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UK budget 2010: New era of austerity in Europe?

UK budget 2010: Britain today unveiled budget cuts to raise £40 billion in state revenues through tax increases, welfare cuts, and salary freezes. But history suggests that raising taxes during a recession can cause a double-dip.

By Correspondent / June 22, 2010

UK budget 2010: Britain’s Prime Minister David Cameron (l.) and European Commission President Jose Manuel Barroso (r.) address a joint news conference before a European Union leaders' summit in Brussels, June 17.

Thierry Roge/Reuters

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London

Britain unveiled its emergency budget today, becoming the latest standard-bearer for a grim reality that is uniting nations across the Continent as deep budget cuts herald a new era of austerity.

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Chancellor of the Exchequer George Osborne, who oversees Britain's treasury, described the £40 billion plan aimed at reducing the United Kingdom's record peacetime budget deficit as "tough" but "fair." While vowing to protect the poorest of Britons, the chancellor announced an array of measures that will still pinch pockets: a two-year freeze on public sector pay for those earning more than £21,000; a 2.5-percent rise in the VAT, to 20 percent; and a three-year freeze on child benefits. Higher-income earners will find their capital gains tax rising from 18 percent to 28 percent, and the threshold for higher-rate income tax will be frozen until 2013.

"Today we take decisive action to deal with the debts we inherited and confront the greatest economic risk facing our country," Chancellor Osborne said today (full text of speech).

Britain's budget cuts exemplify a Europewide return of fiscal conservatism less than two years after Keynesian intervention (in the form of stimulus programs) was the emergency tonic for the 2008 financial crisis. From Spain to Hungary, millions of government workers are being fired or told to postpone retirement. Projects are being junked in a bid to tame soaring deficits and win approval from investors.

"There is only so much borrowing that governments can do before the markets will say: 'no more, we can lend you no more money,' " says Richard Wellings, an economist at the Institute of Economic Affairs, a right-of-center British think tank that wants deep cuts.

Dr. Wellings argues that European governments have no choice but to trim spending, since fears of sovereign defaults already have investors backing away from government debt.

Osborne's cuts hold risks

Britain's deficit is a legacy of a spending boom that delivered new schools, hospitals, and roads before ending in 2008. It stands at more than 11 percent of gross domestic product (GDP).

But critics claim that Osborne risks choking off Britain's fragile economic recovery by cutting too much too fast. Others fret about export-led growth potential if Britain and other European states all reduce spending simultaneously.

Even Europe's economic powerhouse, Germany, has unveiled a fiscal austerity program designed to save nearly $100 billion by 2014 and more than halve this year's projected deficit of 5 percent of GDP.

Fears about deficit crises elsewhere in Europe have whipped up a German "austerity frenzy," says Irwin Collier, professor of economics at the Free University in Berlin. Germany, he says, is uniquely placed to make other European states' problems "a lot easier" by spending more rather than cutting back. "When they all start contracting at the same time, they are all going to find themselves back in the same place, but a lot poorer."

So why wield the ax? The answer, at least from Britain's government, is that it has worked before.

Canada and Sweden in the 1990s are held up as models of developed countries who successfully tackled deficits.

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