It's nice to see that some governments around the world have decided that less spending may be a good tactic to help get out from under enormous piles of debt. We learned on Wednesday that when it comes to budget cuts and measures of austerity, the British government is not messing around. The country announced its Comprehensive Spending Review, which plans to relieve its 155 billion pound ($243.37 billion) deficit by cutting public spending within five years by 83 billion pounds, which is the equivalent of $130 billion.
Unfortunately, the U.K. budget cuts will result in the loss of more than 490,000 public sector jobs, reduced welfare benefits, and a rise in the retirement age at an earlier date than previously anticipated. The austerity measures also include cuts in defense and police protection spending -- and even budget cuts for Queen Elizabeth II.
The harsh reality is that the U.K. deficit is around 11.5% of the country's economic output. This is even higher than the United States, whose deficit is at 10.7% of the economic output. Contrast that to Germany, whose deficit is only 5.4% of economic output, and one can see the need for austerity. The question remains whether this is too much too fast, or if the hole is now too deep to get out of any other way. Britain's top finance minister George Osborne thinks it is a necessary evil, as the country faces extremely high interest payments for running such a large deficit.
While there will be many arguments about how the austerity measures will affect the British economy, one measure that is sure to affect banks with operations in the U.K. is the new "maximum sustainable" bank tax. Details of what this means are still not entirely clear, but the tax will be applied to U.K. banks and business societies with more than $31.5 billion in liabilities. It will also include foreign banks with U.K. operations with balance sheet liabilities at levels above the threshold.
The new permanent tax to be put in place on Jan. 1 will replace a temporary tax on bank bonuses. Osborne said, "The permanent levy will raise more net each year and every year for the Exchequer than the one-year bonus tax did. We neither want to let banks off making their fair contribution, nor do we want to drive them abroad."
Taking business elsewhere
European-headquartered banks Barclays
The banter began earlier this year when the British government doled out a one-time tax on bank bonuses that collected 50% of all bonuses that were more than $39,000. As a consequence of the tax Goldman Sachs paid $600 million, JP Morgan
What it all means
This is the billion-dollar question. The U.K.'s Daily Mail has referred to the austerity package as "the greatest economic experiment of modern times," and that Osborne "will be the most hated man in Britain," but if nothing else he is serious about austerity. He also made it clear that he and other British government officials are keenly aware of the threat of banks leaving the country if the new permanent tax is deemed uncompetitive.
However, some think the bank tax is just another slap on the wrist for the financial sector. In The Guardian, Sam Jones writes that the bankers are winners, suggesting that, "Despite being blamed for helping to create the present economic mess, further details of the bank levy suggest banks and their well-remunerated high flyers have escaped the [Comprehensive Spending Review] virtually unscathed."
As more details are announced, investors would be wise to pay attention to those banks with significant business in Britain. Opinions vary on how the bank tax and austerity measures will play out, but there is no doubt it will have a big impact on earnings.
Do you think the U.K. austerity measures are the right course of action, and how do you think will the new tax affect the banks? Let us know in the comment box below.
Andrew Bond owns no shares in the companies listed. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.