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Market Update

Full impact of the financial crisis still to come

The meltdown of the financial sector will take a large bite out of the government's tax revenues, according to new research

Holly Cook 19 March, 2009 | 9:23AM
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Alastair Darling’s budgetary hopes are set for a big knock as the financial sector collapse will mean more than 40% is slashed from the Treasury’s tax revenues in 2009/10, new research has shown.

A study by the Centre for Business and Economics Research (cebr) released this week claims that while the recapitalising of the banks and the asset protection schemes have attracted the most attention, it is the collapse in revenues that is the greatest risk to the government’s finances in the post-credit crunch era.

The cebr said their study corroborates recent research from Kenneth Rogoff and Carmen Reinhart, which found that the real value of public debt tends to explode after a financial crisis as governments suffer a collapse in tax revenues in the wake of deep and prolonged output contractions, exacerbated by “often ambitious countercyclical fiscal policies aimed at mitigating the downturn.”

Taking Price Waterhouse Coopers’ estimate that the financial service sector generated £67 billion in tax revenue in 2006/07 as its starting point, the cebr claims that huge losses across the sector, job and bonus cuts, together with the fall in interest rates paid, will lead to a dramatic reduction in Darling’s tax revenues to around £39 billion in the financial year 2009/10. “Moreover, some of these hits are likely to be long lasting,” the report said, pointing out that the scale of the losses that the banks can bring forward means that they will have to pay little corporation tax for many years.

For 2009/10, cebr calculates the Chancellor is set to lose out on £9 billion in corporation tax and £10 billion from smaller income tax and National Insurance contributions, as well as reductions in stamp duty and other sources of tax income from the financial sector.

The research group forecasts job numbers and bonuses will remain depressed until at least 2013, but said that there is little evidence that the longevity of the problem is yet fully understood by the Treasury.

“There is scope for argument about whether the bank bailouts represent real public spending, since it is more than likely that the government will eventually get most or even all of its money back,” the report said. “But this loss of tax revenue is a real long term revenue hit—equivalent in scale to 29% of the NHS budget, 57% of the schools budget, or 79% of the defence budget.”

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Holly Cook

Holly Cook  is Manager, Morningstar EMEA Websites

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