally... Even a ‘living goddess’ is sometimes faced with tough decisions.

Chanira Bajracharya, 15, has been the Kumari or ‘living goddess’ of Patan, an ancient town south of Kathmandu, for nine years, blessing devotees at the temple and riding in decorated chariots 18 times a year during Hindu and Buddhist festivals.

Now, with her time as living goddess drawing to a close - the young virgin deities retire on reaching puberty - Bajracharya is contemplating a career in banking if she makes grades good enough to study commerce or accounting. Let’s face it, she can probably do just as good a job as some of those who were at the head of major banks in the credit crunch.

Have a good week.

Peter Sleep
Senior Investment Manager
Seven Investment Management Limited

For previous editions of our Weekly Update, please click here

This article represents a personal and light-hearted view from Director, Justin Urquhart Stewart of Seven Investment Management Limited, and is based on current financial news and events around the world. Its content should not be used for investment purposes and you should contact an independent financial adviser before making any investment or financial decision. Seven Investment Management Limited is authorised and regulated by the Financial Services Authority. Member of the London Stock Exchange. Head office: 23 Austin Friars, London EC2N 2QP. Telephone 020 7760 8777. Registered in England and Wales number 4092911. Registered office: 3 More London Riverside, London SE1 2AQ.