Preview: UK pre-Budget report 2005

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Gordon Brown’s ninth pre-Budget report will be one of his most difficult. Against a backdrop of a sluggish economy - with many of the big tax and spending decisions in this parliament postponed; the chancellor will struggle to stop this set-piece Parliamentary event being dominated by admissions he got his economic forecasts wrong.

The pre-Budget report - often called a green budget even though its got nothing to do with the environment - is Mr Brown’s opportunity to give an update on the Treasury’s views of the economy and the public finances - and to tell tax professionals and the public about the ideas for tax changes that the government has got. Often under Mr Brown it has become a mini-Budget with many policies being announced and financial goodies distributed to important elements of the electorate.

This year the economic backdrop to the pre-Budget report is weak. Shoppers have been more careful with their money; high oil prices have pushed up the cost of motoring; and companies have been cautious about new investment.

The annual rate of economic growth has fallen to its lowest level since the last time the economy fell into recession in the early 1990s.

Worse for Mr Brown, his economic forecasts for this year are hopelessly out.

As recently as March, the Treasury forecast the economy would expand by 3 to 3 and a half per cent this year. With most of the figures already in - it looks pretty certain that the final figure will be about half that - 1.7 per cent.

This will be embarrassing for the chancellor, since he made such a song and dance last year about how his record on forecasting was better than others. And all though the election campaign, when the figures were going against him, he continued to insist that his forecasts would be met.

The pre-Budget report will be the time he finally has to accept they won’t. According to independent economists, his forecasts for next year of 2 and a half to 3 per cent growth look a bit toppy too.

As to an explanation of his forecasting fallibility, Mr Brown has already revealed his hand. He will blame the high oil prices, which briefly pushed a barrel of crude above $70 in the Autumn.

Opposition politicians will be less than impressed with this explanation. They will point to the Bank of England, which says the main cause of the slowdown has been low income growth for the past two years, caused in large part by Mr Brown’s tax increases. They will point to the National Institute of Economic and Social Research, which lays the blame at the Treasury’s over-optimistic investment forecasts, not oil prices. And they will point out that the US and Asia - who also have to deal with high oil prices - have rapidly growing economies.

Even within Europe, Britain has slipped down the growth league. It will be about 18th out of 25 this year, down from 12th position in 2001.

After his growth forecasts, Mr Brown will turn to the public finances.

These have been steadily getting worse since 2000. A surplus of £16bn has turned into a deficit of £39bn. The figures do not look much better if adjustments are made for the small economic downturn between 2001 and 2003. Mr Brown keeps on promising the figures will look better in a few years time, and keeps postponing that happy moment.

This pre-Budget report, he is likely to have to accept - for the fifth year in a row - his Budget forecasts will again be missed . His problem is that although tax revenues are pouring into the Treasury - they are not flowing as fast as he predicted.

Overall tax revenues are up 7.4 per cent this year - compared with the same period last year - but Mr Brown needs an 8.5 per cent rise to hit his forecasts. Corporation tax has jumped by 19 per cent - but that is less that the 28 per cent surge he wanted - and to meet his Budget forecasts, it now has to rise by 50 per cent in the remaining 5 months of the financial year - not likely say economists.

But here, Mr Brown will have an easier time explaining the shortfall. Slower growth means weaker tax revenues. And that is not a problem so long as the growth comes back in years to come. We can expect Mr Brown to revise his borrowing forecasts up a bit, but then show a greater improvement in years to come. In other words he will continue to do exact what he has done for the past five years.

Mr Brown will, of course, say he is on track to meet his two fiscal rules for the economy - the golden rule - only to borrow to invest over the economic cycle, and the sustainable investment rules - to keep net public debt below 40 per cent of national income.

Ever since the Mr brown changed his definition of the economic cycle in July, most economists have stopped paying too much attention to these rules. They’ve been discredited in the eyes of the profession. Instead, economists look at the overall balances, the outlook for the economy, tax revenues and public expenditure and come to a judgment on whether the public finances are sustainable. The vast majority say no. About a £10bn a year tax increase or additional spending restraint is needed to put the public finances back on the straight and narrow, they say.

This sounds a lot, but isn’t really. It’s less than 1 per cent of national income. But don’t hold your breath in anticipation of the chancellor agreeing the public finances need some attention.

It became pretty clear in the summer when Mr Brown delayed the 2006 spending review that the big decisions on tax and spending this Parliament would be delayed until 2007.

So what can we expect from the pre-Budget report. Well, some things are known, and in other areas there is a lot of speculation.

We know the government will give its response to the 2004 review by Kate Barker on the supply of housing - probably including measures to increase house building and possibly including a new tax on the financial gains made when planning permission is granted.

Mr Brown has also said that he will focus much of his energies on improving skills, enterprise and innovation. Expect to hear about enterprise scholarships; a review on the skills Britain needs to compete with China and India in the decades to come and some additions to tax credits given to boost company spending on research and development.

We also have been told that there will be some more treats in store for hard-working families. The 2 million lower income families battling with the nightmare of overpayments of Mr Brown’s tax credits might also hear that the the government has decided to throw money at the problem to avoid the whole idea of tax credits falling into disrepute.

The accounting profession is likely to come under attack from the chancellor, keen to prevent companies using legal avenues to avoid tax. He started a crackdown in 2004 and we can expect him to close more loopholes and in the process raise a bit of tax revenue. Companies will be on guard to complain loudly if they feel the proposals attack long-accepted business practice rather than artificial tax avoidance schemes.

Finally, if Gordon Brown is really strapped for cash, he might consider a special tax on oil companies - who have been making huge profits as oil prices have risen. This would cause howls of anguish from oil companies, who thought the North Sea oil taxation regime was settled in 2002, when they were hit by a new supplementary corporation tax. but if Gordon Brown chooses to hit oil companies hard, he will be gambling that the public would not feel much sympathy for the likes of BP and Shell shareholders.

As ever, Mr Brown will spring some surprises and skate over his economic difficulties, trying to concentrate on the way he can improve Britain’s economy for the long-term. This year, however, all eyes will be on the economy and just how Gordon Brown will explain a slowdown he said could never happen.

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