Does the Chancellor face a black hole?

Analysis By Evan Davis BBC economics editor

Economic growth has been stronger than feared

The Chancellor has given himself some slack before he needs to raise taxes to reduce the growing budget deficit.

"There's good news and bad news, Chancellor", the Treasury Mandarins could be saying this week.

"Which would you like first?"

Mr Brown might be tempted to take the good news.

And it is good.

The Chancellor's forecasts of UK economic growth - forecasts that were widely derided as over-optimistic at the time he made them last April - suddenly look reasonable.

So, for example, Mr Brown said the economy would grow by 2% to 2.5% this year.

The consensus forecast (that is, the average of reputable independent forecasts) is for growth of 2% exactly, just within Mr Brown's range. He may not be so lucky next year.

The Chancellor forecast growth of at least 3% in 2004 and the consensus forecast is still below that.

But at least, on growth Mr Brown does not look to have discharged himself badly this year.

Public finance problems

So what about the bad news?

Well, that concerns the public finances.

Notwithstanding the fact that the economy seems to be growing adequately, the public finances are looking very out of sorts.

The Chancellor could face hard choices on tax

For one thing, we are half way through the financial year, and the government has already borrowed £22.5bn.

If the pace of borrowing follows the pattern of last year, Mr Brown is on target to take the country £37.5bn into the red over the fully year.

That is well ahead of the budget forecast of £27bn. There are two reasons for this bad news.

First, public spending is running well ahead of budget so far this year.

Current spending is increasing at 9.8% per year, compared to a forecast of 7.0% per year.

That may not matter, as government departments can retrench in the last few months of the year to get back into line. So we shouldn't worry about that.

Missing tax revenues

But the second problem is that the tax revenues are running below expectation as well.

Central government receipts have increased by only 5.9% compared to last year, as opposed to the government's forecast of 7.3%.

Inland Revenue taxes, like income tax and national insurance in particular are coming in below expectations.

It seems that the Treasury was simply over-optimistic in assessing how much income would be forthcoming this year.

In particular, one problem might be that the incomes of the rich are being constrained, and for every pound a rich higher-rate taxpayer doesn't earn, the Chancellor loses more tax revenue than he gains from an extra pound in the hands of a standard, 22% rate taxpayer.

Leeway

The Chancellor can sit back and relax for a year or two.

He has kept government debt down in the first Labour parliament enough to have some leeway.

Governments can borrow with impunity in the short term.

But what about the medium to long term? If conditions do not improve, Gordon Brown may be in a little trouble.

For example, the Chancellor's favourite measure of borrowing is the so-called "Current Budget", the surplus of revenues over expenditure, excluding investment spending from the calculation.

His target is for the Current Budget to remain in balance over the course of the economic cycle - the so-called Golden Rule.

But even in the Treasury's current projections, Mr Brown is anticipating that his finances return to a surplus of only £6bn in the financial year 2006/7, a dangerously slim safety margin should things not turn out to plan.

And so far, things are not turning out to plan.

Timing

Finally, of course, Mr Brown has to think about the timing of the bad news.

If he simply does nothing, and hopes that tax revenues pick up without new budget tax rises, the Chancellor may find himself having to act, just as we approach an election.

So, there you have it. There is good news on growth, and there is bad news on the public finances.

Personally, if I was Chancellor I suspect I would rather have a little less economic growth and a little more tax money pouring into the exchequer.

But it is better to apparently have some good news, than none at all.