Budget 'must raise taxes by �8bn'

By Steve Schifferes Economics reporter, BBC News

The chancellor is expected to deliver his budget in March

Chancellor Alistair Darling will have to raise taxes by �8bn in his Budget if he is to keep to the "golden rule", according to a respected think tank.

The Institute for Fiscal Studies' (IFS) Green Budget warned that without the increases the government would miss its fiscal target on public borrowing.

The IFS said that the economic slowdown would reduce corporate tax revenues, widening the budget black hole.

And it warned that the government could also break its debt rule by 2010/11.

The day of judgement cannot be postponed forever Robert Chote, Director, Institute for Fiscal Studies

And with the government starting a new economic cycle with a large current deficit, it is likely to struggle to meet its "golden rule" - that borrowing and spending should balance out over the whole period of ebbs and flows in growth.

Difficult choice

The IFS said that, with the slowing economy, the government is facing a difficult choice.

Mr Darling's first Budget could be tougher than his predecessor's

If it raises taxes, it might slow the economy further.

But Robert Choate, the IFS director, said that a modest tax rise could be offset by further interest rate cuts by the Bank of England, which are widely expected later this year.

And he argued that it was vital that the government restored some credibility to its fiscal rules, after a period in which it seemed to be always changing the goalposts.

He said that the government had been continually revising upwards its budget deficit, and "the day of judgement cannot be postponed forever".

Economic uncertainty

However, new forecasts from David Miles, chief economist at Morgan Stanley, showed that any further slowdown in economic growth could throw the budget calculations completely off-course.

Morgan Stanley forecasts that if the UK has just a mild economic slowdown, with economic growth of 1.75% in 2008, and a recovery to 2.25% by 2009, then it will take until 2011/12 for the current budget to return to surplus.

But on their pessimistic case, with UK growth slipping to just 0.5% in 2008, and 1.75% in 2009, public sector net borrowing would double to �68bn by 2011/12 and total government debt would rise well over target to over half of GDP.

This scenario could happen if the credit crunch got worse, causing house prices to fall further and sharply curbing consumer spending.

Spending squeeze

The NHS will enjoy record increases no longer

The IFS also pointed out that in order to keep the budget deficit under control, the government will have to stick to the very tough spending targets announced in the comprehensive spending review in October

Public spending is planned to rise by just 2.1% per year, half the rate in the last decade, and will fall as a share of national income.

The IFS said there could be particular problems in several areas:

• Health spending
• Poverty
• Local government spending
• Public sector pay

On health, the IFS says that government spending needs to be between �6bn and �10bn higher than planned to meet Derek Wanless's target of developing a world-class health service.

Recent research by the Office for National Statistics has shown that productivity in the health service has not been rising as fast as investment, not yielding the outcomes that were hoped for.

And the IFS argues that the government will need an extra �3.4bn to have a 50% chance of meeting its poverty target of reducing child poverty in half by 2010/11.

But the biggest squeeze on public spending next year will be on local government, which is only getting a 1.5% spending increase in the next two years, while council tax increases are being capped at 5%.

This could lead to big cuts in discretionary council services, or pressures to raise council taxes further, according to the think tank.

Public sector pay

The IFS also said it is wrong to argue that the 2% inflation target means that the government must keep public sector pay below that level.

It said that pay could rise further, taking into account the rise in productivity and differences in "pay drift" - when pay goes up automatically.

The report suggested that there is scope for a higher rate of increases for teachers, doctors, and the armed services.

It also suggested that pay increases should be targeted towards London and the Southeast, where the public sector is having recruitment difficulties, rather than spread evenly around the country.

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