Complete interview with George Osborne

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Q: You have received warnings from U.S. president Barack Obama, and to a lesser extent from Canada and other countries, that the big economies need to maintain expansionary policies until sustainable growth returns, until 2011 at least, or we will risk jeopardizing the recovery. But your government, like Germany's, has decided to go for immediate and sharp cuts to spending. Are you risking another recession?

A: Actually I'm not sure I accept the premise of the question, because I think all the countries of the G20 accept, and this was specifically recognised in the communiqué of the Finance Ministers' meeting in South Korea, that countries with high budget deficits need to accelerate the reduction of the structural deficit in their country, and there are few countries with higher budget deficits than the UK's, and that's a situation obviously we've inherited as a new government.

So I don't think there is anyone out there urging the UK not to take the course of action we have.

Tim Geithner was in London a few weeks ago and explicitly endorsing some of the early action we had taken to reduce expenditure this year. And as for the Canadian government, Jim Flaherty and Steve Harper have been and some of the most outspoken advocates of countries getting their public finances into order...

Q: But they're saying to wait until 2011 before doing anything that might hurt growth…

A: What they're saying and what everyone is saying is that countries with very high deficits need to take action. In the G20 communiqué which we all signed up in Busan in South Korea a couple of weeks ago there was an explicit recognition that some of these countries, including Ireland and the UK, needed to take action in this current year, and part of the communiqué explicitly recognised that, that for some countries they needed to take action this year.

So I don't think there's a huge amount of disagreement about the fact that a country like the United Kingdom, with more than ten percent budget deficit, needs to take action. Of course, what people want to see is a coordinating approach around the world where countries with high deficits are taking accelerated action, but at the same time we are, the surplus countries are making their contribution, and to be fair, China has indicated that it will take significant steps with its currency. To be fair to Germany, the pace of its fiscal consolidation - - given the history of that country and its concern about inflation -- is not excessive or overly aggressive.

So what I think we would hope to see come out of Toronto is a coordinated approach in the sense of surplus countries supporting countries with very high deficits, doing what they can to reduce those deficits and showing the world that they can live within their means.

Q: But do you take to heart Paul Krugman's warning that a sudden, sharp economic contraction coming from several countries could put us in a very dangerous situation where we have a return to recession at a moment when we don't have the usual fiscal tool of interest-rate cuts available?

A: Firstly, and I think the greatest risk, if there is a risk out there, is the sovereign debt risk. And that's clearly the case in Europe. So therefore the best way of addressing that, and heading it off, is those countries which have very high debts to take action to reassure markets and their own domestic populations that they have the situation in hand. Greece now has a program of debt reduction, and Spain now has a program of debt reduction, and so on. And in the UK, and we're obviously in a different situation to the Euro zone, but nevertheless the UK with its very high deficit, the second-largest in Europe, has taken action, and I would argue decisive action in the Budget this week.

So the most obvious risk out there in the global economy is the sovereign debt risk at the moment, and that's what we need to overcome.

You're right in this sense, that one of the consequences of the last couple of years has been that the very large levels of private debt that have built up on bank balance sheets and among households have, in many countries, been transferred to public balance sheets. Certainly this is the case in the UK, and that means that the scope for fiscal action in a country like the UK is very much more limited, and we need to get our house in order.

Q: How much of Britain's shortfall is actual structural deficit versus the one-time costs of bailing out banks? Do you treat this as an equity stake that will earn a return, or as part of the deficit?

A: Oh no, the deficit doesn't take account the stakes in the banks, which are accounted for separately in the national accounts, and we have a significant structural deficit as well, which is larger than was forecast before we came into office. We have set up an independent body, the Office for Budget Responsibility, which has assessed the whole structural deficit, and found it to be higher than was previously forecast, and our challenge in the United Kingdom is that the structural deficit is more about two things.

One has been the effect of the recession on certain sources of revenue, like for example tax receipts from financial services and tax receipts from housing transactions - and it looks like it's going to be a very long time before they return to pre-crisis levels, and therefore they have a sort of structural effect.

Second, during the middle part of this decade, we were building up a structural deficit from the good years, so tackling the structural deficit is not just about addressing the cost of the recession, it is also about putting right the situation in the middle part of the decade when we were overspending.

That's why, if you look at the Budget we have announced this week, it obviously has some tools which have immediate effect, like the increase in value-added tax [sales tax] from 17.5 to 20 per cent from the beginning of next January, and some reductions in welfare expenditure.

We're also going to have to cut government department budgets next year... And those are relatively short, immediate steps we are taking, they're staggered in the sense that they come into effect over a period of a couple of years, but they are fairly immediate.

At the same time we are also looking at things that will permanently improve the structural situation, so for example yesterday we began the discussion about bringing forward the increase in the state pension age to sixty-six, and we've also linked our benefit expenditure to the consumer price index rather than the retail price index.

So we're trying to do some things that will have relatively immediate effect, by which I mean in the next couple of years - shortish-term effect -- but also structural reforms, like for example the state pension age, which won't come into effect for six or seven years, but nevertheless will put the medium-term and long-term finances on the UK on a much stronger footing.

Q: Is that why you went for VAT increase rather than other tax sources?

A: The truth is that in the United Kingdom, if you are looking for a tax that can raise a substantial amount of money, you're really rather limited. You have National Insurance - an employer and employee tax -- income tax, or VAT.

What I was trying to do in the budget was not just cut deficits but reward work and encourage enterprise and try and stimulate a private-sector recovery. And further increases in National Insurance, over and above the increases we've inherited from our predecessor government, I don't think would have helped; indeed they would probably have harmed work incentives. We actually reduced national insurance for employing people for under 20,000 pounds a year. An increase in income tax would also have damaged incentives, and so VAT presented itself as the tax available to raise a significant amount of money.

Now, we did increases some other taxes - there was an insurance premium tax we increased, capital gains tax for higher earners went up from eighteen percent to twenty-eight percent, so there were a number of tax increases. By the way, there were also some tax reductions, so we were also trying to pull off a structural reform of the tax system to make it fairer. We've taken almost a million people out of income tax, those on the lowest incomes in the country, by raising the threshold at which you start paying tax; and also, and very significant, I think, and certainly a big signal of British intent around the world, is the reduction in our corporation tax rate from twenty-eight per cent to twenty-four per cent, so that will give us a corporation tax in four years time that is the fifth-lowest in the G20, and will maintain our position as the lowest in the G7. I think Canada is taking its corporation tax to twenty-five per cent while we'll be on twenty-four per cent.

And I think people around the world, at this G20 summit and elsewhere, will take one look at Britain and say 'There is a country serious about being open for business.'

I see the Budget as performing a number of things, and obviously, the deficit reduction was the feature of the Budget that grabbed the headlines, along with the increase in consumption tax, the welfare bill cuts and the like. But the corporate package, which is a big reduction in the headline rate of corporation tax, a reduction in the cost of employing people on lower incomes, a reform of intellectual-property taxation, a look at the way we tax the profits of international companies - - so that the UK is a really attractive place to come and locate your headquarters.

All of these things are part of saying 'Yes, we need to deal with excessive public consumption, but we also need to stimulate a private sector recovery.'

Q: In October you'll be launching a government-wide program of cutbacks, what we in Canada called "program review." How much do you want to reduce the size of government?

A: First of all, it's not an ideological crusade. It's not a question of wanting to, it's question of having to deal with a very large budget deficit we've inherited. And it's not done with any great relish, or ideological zeal, it's done out of fiscal necessity.

First of all we have looked at all sorts of countries around the world that have undertaken these sorts of exercises successfully, and the striking example is Canada in the 1990s.

We've spoken to some Canadian government ministers and officials who were engaged in the exercise in the 1990s, and we have learned some lessons from that. The lesson we learned is that you make it the collective work of the government, and you avoid the government splintering into departmental silos, and you make a fundamental examination of the purpose of government, the scope of government, rather than simply trying to salami-slice everything down. And you also engage the public, so that there is a really determined effort to allow the public at all levels - - general members of the public with bright ideas; teachers who have innovative ideas about running schools; and the brightest and best officials in government, who won't necessarily all work in the Treasury, who can be brought together from their individual departments into a central unit; different ministers - not necessarily Cabinet ministers, but middle-ranking ministers who are bright stars brought together...

And quite a lot of these ideas of ours have been adapted from what we've seen in countries like Canada doing successfully.

Now all countries are different. In Canada, the individual provinces have borne a lot of this burden, and we're not a federal a country, I'm not saying they are exact comparisons, but we've made a real effort to learn what works around the world, and to get the mix right between tax increases and spending reductions.

At the end of the budget about eighty percent of the effort is from spending reductions, and twenty percent will come through tax increases. Again, that is certainly an attempt to deal with the structural problem, which was, for too many years, excessive spending, rather than under-taxation.

Q: To get debt under 40% GDP is going to take time and a long period of austerity -- how much effect will the cuts have on economy?

A: It will be quite a while before the UK public debt goes below forty per cent; it's not going to be done in a decade.

What the Budget provides for, and what the deficit-reduction plan provides for, is an instilling of confidence in the UK that will increase GDP. We published in the Budget for the very first time in British history independent forecasts of economic activity, unemployment, as well as the public finances.

That is all, in the past, a decision made by the Chancellor of the Exchequer, the growth forecasts and so forth, and we have created an independent body, an Office for Budget Responsibility, which I think it's today that the IMF has applauded as an example for other countries to look at. We've only been in office for seven weeks, and what that Office for Budget Responsibility has told us is that, taking into account the Budget measures, the GDP of this economy is expected to grow each year, and that growth is set to increase, and unemployment is set to fall over the forecast period. So it forecasts a steady recovery that creates jobs.

I think that the absolute prerequisite of that is the confidence that Britain is dealing with its debts, and that businesses out there know that they can invest and hire people without the fear of ever-higher taxes driven by a debt spiral; and families can spend with the confidence that ever-higher debts are not going to lead to ever-higher interest rates, that we can keep interest rates lower for longer, and the governor of our central bank made a significant intervention the week before the budget, saying that tighter fiscal policy could be offset by a looser monetary policy.

I don't see it as taking money out of the economy, I see it as putting confidence into the economy, and it was in short supply.

Q: Do you think the budget helped save UK from escalating cost of borrowing?

A: Yes I do. I think that if we hadn't given that budget then market interest rates would have risen. It's quite striking that in the seven weeks this government has been in office that our yields have come down, our bond yields, whereas actually quite a few European countries have seen bond yields go up, so it's not part of the general trend, we've seen countries like Spain and others increase.

I think what has happened is that a new government has come in, made a strong start, I think people have seen that we're going to deliver what we promised in the election, and we fought the election seeking that mandate to reduce government spending and deal with the deficit, and we're doing that, and that has instilled confidence in that first period of office.

And I think we've also done some things that the rest of the world are going to notice: the aggressive reduction in corporation tax, business tax, the creation of independent fiscal institutions like the Office of Budget Responsibility, a budget that actual turns promises and action into concrete measures to reduce the budget deficit.

So I think we can turn up at the G20 able to say, 'Look, we are a new government but we are delivering on the promises that we have made, and we are putting our own house into order.'

Q: Do you think that the idea of an international bank levy is still salvageable?

A: My own personal view is not that I am seeking some global agreement that forces every country to have a bank levy. So I'm not seeking to force the Canadian government, or anyone else, to impose a bank levy if they don't want to. What I've been seeking is something that I think is appropriate for the United Kingdom. I think that it's both economically sensible that we as a government extract a price for the implicit guarantee of wholesale funding of the banks, and that's what the bank levy we've proposed in our Budget does.

But also it's perfectly fair to ask our banks to make a contribution to reduce this deficit, just as we've asked everyone in the country to make a contribution, and my mantra has been that we're all in this together, and all sections of society have had to make a contribution, the richest have paid more than the poorest as a proportion of income, and I think it would have been rather extraordinary in the British context if we had left the banks out of that.

I think it's right for the UK. What is helpful is that the IMF has provided a framework for levies for countries that want to introduce them, and we have gone for one of the two options they have proposed, and we are looking at the second one, the Financial Activities Tax, 'FAT' - - one of the less attractive acronyms doing the rounds. The other one is a levy on profits and pay.

So we've done it within the framework of the IMF, and we've also done it in a way that is coordinated with France and Germany, so the day I made the announcement the French and Germans also made an announcement.

But I am absolutely not at this G20 summit asking the Canadians or anyone else to do things they don't want to do domestically. I'm a live-and-let-live kind of guy.

Q: Is there danger that if Europeans do this and others don't, there could be a flight to the banks that don't face levy charges.

A: I don't think the bank levy we have proposed is going to have that effect…

Other countries are doing it, I don't think it will create a vastly uneven playing field, in the end each country needs to do what it thinks is appropriate, but I think it is sensible that it takes place under an umbrella of IMF proposals; on the other hand, if you want to introduce a set of proposals, you go ahead and do it.

Q: Are you also following Stephen Harper's advice and raising bank capital requirements...

A: Both our own regulator, and the G20, are in the process of making sure that banks in the future are better able to withstand the sort of shocks we saw in the last couple of years. I think it's important that we give the banking community some certainty about what those requirements are going to be.

So I think that's where the G20 is coming to. I found, when I've met Jim Flaherty on quite a few occasions, both in opposition and now in government, and we get on very well, and we agree on many things, and my Prime Minister and Mr. Harper and I think there's a lot of common ground, so I think the G20 tomorrow is going to be an opportunity to spread out quite a lot of that common ground.

Q: Is there undue dismissal of insurance schemes such as bank levies amongst countries that didn't need to bail out their banks?

A: I'm a great believer in countries doing what they think is right for their own individual circumstances, and as I say I think it is sensible that countries that are looking to introduce bank levies do so with some common principles, and I think the IMF have provided those, but as I say I'm not turning up in Canada and demanding that the Canadians or anyone else introduce a bank levy if they don't want to, that's up to different governments of the different member states of the G20.

Q: Beyond declarations, what would you like to see out of this G20? It is an awkward meeting of authoritarian state-capitalist countries and market economies - do you think any common ground can be found?

A: Yes I do, speaking as someone who has only been in office for two months. Personally I found that the G20 meeting I attended in South Korea, and no doubt I will feel the same about the one in Toronto, I thought it was a good thing that the different economies of the world were coming together in one place. The G8 doesn't really provide for that, and the post-war organizations like the IMF and the World Bank, as important as they are, are nevertheless quite large and formal organizations. I think it's good that you've got the United States and Canada and China and Saudi Arabia and Brazil and South Africa and the UK all sitting round the same table and talking about the same issues.

Even though each country has its own problems and different countries are at very different stages of development, nevertheless we have a common purpose in trying to get a sustainable world recovery, and I think there are common issues, global imbalances are by their definition best dealt with globally: Global free trade, the Doha Round, which I think we really could seize, and it really would enhance the recovery and increase prosperity across the globe. That's something that pressure at the G20, either at leaders' level or finance ministers' level, is most likely to lead to a positive outcome. So I think there are shared objectives.

I'm confident that by November, we're going to have common global standards on capital, liquidity and leverage in our banking systems.

No one is saying the G20 should be the global government, no one is saying it's the cabinet of the world; every country has its own particular situation, its own particular governance; some which are democratic, some which aren't. But there is a common agenda around a safer banking system, a sustained global recovery, more free trade. I think it's a good thing that we get together regularly to talk about it.