Tax Analysts Blog

A Tale of Two Budgets

Posted on Dec 14, 2009

Despite all the hullabaloo over the proposed one-time 50 percent tax on bank bonuses, the controversial "supertax" is not the most important feature of the December 9 preview of the UK budget. It's what the report did not say that deserves our attention. In the face of upcoming elections in the spring, the Labour government declined to include significant cuts in government programs. One analyst from Barclays Capital commented: "The lack of detail on spending cuts is a big concern for investors." The Financial Times reported: "Bond markets took fright at what was seen as the timidity of the UK government's fiscal consolidation plans." So, on the day of the report's release the risk premium on U.K. bonds--as measured by the difference in yield between U.K. and German 10-year bonds--jumped 16 basis points.

On December 9 the Irish government also released its budget plan--"the most painful budget in a generation." In contrast to the timidity of the UK budget, FT characterized Ireland's budget as: " . . . brutal. Masochistic even. But, sadly, it is also necessary." As a result, Irish bond yields fell 17 basis points, according to the FT.

These days the market for sovereign government debt is especially jittery because of the two-week old debt crisis in Dubai and because of the collapse in prices of Greek government bonds last week. And on top of this there are underlying fears throughout financial markets that we may be in the midst of a liquidity fueled asset bubble that could deflate next summer if the Fed starts cutting its unprecedented support of financial markets and lets interest rates rise.

The pressure from bond markets on governments to reduce their deficits was also a subject of an article in this morning's New York Times. Putting matters into context for U.S. readers, the Times points out that it was the influence of powerful "bond vigilantes" in financial markets that motivated President Clinton to push for deficit reduction in 1993.

But for the time being deficit reduction in the United States has been put on hold due to the recession. That's understandable. But the prospects for future deficit reduction are not bright. The Obama administration talks the talk, but they have yet to demonstrate a commitment to deficit reduction with action. For example, the President has given no indication that he objects to congressional plans to pay for a jobs bill with unused TARP funds or to allow Congress to issue $234 billion more of debt to pay for permanent estate tax relief.

Don't pin your deficit-reduction hopes on the special bipartisan panel for deficit reduction proposed by Senators Conrad and Gregg. The well-intentioned plan is running into stiff opposition from, for example, House Speaker Nancy Pelosi and Senate Finance Committee Chairman Max Baucus. Pelosi and Baucus don't want such a commission to circumvent current congressional procedures where they wield so much power. So there is one question we must get Pelosi and Baucus to answer: if they do not support Conrad-Gregg, what is their plan for addressing unsustainable federal deficits?

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