Today’s public sector borrowing figures (pdf) won’t make for cheery reading at the Treasury. Borrowing came in at £14.0 billion in June 2011, up from £13.6bn in June 2010. Cumulative borrowing in the first three months of the financial year 2011-12 now stands at £39.2bn, only a fraction down on 2010-11 despite the beginning of spending cuts and tax rises.

The early indications are that George Osborne’s changes in fiscal policy are not bringing down the deficit. Rather than looking at the volatile monthly series, it is worth taking a moment to look at the quarterly deficit figures:

The prospects now for Mr Osborne meeting his borrowing target of £122bn for 2011/12 (as forecast (pdf) by the Office for Budget Responsibility in March now look weak. The OBR forecasts are premised on growth in 2011 of 1.7% but the Treasury’s own latest round up of independent forecasters (pdf) suggests growth will actually be 1.3% – which would no improvement at all on 2010.

If in autumn the OBR is forced to revise down its growth forecast it will have no choice but to also revise up its borrowing forecasts. In March this year the OBR revised down its 2011/12 and 2012/13 growth forecasts by 0.3% – it then had to revise up borrowing for those two years by £14.3bn (i.e. by more than the VAT rise raises annually).

If the OBR has to revise down 2011 growth by 0.4% or more then the impact on the deficit could be even larger. Mr Osborne’s lack of a growth strategy could easily undermine his deficit reduction plans.

Tory MP Matthew Hancock has made a massive error in his analysis of the American economy, writes Duncan Weldon

Tory MP and former George Osborne advisor Matthew Hancock has written a post for the Spectator’s Coffee House blog claiming that Labour are drawing the wrong lessons from America.

He accuses Ed Balls of getting “his figures wrong” on the US deficit plan and makes the bizarre claim that the US plan involves cutting faster than his own government’s plan. This is despite the IMF last week describing the UK plan as the “largest fiscal adjustment” of the major economies.

People who live in glass houses shouldn’t throw stones and Hancock himself makes a colossal factual error. His whole argument is underpinned by the notion that if countries do not quickly deal with their deficits then the bond markets will extract a high price. He uses the example of the downgrading of the US last week and claims that this has caused US interest rates to rise.

“The consequence? US interest rates have risen, just as they would do here if we were foolish enough to abandon our plan… The down-marking of US debt, and the reaction of US interest rates that followed, shows the gamble we would be taking if we abandoned our plan.”

The problem with this claim is that it is factually incorrect. US bond yields fell after the downgrade - something widely remarked on in the financial press and something he really ought to have checked before publishing the article.

Tuesday’s Public Sector Borrowing figures came in ahead of expectations, driven by bumper income tax receipts.

Over at the Guardian website I argued that this partially represented the impact of the 50p rate:

“Last week’s labour market statistics showed that there had been no improvement in the overall labour market with the percentage of people aged 16 to 64 in work being static at 70.5 per cent between December 2009 and December 2010. The same report said that average weekly earnings had grown by only 1.1% over the past year.

“So we have a mystery – the number of people in work is fairly constant, earnings have only increased by 1.1% and NICs [National Insurance Contributions] are only up by 4.4% and yet income tax revenues are up by nearly 18%.

“The most likely explanation is that higher income tax receipts partially represent the new 50p rate kicking in and rasing revenue. How else to explain the figures? Receipts are up way in advance of earnings or employment growth.”

Chris Dillow, on the Investors’ Chronicle website, wrote:

“The biggest reason for this is that income tax revenues are booming. The OBR predicted that they would rise 3.1 per cent this year. In fact, they are up by eight per cent, bringing in an unexpected £5.6bn for the Treasury.

“This hasn’t happened because the labour market has been stronger than the OBR expected. If this were the case, national insurance contributions would also have exceeded expectations, but in fact they have been the one major revenue source to have undershot their prediction; VAT and corporation tax are slightly ahead of forecast.

“So, what’s happened? One reason is that bankers’ bonuses have been unusually large. The other, more intriguing one, is that the rise in the top rate of tax, far from causing an exit of high-earners, has in fact raised revenues because we are on the upward-sloping part of the Laffer curve where higher taxes really do bring in more revenue.”

Over at the Spectator Coffee House blog, Fraser Nelson was quick to claim that this was not the case:

“A jubilant John Rentoul has just tweeted:

‘Where is Fraser Nelson when you need him? The 50p income tax rate has brought in a ton of money. He said it would probably reduce revenue.’

“He is absolutely right – but not for the reasons he thinks. Were John self-employed, he’d know that the tax paid last month was in respect of the 2009-10 tax year – when the top rate of tax was 40p.

“Of course, many of the super-rich are on PAYE – but that has happened since last April. It doesn’t explain a January uplift.”

This point has since been echoed by the TaxPayers’ Alliance, the Adam Smith Institute and Tory bloggers.

There are two problems with this explaintion. First that it does not explain why income tax receipts have increased in advance of earnings or employment growth each month since April 2010 (when the 50p rate was introduced) and second that it is factually wrong.

Fraser Nelson appears confused about how self assesment actually works. Had he consulted the HMRC guidance before writing his post, this confusion could have been avoided:

“You’ll usually have to make ‘payments on account’ of the current year’s tax. You’ll have to make two payments, one by 31 January in the current year and the other by the following 31 July. Each payment is half of the tax due for the previous year.

“For example, for the tax year 2010-11 (6 April 2010 to 5 April 2011) the first payment on account will be due on 31 January 2011. The second payment on account will be due on 31 July 2011.”

In other words, self assessment payments received in January did include tax receipts related to the year 2010/11 and hence a 50p effect.

The long awaited outcome of the government’s “Project Merlin” deal with the banks has been published. Questions are already being asked about the failure of government to get tough on bonuses and the low level of transparency on pay, but perhaps most worrying is the failure to deal with the central question of bank lending to support the recovery.

Chancellor George Osborne has been keen to talk up that the banks have agreed to extend loans worth £190 billion to UK business in 2011, up from £178bn in 2010 – but there are two very important caveats to this.

First the agreement is for gross lending rather than net lending – i.e. it only refers, it takes no account of repayments on existing loans. It would be perfectly possible for banks to issue gross loans of £190bn but fund this by calling in old loans. What matters for the UK is not gross lending but net lending.

The coalition agreement (page 9 of the pdf) emphasised that net lending targets could be introduced to ensure that banks lend to small and medium sized businesses:

“We will develop effective proposals to ensure the flow of credit to viable SMEs. This will include consideration of both a major loan guarantee scheme and the use of net lending targets for the nationalised banks.”

This now seems to have been abandoned. As business secretary Vince Cable commented less than a year ago:

“This would be completely letting the banks off the hook. It’s perfectly possible for banks to achieve a gross lending target while withdrawing capital from small to medium-sized businesses.

“Even if they have a gross target, what assurances do we have that it will be enforced, because the banks have been running rings round the Government so far?”

This looks like a climb down from Vince Cable and a victory for the banks.

Furthermore, the agreement includes a let out clause for the banks:

“Each bank’s lending expectations, capacity and willingness, as set out above, will be subject to its normal commercial objectives, credit standards and processes and regulatory obligations, as well as the availability of the required funding.”

This potentially provides the banks with a ready made excuse when they fail to meet the targets.

As the graph above shows, loans to UK non-financial companies have been falling for 18 months; this agreement may do nothing to reverse that trend.

On the Today programme this morning deputy prime minister Nick Clegg repeated the now discredited claim that when the coalition formed Britain was “on the edge of bankruptcy”. The argument dates from a December 2008 Telegraph article by David Cameron and is an important component of the government’s “there is no alternative” defence of its policy of spending cuts.

Despite Mr Clegg’s claims UK bond yields – the best measure of how the market perceives the risk of default – were near record lows in May.

In fact the yield on UK government ten-year bonds was only 3.84 per cent on the day on the general election. It closed on Friday at 3.62 per cent. This does not look like the bond yield of a country that was “on the edge of bankruptcy”.

Greek bond yields soared to over 12% in May, whilst Irish yields hit over 9%. There is simply no comparison. If a yield of 3.84% implies the “brink of bankruptcy” then it is hard to see how George Osborne is so confident that the UK bilateral loan to Ireland, with a yield more than twice as high, will ever be repaid.

Former Treasury Permanent Secretary Andrew Turnbull has already made clear what he thinks of the “brink of bankruptcy” claim, as politics.co.uk reports:

“Well I always thought that we were capable of producing a financial settlement that wouldn’t take us into Irish and Greek problems,” Lord Turnbull told the committee.

“A very large part of our debt was domestically held. If people are going to sell gilts they’ve got to buy something else. Who are these great shining examples of people who are issuing rock solid debt you want to buy?”

When pressed on whether he thought the UK was on the brink of bankruptcy, the peer replied: “No, I don’t.”

BBC Economics Editor Stephanie Flanders has written that:

Whatever you think about the fiscal mess that the coalition inherited, these are not the characteristics of a country on the “brink” of bankruptcy or default.

It’s time that Nick Clegg stopped repeating old Tory attack lines.

Update 1615hrs

Listen to Nick Clegg’s lies:

Free market think tank Reform has named Irish finance minister Brian Lenihan “Reformer of the Week”. Their reason?

“… for announcing a further €4.5 billion in spending cuts and €1.5 billion in tax increases in order to maintain the country’s fiscal credibility.”

This is despite the economic disaster that has been unfolding in Ireland over the past two years. In 2008 Lenihan decided against a fiscal stimulus and instead tried to balance the budget through spending cuts and tax rises.

This strategy has proved self defeating as the welfare bill (despite cuts) continues to rise and tax revenues continue to underperform.

There are now renewed market fears over Irish growth and its ability to service its debts. And yet, despite the mounting evidence that Irish policy is failing, the British right continues to heap praise on their policy choices.

Before the recession George Osborne called Ireland as a “shining example of the art of the possible in economic policy making”. Even as the IMF warned that the Irish economy was “unbalanced”. Even after the recession hit and the long series of austerity budgets began, Tory politicians and bloggers continued to be supportive.

In December last year Guido Fawkes wrote that, due to their austerity budgets, Ireland “will bounce back faster than the UK”. Nearly one year on UK unemployment is at 7.7 per cent whilst Irish unemployment stands at 13.9 per cent. Whilst the UK enjoyed decent growth in Q2 and Q3 this year, Irish GDP contracted again in the second quarter.

The British right praised Irish policy before the recession, during the recession and continue to praise it now. They have been consistently wrong.

Ben Brogan, reporting comments by Conservative MP and former George Osborne advisor Matthew Hancock, has argued that the Coalition’s fiscal policies have lowered interest rates.

Brogan writes:

“On March 24, the date of Alistair Darling’s last Budget, two- and three-year rates were 1.205pc and 1.855pc respectively; on election day they were at 1.076 and 1.687; on June 22, George Osborne’s first Budget, 0.784 and 1.292; yesterday they were at 0.68 and 0.96. Ten year borrowing is down from 3.96 to 2.91.”

Whilst yields have fallen across the curve, this is not necessarily the result of Mr Osborne’s budget.

During the same time period, US two-year and three-year rates have fallen from 1.08 per cent and 1.67 per cent on March 24th, to 0.77 per cent and 1.21 per cent on June 22nd and are currently at 0.47 per cent and 0.72 per cent.

They have more than halved, despite Barack Obama not only not cutting now but actually proposing a further stimulus. There is no evidence for Mr Hancock’s claim that the Chancellor’s policies have reduced interest rates.

The West Suffolk MP further argues the falls in two-year and three year rates will mean lower mortgage payments:

“Interest rates on borrowing for 2 years or 3 years – the sort of rates fixed mortgages are based on – have halved. That’s a huge economic boost to families and businesses up and down the country.”

However Bank of England data shows that three-year fixed mortgage rates have only fallen from 4.68 per cent in March to 4.38 per cent in August. Whilst this fall is of course welcome, it is not as large as Hancock suggests.

On a typical £150,000 mortgage it represents an annual saving of £450 annually, easily swallowed by the £500 per household hit from the increase in VAT.

George Osborne’s decision to raise VAT to 20 per cent from January 2011 has been widely described as regressive, including by the new Head of the Office of Budget Responsibility Robert Chote.

Mr Chote has also emphasised the extent to which raising VAT was not unavoidable, and was in fact a choice made by Mr Osborne:

“When Mr Osborne said that ‘the years of debt and spending’ made the £13 billion increase in VAT unavoidable you might just as well say it was his desire to cut other taxes that made it so.”

The Chancellor’s decision to raise VAT should come as no surprise; it has been the preferred tax of Conservative Chancellors the past forty years.

When VAT was introduced, by a Conservative government in 1973, it was set at 10 per cent. Geoffrey Howe, despite promising not to “double VAT” in the 1979 election campaign, raised it to 15 per cent. It was then increased to 17.5 per cent by Norman Lamont.

In the 37 years since its introduction, VAT has risen from 10 per cent to 20 per cent. Meanwhile the basic rate of income tax has fallen from 30 per cent to 20 per cent.

This shift from raising revenue through progressive income tax to raising it through regressive indirect taxes was one of the hallmarks of the last Conservative Government.

When Mrs Thatcher came to office in1979, 39 per cent of revenue came from direct personal taxes and only 33 per cent from indirect taxes. By 1996/97, the proportion of revenue raised from direct taxes had fallen to 35 per cent and that from indirect taxes had risen to 37 per cent. Between 1997 and 2010, more revenue was raised from direct taxation than indirect taxation in every year.

As Alistair Darling delivered yesterday’s PBR with the themes of investing in growth, taxing fairly and safeguarding the recovery, quite a different budget was delivered in Ireland.

Finance Minister Brian Lenihan announced further cuts in spending and welfare benefits, at his third budget in 12 months. Large scale tax rises have already been announced.

The measures were praised by Tory bloggers and politicians and gave a taste of what a future Tory budget might look like. George Osborne has long been a supporter of Irish policy, stating in February 2006 that:

“Ireland stands as a shining example of the art of the possible in economic policy-making.

“With its vision of a highly-educated, innovative, open, dynamic, low-tax economy, and relentless focus on the long-term drivers of prosperity, Ireland’s economic miracle has shown that it has the right answers to the challenges of the new global economy.”

Iain Dale writes that:

“The PBR the British Chancellor should have delivered, was delivered yesterday in Dublin. Hopefully George Osborne is studying it in great detail.”

The results of Ireland’s policy are plain to see:

• Irish unemployment is 12.5 per cent;

• The country is experiencing deflation at –6.6 per cent;

• GDP has fallen 7.4 per cent over the past year and 10.5% from its peak;

• And despite the cuts they have still had their credit rating downgraded.

But what exactly are the measures that the Tories are so keen to praise?

– Child benefit is being cut by 10%.

– Unemployment benefit is being cut by 4.1%, with larger cuts for those under 25.

– Public Sector workers are facing pay cuts of 5-8%.

– Prescription charges are being increased by 50%.

– Other increased health charges including A&E, inpatient and outpatient charges and a higher monthly threshold above which people cannot get free drugs under the Drug Payment Scheme.

– The Health budget is being cut by €400mn on top of previously announced cuts

– Further departmental cuts will be announced in coming days.

– €960mn is cut from the investment budget

All the world’s major economies have had their public finances damaged by the global recession. And now all must take steps to rectify them. Alistair Darling made the tough choices necessary to halve the deficit over the next Parliament yesterday and did so guided by the principle of fairness.

The Irish, egged on by the Tories, have instead opted to attack the poorest in society; as Irish Labour Leader Eamon Gilmore has said:

“This is a budget that is viciously anti-family, fundamentally unfair and socially divisive.

“Everyone knew that a tough budget would be required because of the unprecedented economic shambles created by Fianna Fail over the past twelve years, but few people could have anticipated a budget that would be so lacking in fairness.

“The reduction in child benefit will hit the incomes of most families in the country. An across the board cut in child benefit will hit to [sic] low to middle income families particularly hard and runs the risk of plunging even more children into poverty”

Credit Suisse’s Head of Asset Allocation, Michael O’Sullivan has commented that:

“Arguably the Irish bond market is being saved at the expense of Irish society.”

O’Sullivan, 38, author of a 2006 book on Ireland’s economy, added in the interview at Bloomberg’s London bureau that:

“By cutting spending you lower the trend line of growth and store up bigger fiscal problems down the line.”

The economic and social disaster occurring across the Irish Sea is an important reminder of exactly what Osborne’s plans mean.

The gift that keeps on giving, is at it again. On his Telegraph blog, Daniel Hannan preempted the pre-Budget report with a recipe for economic disaster. Repeating his post in full he says:

“If you were overdrawn and in negative equity, with debts on a dozen credit cards and unpaid bills littering the table, what would you do? Would you try to spend less, or would you set out to spend more?

“Ireland is trying to spend less, with cuts across the board. Everyone will share the pain, from cabinet ministers to benefits claimants. The Taoiseach, who is expected to take a 20 per cent salary reduction, reckons that the new budget will reduce Ireland’s deficit by 4 billion euros.

“The United Kingdom, by contrast, wants to spend more. Alistair Darling will continue to expand the budget, and will raise taxes accordingly.

“I have been disobliging about Biffo Cowen in the past, but the fellow is at least trying to do the right thing, acting in the national interest, even if that means dropping in the polls. Labour, by contrast, would rather bankrupt Britain than alienate its remaining supporters in the public sector. Who are the patriots here? Who the rogues?”

The facts:

- Irish unemployment is 12.5 per cent
- the country is experiencing deflation at -6.6 per cent deflation
- GDP has fallen 7.4 per cent over the past year (and GNP by 11.6 per cent).
- And despite the cuts they have still had their credit rating downgraded.

Don’t forget the Chancellor’s line that, “The choices are between going for growth or putting the recovery at risk.” Well said, Darling.