Bright picture at odds with reality

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Gordon Brown may have sought to conjure an image of sunny uplands for the public finances on Wednesday. But his actions showed he is in a dark tunnel – with no certainty he will emerge from it in time for the next general election.

The Chancellor claimed that “our fiscal discipline is the foundation of the strength of Britain’s finances”. But if the story was that simple, he would have had the cash to cut taxes uniformly rather than reducing the burden on some tax payers while raising it for others. Nor would he be planning a squeeze on taxation and public expenditure over the next three years that will raise the tax burden to levels last seen at the start of the 1980s.

This raises the question: is the light the chancellor can see at the end of the tunnel reality or mirage? Will Mr Brown’s planned prudence after so much profligacy give the soon-to-be prime minister Brown sufficient leeway to end the fiscal squeeze before he goes to the polls?

The story of Mr Brown and the public finances is best summarised by a chart with the user-unfriendly title “cyclically adjusted current budget surplus”. This measures the underlying difference between tax revenues and day-to-day public expenditure and strips out the ups and downs of the economy.

Between 1996-97 and 2000-01, the public finances improved sharply – the result of extremely tight controls on public expenditure and unexpectedly rapid growth in tax revenues.

Then Mr Brown turned the spending taps on – opening up a black hole of lost revenues. The Treasury’s forecasts moved from persistently pessimistic to overly optimistic. The cyclically adjusted deficit grew to 1.5 per cent of gross domestic product in 2004-05.

Mr Brown has been clawing the deficit back ever since, first with stealth tax increases – raising tax rates and revenues as a share of GDP – and then by planning much tighter public spending control in the years ahead.

Worse, every year since 2001, for seven Budgets in a row, the chancellor has gabbled his public borrowing figures when announcing them to the House of Commons. So fast do they come out of his mouth that you know there is something to hide. Analysis of on Wednesday’s figures showed a current budget deficit £3bn higher than his December forecast in 2007-08, and £1bn worse in every subsequent year.

The Budget red book details the reasons.

It is not the economy that is to blame for the errors. Economic growth is forecast to change barely at all from the Treasury’s December forecast and most independent economists are reasonably satisfied that Mr Brown is not predicting an unachievable economic expansion over the next few years.

The problems have instead come in forecasting taxes and public expenditure. Tax revenue forecasts have again proved too optimistic and the Treasury has had some difficulty living within its current generous spending totals.

Compared with last year’s Budget, tax revenues are now projected to be £2.1bn lower in 2007-08. Corporate tax revenue is the villain of the piece with North Sea revenues falling far short of expectations. Mr Brown blames a lower oil price, lower production, higher investment and a stronger pound for reducing the sterling profits in the North Sea.

On public expenditure, the Treasury was also unable to keep within spending plans for day to day bills – overshooting by £1bn this year and £2bn subsequently.

Persistent forecasting errors delay the point at which the government can stop squeezing the public with a higher tax burden and slower spending growth. It plans now to run a cyclically adjusted current budget surplus of 0.4 per cent of gross domestic product in 2009-10.

If a future chancellor achieves such a borrowing path, Mr Brown will be able to go to the country around that time, safe in the knowledge that he has finally reached the end of his tunnel of borrowing and is able to be a little bolder on public spending or tax cuts.

He would be able to raise the growth of spending to the level of growth of the economy, for example, throwing down the gauntlet to the Conservatives to spell out exactly what they would cut if they wanted to reduce the share of spending in GDP.

But it is a big ‘if’. And not everyone believes the government will pull it off. Peter Spencer, economic adviser to Ernst & Young, said the strategy would fail. “The plan is to borrow now and pay later, but the reality is to borrow, borrow, borrow,” he said.

Calculating that £10bn of tax rises were needed to satisfy the dictates of prudence, Roger Bootle, economic adviser to Deloitte, said: “The fiscal position remains concerning and any marked shortfall in economic performance would see the borrowing numbers at uncomfortable levels”.

Andrew Haldenby, Director of the right-of-centre think tank Reform, said the Budget “does not put the public finances on a sustained path of fiscal discipline. A more responsible stance on spending will be needed to deliver a sustained programme of tax reduction, which would bring dramatic benefits to UK growth”.

These comments might yet prove too pessimistic but they show just how tough it will be for the public finances to emerge from the woes of the past five years in time for the next election.

Mr Brown remains in the tunnel, seeing the light ahead, but without any certainty he will get there in time for his next encounter with the voters.

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