Packing on the Pounds

Story Highlights:

• The recently announced UK budget is big—£175 billion ($257 billion or 12.4% of GDP) for this fiscal year and £173 billion next fiscal year—and contains spending measures aimed to help the UK economy weather and recover from its almost yearlong recession.
• Government spending, though never perfect, is appropriate in today's economic environment. The money eventually makes its way to private hands and is spent, re-spent, and re-spent again—mostly by the private sector.
• The size of the projected UK budget deficit needn't cause worry. History shows high budget deficits are unlikely to doom the economy or markets.
• Overall, the UK budget, though highly anticipated, didn't offer many surprises and is appropriate in today's economic environment.

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There's no easy way to say this, but the recently announced UK budget is a bit hefty. The budget—£175 billion ($257 billion) for this fiscal year and £173 billion next fiscal year—is £125 billion higher than forecast last November. This gain's no surprise as the UK recession grinds on. But no Weight Watchers needed here—the budget's considerable girth is perfectly healthy for a country dealing with a sizeable recession.

The UK budget, amounting to 12.4% of GDP this fiscal year, contains spending measures aimed at helping the UK economy weather and recover from its almost yearlong recession. These include provisions to help support credit insurance, the auto sector (scrappage scheme), employment (training, work placement, jobs programs, youth training), businesses (tax deferment options, strategic investment fund, oil field development), individuals, homeowners and homebuyers, and the environment.

Government spending, though never perfect, is appropriate in today's economic environment. Though we'd prefer the private sector to direct spending, government spending, no matter how clumsy, doesn't amount to empty calories—the money eventually makes its way to private hands and is spent, re-spent, and re-spent again. Especially in a recession, when economic activity slows, government spending can inject much needed energy into the economy.

Concerns over the size of the UK's projected budget deficit—the result of all this spending—are widespread, but should take a backseat. Using the budget figures, UK net debt to GDP will rise to 59% this fiscal year, 68% in 2010 fiscal year, 74% in 2011-2012, 78% in 2012-2013, and 79% in 2013-2014. Net debt at 79% of GDP sounds startlingly high, but remember, budget deficit predictions almost never reach expected levels. Plus, history shows high budget deficits are not likely to doom the economy or markets. It's almost opposite. Historically, market returns are on average higher following extremely high budget deficits than following extreme budget surpluses. The US and UK have run budget deficits for decades alongside growing economies and rising markets.

There are some sour notes in the UK budget, notably tax increases on top incomes, tobacco, alcohol, and fuel. Those earning more than £100,000 will lose personal income tax allowance come next April, and incomes north of £150,000 will also see less tax relief on pension contributions. In our view, raising taxes now could hinder rather than help economic recovery.

Overall, the UK budget, though highly anticipated, didn't offer many surprises. Many of the announced budget measures were expected and have been discussed for some time. Its size may be larger than forecasted, but with recession still underway, this isn't the time to worry about packing on the pounds.