Labour's biggest financial test yet

By Hugh Pym
Economics editor, BBC News

Alistair Darling will say how the economy is performing

The worst economic outlook since the early 1990s will be the bleak backdrop to the pre-Budget report.

Its has taken on the air of an emergency Budget and will be the most important financial statement delivered since Labour came to power in 1997.

The prime minister and the chancellor have had to make a critically important judgement.

Get it right and their policies may soften the blow of recession without frightening the financial markets.

Get it wrong and government borrowing becomes ever more difficult to finance with tax revenues falling in a recession-gripped economy.

Taxes

Chancellor Alastair Darling will try to ease the pain felt by many households and companies. He will pump money into the economy, hoping it will be spent quickly.

Tax breaks aimed at middle and low income earners seem set to be at the heart of the package of measures.

There are hopes tax cuts will help boost spending

This could involve an extension of the tax handout which followed the row over the abolition of the 10p tax rate.

A cut in VAT from 17.5% to 15% will, the chancellor hopes, boost spending in the shops.

The logic is that aid is targeted at families most in need, who happen to be those who are most likely to spend rather than save the cash.

There may well be public spending increases too, though it's not clear whether there will be new money or resources shifted from earlier years.

The employers' group the CBI wants the focus of the pre-Budget report to be on infrastructure spending. It also has called for a series of measures to help business.

Public finances

The chancellor will have to borrow to fund these initiatives, adding to the red ink in the government's public finances.

Borrowing is already set to approach �70bn in the current financial year as the downturn hits tax revenues before rising even higher next year.

A fiscal boost in the PBR is likely to add at least another �15bn.

What is now becoming clear is that Mr Darling will announce specific tax increases for a couple of years down the line, while also announcing a handout in the more immediate future.

He will also announce a tight clamp on public spending increases from 2011 onwards.

The idea here is to convince the markets that he is serious about getting the public finances back on an even keel.

Borrowed money

He clearly feels the need to spell out precisely how he will claw back the cash he has given away and more to bring down the borrowing total.

Even so he is set to announce that public borrowing could rise to nearly �120bn pounds in 2010 - 8% of national income.

A proportion as high as that would be even greater than during the peak at the time of the last recession in the early 1990s.

It would be higher too than run up by the Labour government in the mid 1970s.

The stakes could hardly be higher.

It is a crucial judgement for this government to make.

Whatever happens, the Conservatives are sure to step up their charge that the chancellor has come up with a tax con not a tax cut.