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 Wednesday, 3 April, 2002, 16:55 GMT 17:55 UK
The chancellor's economic playing field

When Gordon Brown delivered his pre-Budget report in November, all eyes were on the economy.

With the UK's major competitors floundering after 11 September, how would the country weather the storm?

By most accounts, remarkably well. But, in the run up to the Budget, questions remain.

Even at the time of the pre-Budget report, Mr Brown remained upbeat, saying the economy would expand by 2.25% in 2001.

In the event, he proved to be a little too upbeat - the latest official figures are closer to 2%. And between October and December, the economy failed to grow at all.

Nevertheless, in 2001 as a whole UK growth was the strongest in any of the G7 countries, and already experts say the economy is bouncing back.

So, it was an extremely short and shallow downturn by post-war standards, especially given the extent of the global slowdown.

Mr Brown is renowned for putting sound economic management near the top of his priority list.

But economists say that much of the credit for steering the economy away from danger should go to the Bank of England, for their swift reaction in cutting the cost of borrowing to a 40-year low.

However, the economy is not completely out of the woods yet.

Manufacturing is showing only tentative signs of recovery, and has a long way to go with employment in the sector at its lowest since figures were first published almost 20 years ago.

Consuming issues

By contrast, consumer spending continues to thrive, and, despite forecasts to the contrary, the housing market has failed to cool down.

As in the past few years, household expenditure continues to drive growth in the economy at large - not surprising given that interest rates are just 4%, and real incomes growing rapidly.

With billions of extra pounds of public spending being released, consumers should get an extra boost.

But the persistent gulf between industry and the consumer means that the recovery could be as unbalanced as the slowdown.

For the interest rate setters, that poses a potential headache. If consumer spending shows signs of overheating, then inflation may rise above the government's target.

The Bank of England has suggested that consumer spending growth should slow of its own accord.

Unemployment is still at its lowest for over 20 years.

With many of the redundancies announced at the end of last year only now becoming reality, the jobless total could soon begin to rise again.

Blot on the landscape?

Experts are almost unanimous in saying that the next move in interest rates will be up. But that move may not come for several months.

On average, independent economists predict that the economy will grow by 2% this year, with growth speeding up towards the end of the year.

Most think that the Chancellor's prediction of 2% - 2.5% this year and around 3% in 2003 is over-optimistic.

Weaker growth tends to mean lower tax revenues and higher government spending - and a lighter public purse.

So could last year's slowdown blot the Chancellor's so-far impressive record on public finances?

More importantly, could it restrict his spending plans over the next few years?

Back in November, the Chancellor predicted that public sector borrowing would be about 2.5bn in 2001-2, the financial year that has just ended.

In actual fact, thanks to strong tax receipts the actual figure is likely to be lower than that. The public purse may have ended the year in surplus.

As he has persistently done, the Chancellor has probably underestimated the health of the public finances.

And even if he has been over-optimistic about economic growth this year, the government's finances shouldn't actually be jeopardised in the near term.

When forecasting public finances, the Chancellor uses a fairly cautious assumption that the economy will grow by 2.25% per year in the medium term - somewhat less than the economic growth he actually forecasts for next year.

Big spender

But further out, it's not the economy so much as the Chancellors spending plans that are the issue.

In the next couple of years he intends to raise spending by 3.6% per year. He can fund it easily, with the public purse bulging during recent years.

But the so-called war chest is emptying fast, and in the Budget Mr Brown may indicate how much he wants to spend between 2004 and 2006.

With health and education still key priorities, he won't want to scrimp. To keep boosting spending at a similar to the current rate, he either has to borrow or raise tax revenues.

According to his own self-imposed rule, Mr Brown can only borrow to invest (i.e. fund capital spending) over the economic cycle, so to carry on boosting current spending taxes will have to be raised.

The highly respected Institute for Fiscal Studies estimates that after 2004 Mr Brown may need to get an extra 2bn a year into the Treasury coffers.

Tax rise

But how? The measures announced in the past couple of weeks suggest that Mr Brown has awarded business a tax cut of up to 1bn - something which will help the corporate sector on its way to recovery.

The obvious solution - and one which would help rebalance the economy without the need to raise rates - would be to tax consumers.

According to economists at Deutsche Bank in London, "the chancellor should raise personal sector taxes by 4-5bn on April 17 to take some of the pressure off the [Bank of England's Monetary Policy Committee]."

The question is how.

Having ruled our raising the basic and higher rates of income tax in the election manifesto, the Chancellor has eliminated some of the more obvious options.

Once again, he has a tricky juggling act to perform.

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