By Steve Schifferes
Economics reporter, BBC News
A leading think-tank has suggested that the government may be planning further cutbacks in public spending after the next general election.
The UK is facing a significant funding shortfall, the IFS says
The Institute for Fiscal Studies (IFS) says the chancellor has pencilled in an extra £12bn worth of cuts in the next spending round which begins in 2010-11.
Public spending growth is already set to slow sharply, to below the pace of economic growth, over the next years.
On Wednesday, the Chancellor Alistair Darling handed down his first Budget.
Based on his plans, the latest revelations from the IFS suggest that the government believes the current problems in the global financial markets are doing long-lasting damage to the UK's public finances.
According to IFS calculations, the Chancellor believes there will be an extra £7.5bn shortfall for the next five years.
He is planning to make up some of that shortfall by tax increases - which will amount to £9bn over the period - as alcohol and road taxes rise sharply in real terms.
But two-thirds of the budget shortfall will have to be made up by further restrictions on public spending, on current plans.
The news will not be welcome to the public sector unions, who are already facing a 2% pay freeze.
Breaching the rules
According to IFS director Robert Chote, the government will have to borrow £20bn more than planned six months ago, as the slowing economy hits tax receipts and higher inflation raises the costs of benefits.
He says that there is a real danger that Mr Darling could breach his own fiscal rules, as the government has run out of room for manoeuvre.
In particular, there is at least a 50% chance that the 'sustainable investment' rule, which limits total government debt to 40% of gross domestic product (GDP), will be breached in the next few years.
The government's own projections suggest that it will be just £2.8bn below the level within three years - and that is excluding the effect of Northern Rock and the proposed inclusion of some of the costs of private finance initiative (PFI) projects.
If the limit is breached, it will restrict Labour's scope to increase capital spending on building more schools, hospitals and roads.
The IFS says that the chancellor is also sailing close to the wind on the golden rule, which states that the current budget should be in balance over the whole economic cycle.
And there are still questions about how to define the economic cycle, as the current slowdown could be interpreted to mean we are still in the same cycle as when Labour came to power.
Should that be the case, then it could mean that we will not know whether Labour has met its own targets until after the general election.
The IFS warns that a further deterioration of the economy, or further pressures on spending, could throw the chancellor even more off-course.
For every 1% reduction in the rate of the growth of the economy, there would be around an extra £8bn to £10bn bigger budget deficit.
And more might be needed to be spent to meet the government's objectives of helping pensioners with fuel bills (making permanent the £500m extra in winter fuel allowance this winter).
As well as reducing child poverty by half (increasing the £1bn already committed by another £2bn-£3bn).
Luckily for the government, the measures on child poverty, which say whether its target has been met will not be published until after the latest date for an election in 2010.
But the government's difficulties are not all good news for the Conservatives.
Their plan to "share out the fruits of economic growth" by only giving some of it to the public sector already looks like being implemented by Labour in the run-up to the next election.
And it may be hard for either party to run on a platform of higher taxes to close a growing budget gap.
Just as in 2005, the hard choices may begin after a winner is chosen.