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Last Updated: Monday, 29 November, 2004, 22:02 GMT
Gordon Brown's challenges
Analysis
By Robert Chote
Director of the Institute of Fiscal Studies

Gordon Brown
Grab some taxes here...

When Gordon Brown delivers his Pre-Budget Report on Thursday, he may take a moment or two to remind us - however subtly - that the economy is now embarked on its fiftieth successive quarter of growth.

But although sustaining this remarkable period of stability is a genuinely impressive achievement, the state of the public finances is likely to attract a little more attention.

Here too the position is fundamentally sound: the government's debt has been rising for a couple of years, but is still modest by historic standards and relative to the industrial country average.

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Unfortunately for the chancellor, he set himself a rather tougher target - and if the trends of recent months continue he is on course to miss it. Not an ideal position with the election probably just six months away and the opposition looking to dent his reputation for economic competence.

Overoptimistic

Mr Brown's problem is his self-imposed "golden rule". This says that on average over the ups and downs of an economic cycle the government should only borrow to pay for investment that supposedly benefits future generations. In other words, day-to-day spending that benefits today's taxpayers should be paid for with today's taxes.

Gordon Brown
... spend the taxes over there

In judging whether this rule is being kept to, the Treasury assumes that the current cycle - upswing, peak, downturn, trough and recovery - covers seven financial years from 1999-2000 to 2005-06.

Go back two or three years and the Treasury was predicting that tax revenues would be far in excess of what was needed to pay for non-investment spending over this period. But its last three Budget forecasts have been overoptimistic and the comfort zone has steadily shrunk.

In March the Chancellor predicted that he would overachieve the golden rule over this seven year period by just 0.7% of a year's national income - about 8bn.

Since March, spending has been stronger and tax revenues weaker than the Treasury predicted for the year as a whole. If this persists, borrowing to finance non-investment spending may be 12bn higher than expected, more than wiping out his remaining room for manoeuvre.

Spare capacity

If the Chancellor manages not to spend the 3bn put aside in his Budget plans for unexpected contingencies this year and next, it will be a closer run thing. But if any of this year's overshoot in borrowing persists into next year, the rule would still be missed.

The Treasury dismisses any such suggestion. If the rhetoric of recent weeks is anything to go by, the Chancellor will insist that the rule is going to be met and disparage the forecasting record of anyone who suggests otherwise.

Over the next five months, he expects spending to slow and revenues to pick up - in part as oil producers pay more tax. This may be true - the public finances are hard to forecast accurately even over short time horizons.

Alternatively, he may argue - in line with the views of the Bank of England and a number of independent economists - that the spare capacity in the economy has been used up more quickly than he thought and that we are already in the last year of the cycle.

This would make the rule easier to meet in the short term by lopping off one year's deficit. But it would strengthen the case for fresh tax increases after the election to ensure that the Treasury brings in enough revenue to meet the rule in the next cycle with the comfort it has sought in the past.

If the Conservatives were to win the election, it would limit the extent to which they could promise lower taxes paid for with spending cuts.


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