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Posted on March 19th, 2013, by

George Osborne released his Budget 2011 on 23 March 2011. He described the Budget as a Budget for Growth which he claimed is fiscally neutral. (Peters)
Interestingly this Budget unveiled a few surprises including reducing the headline Corporation tax rate by 2% instead of the planned 1%, reducing fuel costs, disappointingly he announced the 50% income tax rate is here for the interim but described it as temporary. (Osborne’s Budget to fuel growth)

He announced a number of new tax consultations including a review of integration of the income tax and national insurance regimes, introduction of a statutory tax residence test, first step of introducing some recommendations of the Tax Simplification Committee by abolishing 43 out of date reliefs, anti-avoidance provisions across a number of tax heads, etc.
Neutral budget definition

The term neutral budget helps to ease general public’s concern about budget spending.
It means that although according to its conditions bigger expenditures are required, it will in any case result in other savings and no new taxes or deficits will be incurred.

UK Budget 2011: general description and key mesures
The 2011 Budget of the Conservatives’ and Liberal Democrats’ coalition government confirms their commitment to stay the course on fiscal consolidation. Their efforts to restore the sustainability of UK’s public finances, however, remain complicated by the nation’s fragile economic growth. With persistent investor concerns regarding the health of government finances globally, and particularly in Europe, the success of the UK’s ambitious fiscal repair plan will remain at the centre of market participants’ attention and scrutiny.
The financial market response to the Budget was mixed, with the GBP down 0.7% versus the USD and 0.3% weaker versus the EUR. Meanwhile,10-year benchmark gilt yields declined 4 bps to 3.56%.

The measures outlined in the 2010 Budget last June remain largely intact. The cost of new policy decisions in this Budget are broadly offset with measures to raise revenues, and thus the Budget’s impact can be judged as broadly neutral, neither significantly tightening nor easing current fiscal restraint for fiscal 2011-12 or on average over the next five years.

UK’s budget deficit, after peaking at 11.1% of GDP in the FY2009-10 (April-March), is set to narrow to 9.9% of GDP (top chart) in FY2010-11, due in part to in-year spending cuts and the VAT hike. After a further decline to 7.9% in FY2011-12, the government plans to lower the shortfall further to 1.5% of GDP by FY2015-16; nevertheless, the deficit/GDP ratio will remain one of the highest among major developed countries over the next couple of years. Public Sector Net Debt is projected to increase from 60.3% of GDP in March 2011 to almost 71% by March 2014 (bottom chart), before declining ”” more slowly than earlier anticipated ”” to 70.5% of GDP in March 2015 and 69.1% in March 2016. (Peacock)

Neutral budget diagrams
Circular flow shows that the economy is divided into five main sectors: firms, households, government, financial markets, and the rest of the world. Arrows indicate flows of payments among the sectors. Circular flows re different for closed and opened types of economies. Open economy that is linked to the rest of the world through imports (a leakage) and exports (an injection). If imports exceed exports, the excess imports must be financed by a financial inflow from the rest of the world. If exports exceed imports, the resulting trade surplus will be balanced by a financial outflow. Total injections must equal total leakages (S + T + Im = I + G + Ex).

 

 

. Circular flow diagram
A “neutral”¯ budget means that the economy has a balanced current account and government budget; there is an approximate equilibrium where total investment equals total savings. It is shown that SAVING = INVESTMENT in this graph, which is one of the characteristics of “neutral”¯ budget meaning:
S+T
I+G

GDP* GDP
Resource income and spending are not always equal because of leakages. Flows out of the circular flow that occurs when resource income is, received and not spent directly on, purchases from domestic firms, saving, taxes, import purchases.
One of the leakage is imports. In everyday life, we are used to thinking of imports as goods flowing into the economy, so it might seem surprising to see imports represented as a leakage, not an injection. However, there is a simple explanation. The circular low represents flows of money, not flows of physical objects. The leakage represented by the “imports”¯ arrow could perhaps more accurately be labeled “payments for imports of goods and services.
The balance must come in the form of financial inflows from the rest, of the world, shown in the diagram by an arrow from the rest of the world to domestic, financial markets. The most common forms of financial inflows are borrowing from, foreign banks or other lenders, and sales of domestic securities like stocks or bonds to, foreign investors. At least some of these leakages are returned to the circular flow via various injections:
Ӣ Added spending in the circular flow that is not paid for out of current resource income;
Ӣ Investment;
Ӣ Government spending;
Ӣ Exports bought by foreign buyers.
If all the income is spent, businesses will sell all the goods and will be induced to produce all goods again.
It is not possible to explore every possible combination of the way leakages and injections balance, but some important variants are worth mentioning. One possibility is that a country can use a net financial inflow to finance a greater level of domestic investment than would be possible on the basis of domestic saving alone. For example, during much of the nineteenth century, the United States had a persistent trade deficit with Europe and, at the same time, a steady financial inflow that made possible the construction of canals, railroads, and other industrial infrastructure that underpinned the country’s rapidly developing economy. More recently, many of the new member states of the European Union are in the same position, with trade deficits and corresponding financial inflows that help finance their economies as they catch up with their wealthier Western European neighbors. In these cases, an external deficit can be a sign of strength, rather than weakness, for an economy.
Another possibility is that a country may use borrowing from abroad not to finance domestic investment but rather to finance a government budget deficit. In terms of the circular flow diagram, such a country would see funds flowing along the arrow from the rest of the world to financial markets, and from there, flowing directly along to the government through sale of government bonds to foreign buyers. A country in this position is said to suffer from the “twin deficit”¯ syndrome.

 

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