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UK would face a tax of ?16bn a year to join euro

Gordon Brown argued that it was too inflexible and did not fit in with a sensible fiscal policy that ran deficits in bad times and surpluses in good years. It needed reforming on the British model, so that the fiscal rules operated over the length of an economic cycle and allowed specifically for public sector investment.

On Tuesday, however, Mr Blair signed up for changes to the Pact that underline the deficiencies of the failing eurozone model and take it further from the successful UK regime. They make life easier for recalcitrant existing members but make it harder for the UK to comply.

Five years after its launch, the euro has edged down in value from 72p to 69p. That seems unremarkable until you remember that the euro was carefully designed as the successor to Germany's awesomely strong mark and that, a few years earlier, sterling was skulking in the corner as the incorrigible dunce of Europe.

Sterling has strengthened because, through trial and error, we have developed an effective system of monetary and fiscal discipline that has allowed the economy to expand at an average 2.8 per cent a year over the past eight years while euroland languished.

Euroland's response has been to loosen monetary and fiscal rules drawn up to make the new currency credible. That is no longer such a priority. The European Central Bank (ECB) was the first to feel Germany and France's hot breath on its face. The ECB modified its inflation target, which had aimed for price stability, with a ceiling of 2 per cent inflation. The 'clarified' target is to stay below but near to 2 per cent. It hardly matters because eurozone inflation has been above 2 per cent for much of the time. The UK, by contrast, has met its own target.

The Pact was brought into disrepute after slow growth and unemployment pushed France and Germany to break the main fiscal rule. They persistently ran budget deficits well above 3 per cent of national income. Italy was not far behind.

Under the new rules, which are formally unchanged, countries can plead virtually any excuse for breaching the 3 per cent limit and will have more time to put things right. Oddly, capital spending, one of Italy's priorities, does not appear to be a permitted exemption.

The Bundesbank, whose vice-president Jurgen Stark virtually wrote the original Pact, damned the watered down version as 'less transparent, more complicated and more difficult to implement'.

The ECB was 'seriously concerned' but was mollified by a new preventative rule inserted at the behest of the European Commission. This obliges members to keep average deficits below 1 per cent of national income over the medium term.

In Britain, the 'golden rule' for government finance is that current spending and taxes should balance over the cycle but that capital spending is constrained only by a commitment to stop national debt rising above 40 per cent of annual output over a cycle. Within this constraint, net capital spending is budgeted to exceed 2 per cent of output until 2010, which is as far as the projections go.

On eurozone definitions, it is worse than that. Over the period of 2003-04 to 2009-10, which surely qualifies as the medium term, the UK is projected to run an average deficit of 2.3 per cent.

Most economists think that tax will have to rise after the next election to keep on meeting the golden rule. To meet the watered down Stability Pact, however, taxes would have to rise by about £16 billion a year. That is equivalent to 4.5p on the basic rate of income tax. Growth would surely suffer.

The original Stability Pact was a corset rather than a sensible rule because eurozone economies entered the new regime in no state to comply with it. If loosening it helps to boost growth, it will make sense for existing members. The new 1 per cent rule seems to be based on the pessimistic projection that it would stabilise a debt burden of 60 per cent of output, the Pact limit, if an economy grew at only 1.7 per cent.

The Commission says the new rule is not meant to be taken too seriously. Unless the UK is to fall back to such low rates of growth, perhaps joining the euro should no longer be a serious proposition either

Source :channelnewsasia.com