While the bank recapitalisations and asset guarantee schemes have attracted most attention, it is the collapse in revenues that is the greatest risk to the governmentʹs finances in the post credit crunch era.
CEBR’s study corroborates the recent research by Kenneth Rogoffand Carmen Reinhart on the aftermath of financial crises. It points out that the real value of public debt tends to explode post financial crisis.
Interestingly, it finds that the ‘main cause of debt explosions is not the widely cited costs of recapitalizing the banking system’ but rather, the ‘collapse in tax revenues that governments suffer in the wake of deep and prolonged output contractions, as well as often ambitious countercyclical fiscal policies aimed at mitigating the downturn.’
The accountants Price Waterhouse Coopers have estimated that the financial service sector generated £67bn in tax revenue in 2006/07 based on a detailed study of the accounts of a number of major financial institutions and extrapolating.
This estimate looks roughly right and is in line with our calculations. The biggest item is of course income tax ‐£15bn –followed by corporation tax at £12bn.
But the other items are more surprising ‐£10bn from VAT which is unexpected from a sector that is VAT exempt (but VAT is of course collectedin its inputs); £8bn from employers National Insurance contributions which are collected all the way up the earnings scale on all earnings including bonuses; £7bn from withholding taxes on interest payments and the rest mainly from stamp duties, employees NICsand business rates.
Douglas McWilliams chief executive of CEBR, says: “But the huge losses, job cuts and bonus cuts together with the fall in interest rates paid will cause these sources of revenue to collapse. The Chancellor is set to lose £9bn in corporation tax revenue, £10bn from less income tax and National Insurance contributions, £2bn from Stamp Duty and £3bn from withholding tax. Adding in all the other sources of revenue, the total tax take is forecast by cebr to drop from £67bn to £39bn. Moreover, some of these hits are likely to be long lasting.
“The scale of the losses that the banks can bring forward means that they will have to pay little corporation tax for many years. Our forecasts indicate that job numbers and bonuses will remain depressed until 2013 at least. Our tentative forecast is that the tax take will rise to only £46bn by 2012/13.