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British government slashes spending

British finance minister George Osborne produced the harshest budget in a generation on Tuesday, slashing spending, raising taxes and slapping a levy on banks.
/ Source: Reuters

British finance minister George Osborne produced the harshest budget in a generation on Tuesday, slashing spending, raising taxes and slapping a levy on banks in a drive to cut a record budget deficit to almost nothing in five years.

The 39-year-old Conservative Chancellor of the Exchequer said government spending would fall by around 25 percent over four years and announced VAT sales tax would go up to 20 percent from 17.5 next year, with a new 2 billion pound levy on banks introduced at the same time.

Nearly a million of the poorest paid people will be taken out of the income tax net altogether by raising its starting point and the headline rate of corporation tax will drop by one percentage point to 27 percent next year and then keep falling.

Gilts rallied on the coalition government's new plans to cut the deficit which are likely to go some way to assuaging rating agencies' concern given the sovereign debt crisis spreading through the euro zone.

Rating agencies had warned Britain's triple-A status could be at risk if Osborne's plans to cut the record deficit of 11 percent, close to that of Greece, were found wanting.

Osborne said just over three-quarters of the tightening would come from spending cuts and the rest from tax rises. Welfare payments would be targeted and even the expenditure of Britain's Royal Family will be subject to closer scrutiny.

"When we say that we are all in this together, we mean it," Osborne told parliament in his first budget since Britain's Conservative/Liberal Democrat coalition government came to power last month.

Some economists say heavy fiscal tightening could endanger the recovery out of the worst recession since World War II.

U.S. President Barack Obama warned fellow G20 leaders last week not to cut stimulus too soon.

"It seems to be a tighter budget than people generally were anticipating. By the look of the borrowing numbers, there's a bigger squeeze here than most people were expecting," said Jonathan Loynes, chief UK economist at Capital Economics.

But Osborne believes there is no time to waste, though he admitted that growth will be lower this year and next because of his budget.

The independent Office for Budget Responsibility, established by Osborne last month, cut its forecast for economic growth to 1.2 percent this year from 1.3 percent published last week. GDP growth next year is seen at 2.3 percent instead of the 2.6 percent published last month.

Public sector net borrowing is now seen at 149 billion pounds ($230.5 billion), or 10.1 percent of GDP, this year but this is seen falling to 20 billion pounds — or just 1.1 percent of GDP — in 2015-16.

The structural deficit, that which is not subject to the vagaries of the cycle, is expected to fall to 0.3 percent in five years from 7.4 percent this fiscal year.

A tax on banks had been expected to cost the industry between 1 billion and 5 billion pounds, depending on its structure and scale. Osborne said it would come into effect at the start of 2011 and will raise about 2 billion pounds.