The 2003 Budget: slower growth, higher borrowing

Chancellor Gordon Brown's 2003 Budget, delayed due to the war in Iraq, was delivered against a background of a sluggish economy and falling tax receipts. As a result, there was a further downward revision to growth forecasts and an upward revision for borrowing.But, says the Chancellor, better times are on the way.

Key points Basic rates of income tax unchanged. Calls for greater labour market and wage flexibility, notably in the public sector. Measures introduced to boost employment and training. Economic growth forecasts pared back to between 2% and 2.5% for 2003.

In a Budget variously described as "dull", "sotto voce" and a "huge gamble", the Chancellor of the Exchequer, Gordon Brown, delivered a steady, cautious hour-long speech with few surprises for householders, businesses, or indeed the City¹. Against a backdrop of global economic uncertainty and hostilities in Iraq, the Chancellor pared back his growth forecasts and increased borrowing to tide the UK economy over what, he maintains, is just a temporary hiccup. Once a world recovery takes hold, the domestic economy will spark back into life, Brown maintains, boosting the hitherto sluggish tax revenues needed to fund the government's ambitious public spending plans.

Overall, the 2003 Budget was fairly light on new announcements of interest to pay and employment practitioners. Most of the measures that took effect from April this year were actually announced in the 2002 Budget. Of perhaps greatest impact is the one percentage point increase in employee's National Insurance contributions (NICs) on all earnings above £89 a week, effective from 6 April 2003. This raises employee contributions from 10% to 11% on earnings between £89 and £595 a week. The increase is not capped at the upper earnings limit (UEL), which means that employee NICs, set at a rate of 1%, are now payable on all weekly earnings above £595. In addition, the lower earnings limit in respect of NICs has been frozen at £89 a week.

From 6 April 2003, employer NICs increased from 11.8% to 12.8% on all employee earnings above the £89 threshold. There is no upper limit on employer contribution rates.

This year's Budget also included:

a rise in the 10% starting-rate income tax band for 2003/04, from, £1,920 to £1,960;

an unchanged personal income tax allowance, frozen at its April 2002 level of £4,615 a year;

a review of the case for the national minimum wage to be extended to 16- and 17-year-olds, who, at present, are not covered by the statutory pay floor;

the introduction of the working tax credit, which replaces the working families' and disabled person's tax credits;

the introduction of a new child tax credit;

a reduction in the CO₂ emissions qualifying for the minimum company car tax charge, effective from April 2005; and

consultation on the extension of employer-provided, safe, high-quality, childcare.

Encouraging labour market flexibility

A good deal of space in the documentation accompanying the 2003 Budget is devoted to the promotion of labour market flexibility. According to the government, "in a globally competitive market, full employment can be achieved only by creating a more flexible and dynamic economy . . . Flexibility and fairness in the labour market are not opposites but complements; labour market policy can and must promote both."

In the Treasury's view, wage flexibility will play a crucial role in turning vision into reality. This will require pay levels to "respond flexibly to shocks and to imbalances between supply and demand". This has not always been the case inthe UK, it argues. Historically, real wages have tended to be rigid in the face of high levels of unemployment, but have grown strongly when employment levels increase.

The government argues that relative wage flexibility - the extent to which pay rates vary between different sectors or regions in response to changing conditions - also needs to be sufficiently high to provide incentives for workers to move in response to structural changes within the economy. Flexible relative wages, it says, reduce the likelihood of a mismatch between labour supply and demand occurring at the sectoral or regional level. According to the Treasury, there is "considerable scope" for a variation in wage setting behaviour between individual industries and regions, and this responsiveness has indeed increased over time, it states.

Public sector pay lacks "responsiveness"

However, the fact that pay setting in the private sector is largely decentralised means that it is relatively easy to encourage wage flexibility, whether regionally or by sector. But, as the 2003 Budget documentation points out, the same is not true in large parts of the public sector, where what the Treasury describes as "institutional constraints" - a coded term for national pay determination - remain.

Indeed, government studies have found that public sector wages vary far less between regions outside London than those in the private sector. This has led it to conclude that there is "significant scope" for using wages and other terms and conditions as a vehicle to encourage greater"flexibility and responsiveness" within the public sector. This is particularly important, as the Budget documentation makes clear: "the government aims to use pay as part of its package of reforms to improve public service delivery. In reaching decisions . . . the right balance needs to be struck between rewarding people appropriately for their skills, and setting pay at reasonable rates that are consistent with economic stability."

Although many recent public sector deals have reflected these principles, the government is keen to extend this concept still further. With this in mind, it is to amend the remit of the various pay review bodies to "include a stronger local and regional dimension".

This line of thought has already provoked a sharp reaction from public sector trade unions, keen to protect nationally negotiated terms and conditions. Dave Prentis, general secretary of the UK's largest union, Unison, said that regional pay bargaining is a "stupid idea", adding that employees "should be paid the rate for the job regardless of where they live". The joint general secretary of Amicus, Derek Simpson, suggested that while the plan for the Office for National Statistics to publish regional inflation figures would be useful where local pay negotiations already take place, steps would have to be taken to ensure that the data would not be used to effectively "destroy national bargaining in the public services".

"Flexibility and fairness" for the unemployed

The 2003 Budget did include a number of measures to boost employment. For example, unemployed people who have been out of work for more than 13 weeks, and who are in receipt of the Jobseeker's Allowance, will now have to look for work within a 90-minute travel-to-work area, compared with the current 60-minute radius. All those out of work will also have to increase the number of job applications they make in return for benefit, and the unemployed partners of claimants will also be encouraged to find work.

Jobcentre managers are to be given discretionary powers allowing them to respond to specific, localised, skill shortages by, for example, providing training grants and help with travel to interviews, as well as direct cash support to bridge the transition between benefit and work. In return for greater local freedoms, Jobcentre managers will be subject to a new performance system designed to provide higher rewards for those deemed to have achieved against targets. However, there is a sting in the tail - those who fail may be replaced.

Drawing on a new fund, Jobcentres will be able to tackle the particular barriers facing people from ethnic minorities, who often miss out on employment on the grounds of race.

In another measure to encourage the move from welfare to work, from April 2004, men and women taking up jobs will no longer be required to submit a new claim for housing benefit. Instead, they will simply inform their local housing benefit office of the change in their circumstances and, until benefits are recalculated, they will continue to be paid the out-of-work rate.

Wanted - skilled migrants

The government introduced a Highly Skilled Migrant Programme (HSMP) in 2002, designed to attract high-calibre workers from overseas. In the first year of operation, around 1,300 skilled workers entered the UK through the HSMP to seek and take up employment.

This scheme is now to be expanded by adjusting the threshold eligibility criteria; introducing a new category for younger applicants; and taking into account a partner's achievements when assessing individual applications. These new qualifying criteria will come into effect from August 2003.

There is also to be a new entitlement for foreign students starting or continuing courses in science, technology, engineering and mathematics to work following graduation from a British educational institution. From the summer of 2004, they will be entitled to work in the UK for a period of up to 12 months.

In addition, the Chancellor announced that, from May 2003, additional help would be available to firms in the food processing and hospitality industries who are finding it increasingly difficult to recruit unskilled staff. Employers will now be able to apply for 12­-month work permits for an initial annual quota of 10,000 migrants for each of the two sectors. However, companies taking advantage of this facility will be expected to provide suitable accommodation and support for workers employed under the scheme.

Training given a boost

Gordon Brown has previously stated that he wants the UK to compete in world markets on the basis of high skills, rather than low pay. In support of this aspiration, he confirmed his commitment to life-long learning, adding that this is a "classic case of social justice building economic strength".

As announced in the 2002 Pre-Budget Report, the government is to provide an additional £130 million in England to extend the Employer Training Pilots (ETPs) to a further six local Learning and Skills Council areas in Berkshire, East London, Kent, Leicester, Shropshire and South Yorkshire². ETPs were launched in September 2002 to explore ways to counter the "financial barriers, time constraints and information failures" that often prevent people and businesses from accessing relevant training. Across the original six pilot schemes, employers are now encouraged to provide low-skilled workers with paid time off to train. The government is currently evaluating the effect of the subsidies it offers to cover the costs involved, as well as the provision of free training courses up to NVQ level 2.

Elsewhere on the training front, a union learning fund (ULF) has been operating since 1998. Thus far, more than 350 projects have been supported, ranging from the provision of basic skills through to continuing professional development. The ULF has also helped to establish and train a national network of more than 4,500 trade union learning representatives who promote the concept of education at the workplace. In recognition of the success of this scheme, the Chancellor has decided to increase funding by some 30%, taking it from £11 million in 2003/04 to £14 million in both 2004/05 and 2005/06.

Better days ahead

Since the publication of the Treasury's 2002 Pre-Budget Report in the autumn of last year, world economic instability has continued, with confidence buffeted by the possibility and then outbreak of hostilities in Iraq. Despite the robust performance of the domestic economy in recent times, it was almost inevitable that global uncertainty would have a negative impact on the UK, and so it has proved.

Put simply, the 2003 Budget is, as many commentators have pointed out, something of a gamble. Although the Chancellor has pared back his forecast for economic expansion for this year, and increased borrowing to cover a shortfall in tax revenues, he has stuck to his original growth projections for 2004 and 2005. If he proves to be right, then everything will be back on track, and this will have been just a relatively minor setback for a UK economy that has enjoyed the longest period of sustained expansion on record. The problem, and possible crunch in terms of future tax increases, will come if the domestic economy fails to bounce back. This is, in the words of one City analyst, a "double or nothing" strategy.

The key projections around which the 2003 Budget is based are as follows:

Inflation: the Chancellor pointed out that, before the Bank of England become independent, the pre-1997 inflation target on the government's preferred measure (the Retail Prices Index excluding mortgage interest payments, known as RPIX) was 2.5% or less. However, market expectations of UK inflation were almost double this figure, at around 4.5%. Now, he noted, there is a "symmetric" inflation target of 2.5% over the next five, 10 and 25 years, and "the markets expect inflation to be exactly that".

Growth: in November 2002, when the Pre-Budget analysis was issued, the UK economy was forecast to expand by between 2.5% and 3% in 2003. However, a continued weakening in global demand has led to a further downward revision in the Treasury's growth projections, with gross domestic product (GDP) expected to grow by between 2% and 2.5% this year. On the upside, the government is predicting that the second half of 2003 will see a more stable world economic climate. This, in turn, will spark a recovery in UK business and consumer confidence, it forecasts, leading to projected GDP growth of between 3% and 3.5% in both 2004 and 2005.

Taxation and spending: the main tax rises that took effect in April 2003, such as the increase in employer and employee NICs, were actually announced in the 2002 Budget. A freeze in the personal income tax allowance for those aged under 65 was also announced last year. By pegging it at £4,615, the Inland Revenue draws more workers into the taxation net, and takes in an additional £650 million as a result. In terms of expenditure, weakening domestic demand has led to a hole in the Chancellor's ambitious public spending plans, also announced last year. In addition to current commitments, the Chancellor has set aside an additional £3 billion to meet the cost of the war in Iraq, and a further £330 million to aid the fight against terrorism. In total, public spending is set to reach £395 billion in 2002/03, rising to £422 billion in 2003/04.

Deficit: an inevitable consequence of economic slowdown is a fall in tax revenues, and this is reflected in the latest Treasury arithmetic. This reveals a budget deficit of £11.7 billion for 2002-03, compared with a deficit of £5.7 billion forecast in the 2002 Pre-Budget Report, and an actual surplus of £3.2 billion at the time of the April 2002 Budget. However, Gordon Brown still maintains that he is on course to meet the "golden rule" on fiscal stability over the current economic cycle between 1999/2000 and 2005/06. This states that the government borrows only to invest, and that such investment does not lead to unsustainable debt.

1.Budget report 2003: building a Britain of economic strength and social justice, available free of charge from www.hm-treasury.gov.uk.

2.Steering a steady course: delivering stability, enterprise and fairness in an uncertain world, pre-Budget report 2002, available free of charge from www.hm-treasury.gov.uk.

The 2003 Budget: main changes related to pay, benefits and employment

National insurance

Far-reaching reforms of the national insurance system were announced in the 2002 Budget. These have now flowed through to 2003 as follows:

the lower earnings limit, the point at which NI contributions (NICs) start, is frozen at the April 2002 level of £89 a week for both employers and employees;

the upper earnings limit on employee contributions rises by £10 a week to £595. This means that, from 6 April 2003, employees now pay NICs set at 11% on weekly earnings between £89 and £595. In addition, employees now pay NICs set at 1% on weekly earnings above £595; and

employer NICs, paid on employee earnings above £89 a week, are set at 12.8%. There is no upper limit on employer contribution rates.

See table 1 for details of the new NIC rates.

Income tax

The changes to income tax, which took effect from 6 April 2003, are as follows:

the basic personal allowance (the first part of income on which no tax is paid) remains frozen at £4,615 a year. This draws more employees into the income tax net, and will raise an additional £650m a year for the government;

the starting rate threshold (the point at which workers begin to pay the 10% tax rate) increases in line with inflation from £1,920 to £1,960;

the basic rate of income tax remains unchanged at 22%, and is payable on annual taxable income between £1,961 and £30,500; and

the higher rate of income tax remains at 40%, while the threshold for the payment of the higher-rate increases in line with inflation, and now applies to all income over £30,500 a year.

See table 2 and table 3 for details of income tax rates and revised allowances.

National minimum wage

An increase in the national minimum wage has already beenannounced, and it will rise from October 2003 to £4.50 an hour for adult workers aged 22 and over and, subject to a review by the Low Pay Commission, it will rise again to £4.85 an hour from October 2004. For workers aged between 18 and 21, and for trainees, the rate will rise to £3.80 an hour in October 2003 (£4.10 from October 2004). Interestingly, as part of a wider analysis of the training, pay and employment needs of young workers up to the age of 19, the Chancellor announced a review of the case for a minimum wage to be extended to 16- and 17-year olds who, at present, are not covered by any statutory pay floor.

Working tax credit

The working families' and disabled person's tax credits have now been replaced by the working tax credit (WTC). Alongside the minimum wage, it is designed to tackle persistent poverty among those in employment. From October 2003, a family with one child and one earner working full-time on the NMW of £4.50 an hour will have a guaranteed minimum income of £241 a week. For a single-earner couple aged 25 or over and working full-time on the NMW, the guaranteed minimum weekly income will be pitched at £187.

Child tax credit

A new child tax credit (CTC) is introduced from April 2003 that, according to the government, will help more than five million families.It replaces the child elements of the working families' tax credit, the disabled person's tax credit, income support or jobseekers' allowance, and the children's tax credit. Paid on top of child benefit and directly into the bank account of the main carer, the CTC provides a family element of £545 a year (£1,090 for families with a child under the age of one) for all families with incomes of less than £50,000 a year, gradually tapering off for those with incomes above this level. It also contains an element of £1,445 a year for each child or young person in families with annual incomes of up to around £13,000, again gradually tapering off for families with incomes above this threshold. From April 2004, the child element of the CTC will be uprated at least in line with earnings (rather than prices) for the rest of the current parliament.

Company cars

Since April 2002, the taxation of company cars has been based on exhaust emissions, rather than the number of miles travelled. Charges range between 15% of the car's list price, up to a maximum of 35%. As a result of the Budget, the level of CO₂ emissions qualifying for the minimum company car tax charge will reduce by 5g/km to 140g/km from 6 April 2005. The percentage charge rises in 1% steps up to the 35% maximum. The level of CO₂ emissions relating to each percentage charge will also fall by 5g/km from the same date. Motor mileage rates remain unchanged.

Work-life balance policies

Other, previously announced, measures to improve the work-life balance came into force from April 2003, including an increase in flat-rate statutory maternity pay (SMP) to £100 a week. New and expectant mothers can take 26 weeks' ordinary maternity leave, and a further 26 weeks' unpaid additional maternity leave, providing up to one year's leave in total. Adoptive parents now have comparable rights and, for the first time, new fathers also have the right to take two weeks' paternity leave, paid at the same flat rate as SMP.

The government is also consulting on proposals to encourage employers to help their staff meet the costs of safe, high-quality childcare. These include extending the current tax exemption to cover any formal registered childcare contracted for by the employer; a new tax exemption for childcare vouchers; and a rule to ensure that schemes should be generally accessible to all employees. From April 2003, the income tax charge that arises where employers contribute to additional household costs incurred by employees working at home is abolished.

Table 1: National Insurance contributions, 6.4.03¹

WEEKLY EARNINGS	% NATIONAL INSURANCE RATE FOR EMPLOYEES
Up to £89	Nil
£89.01 to £595	11%
Over £595	1%
	% NATIONAL INSURANCE RATE FOR EMPLOYERS
Up to £89	Nil
Above £89	12.8%

¹NICs to be paid on all taxable benefits in kind excluding childcare.

Table 2: Income tax rates from 6.4.03

TAX RATE	BANDS OF TAXABLE INCOME
Starting rate (10%)	Up to £1,960
Basic rate (22%)	£1,961-£30,500
Higher rate (40%)	Over £30,500

Table 3: The Budget - key personal finance changes

ALLOWANCES	£ PA
Income tax - tax year from 6.4.03
Personal allowance	4,615
Blind person's allowance	1,510
Income limit for age-related allowances	18,300
	£PW
National insurance - effective 6.4.03
Lower earnings limit	89
Upper earnings limit	595