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Friday, 12 July, 2002, 06:48 GMT 07:48 UK
Can the Chancellor afford it?

Gordon Brown has said how much money he has, and how he plans to raise it, in the April Budget.

Now the country is holding its collective breath to see exactly where the Chancellor is going to spend his huge amount of extra cash.


The government may be about to embark on too much spending which it will not be able to finance

Vicky Price, chief economic advisor, DTI
Despite the big increases, however, public spending as a proportion of the nation's economy will still be lower than during John Major's term of office - so public expectations of big improvements in public services may be wide of the mark.

And many economists will be worrying about what effect Gordon Brown's three year public spending spree will have on the government's finances.

This spending review, Labour's third, will lay out major increases in funds for public services.

Health will get a pre-announced 40bn cash boost over the next five years.

Health spending will grow by 7.4% a year in real terms during this period, in line with the recommendations of the recent Wanless report.

It will take UK health spending as a proportion of national income from 7.7% now to 9.4% in 2007-08, fulfilling Tony Blair's pledge to match the EU average.

Education targeted

There have also been strong hints that education is in line for a large boost in funding.

The highly regarded economic think-tank, the Institute for Fiscal Studies, has calculated that even after the extra spending on health, there would still be enough money left to boost the education budget by 14bn by 2006.

Social security - already by far the largest single element in government spending - is set to grow to pay for Brown's new anti-poverty tax credits. There will also be strong pressure to find more cash for the police, defence and transport budgets.

All this is being funded by a combination of over 8.5bn of tax rises annually, as well as some sleight of hand by which the Treasury raised its expectations for economic growth and future tax revenues.

Taxes to rise?

However, the suspicion among many economists is that this still won't raise nearly enough money to pay for the extra spending, and that taxes will have to be hiked again, probably as early as the next budget.

A likely candidate for a further tax increase would be another uncapped 1p on employee national insurance, which higher earners would pay on their entire income. This would raise about 3.8bn.

The public finances are already projected to slide into the red over the next four years and beyond as Brown's fabled "war chest" gets used up. Brown insists this will not breech his self-imposed fiscal rules governing acceptable levels of government borrowing.

Weak growth

The headache for the government is that the projections on which these rules are based assume the economy will grow by at least 2.5% a year.

This needs to happen to generate sufficient tax revenues. But growth has been near zero over the last six months, and it looks very unlikely that the target will be achieved this year.

The influential ITEM Club of economic forecasters warned after the April budget that revenue projections by the Treasury would not be enough to cover its spending plans.

Even some government officials admit that taxes will have to go up again.

In a surprisingly candid interview last month Vicky Price, the new Chief Economic Advisor to the Department of Trade and Industry said:

"The government may be about to embark on too much spending which it will not be able to finance. The NHS, education and transport require so much money they will have to raise taxes."

The IFS has also pointed out that Mr Brown's health spending plans cover five years, but the government has only set out three years of tax rises, implying a potential "black hole" in the government's finances after 2005/06.

Conflict with Europe

The spending review may cause further complications over any future plans to take Britain into the euro.

The European Commission has attacked the government's spending plans on several previous occasions for breaching the EU Growth and Stability Pact, which set a limit of 3% of GDP on government borrowing.

Brown has his own rules on borrowing, but these take a much more relaxed view on so-called investment spending, allowing him to greatly boost government spending on roads, schools, and hospitals, while still claiming he is being cautious.

The government's plans for future spending are published on 15 July

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