What is needed to boost the UK economy?

By Evan Davis BBC economics editor

The government faces a significant shortfall

Who wants to win the next election?

Every now and then one has the feeling that a parliament exists simply to put up taxes.

The 1992 parliament was one: over the course of its five-year life John Major's government raised taxes by about 2% of national income. (That's equivalent to about £28bn in today's economy!).

It did the trick; it put the finances on a solid footing, but it was unfortunate for the government, which had won the 1992 election on an implied promise of keeping taxes down.

The 1979 parliament had a similar feel to 1992. The economy was in a trough, the new prime minister wanted to cut taxes, but something had to be done to bring borrowing under control so taxes were raised.

The pain suffered then at least made governing in the subsequent two parliaments somewhat easier.

Different scenarios

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Well here's a question: will the 2009 parliament be one of those fateful occasions that requires a large sacrifice to be made?

It is looking as though it might. At least, it might be unless Alistair Darling makes a more dramatic gesture towards tax-raising than most of us expect.

On current estimates, if all goes well the Chancellor is still about £5bn to £10bn short of where he would like to be.

That can probably be dealt with - a few more years of spending restraint whereby the growth of public spending is below the growth of incomes beyond 2012; the transition to a later state pension age for women and one or two tiny tax rises should solve it.

But that's the "all goes well scenario".

What, if in fact, the economy slows down?

At the moment, the chancellor is relying on the current slowdown being over by Christmas. That is not a majority view.

Now the problem is not so much that the recovery could be delayed by a year. That would be manageable.

Temporary boom

But the difficulties arise if a longer term economic re-appraisal is needed.

The painful parliaments are those where we have to reassess our whole view of the strength of the economy.

For example, the problem in 1992 derived not from a slowing economy. It derived from the fact that by 1992 we realised the late 1980s boom had been a temporary aberration, and not the permanent turnaround we had thought.

Once we sat down it became clear that the rise in government borrowing was not a blip caused by a recession; it was structural.

The economy was simply not as strong as we had been thinking for several years and consequently it would never generate as much tax as we needed.

So taxes had to be raised - or spending cut back.

'Nasty problem'

The worry is that the next few years might bring that kind of realisation.

Consumers have already showed signs of tightening spending

Suppose we discover that before the economy gets back on track to normal growth of 2.25% to 2.5%, it endures two years of 1.5% growth.

That is far from the worst outcome one can imagine. But it leaves the economy permanently about 1% or 2% smaller than the chancellor has been assuming.

That small error would translate into a permanent annual deterioration in government revenues of about £9bn. When you add that to the shortfall we already have, you are half way to a very nasty problem.

In addition, raising large amounts of new money from the public - in return for no extra services - might feel somewhat uncomfortable when a significant economic slowdown is underway.

Recovery

You might ask whether the economy will be that bad. Or whether - just as plausibly - it will be a lot worse than I've described.

I'm not sure. It could go in a multitude of directions.

But there's a general rule here: as far as tax and spending are concerned it is the long term that matters, which means it is both the slowdown and the size of any subsequent upturn that are important.

So we won't really know how far we need to reassess the economy and the public finances until the economic storm has passed, and recovery is well underway.

Only then will we have an idea of what the long term tax generating capacity of the UK economy is and that will not be until the 2009 parliament.

Good luck to whoever takes over.