Home-grown problems

The IMF suggests governments facing more difficult economic times should increase spending. But Brit

Alistair Darling has been accused of being indecisive. Yet he has forged one important change from the pattern set by his predecessors. Instead of keeping the City, the accounting community and business - not to mention parliament - guessing until the last minute about the date of the Budget, he announced good and early that it will be on 12 March.

This will be much to the chagrin of the corporate entertainment fraternity since it is bang in the middle of the Cheltenham Festival of jump racing. Darling will have more than his fair share of hurdles to navigate. As a result of the credit crunch, the economic outlook for Britain looks more uncertain than at any time since Labour came to office. This will have a dramatic impact on the arithmetic.

Lower growth means less tax income from companies and consumers and also pushes up the cost of what economists call transfer payments - the amount of money a government is obliged to spend on unemployment benefits and welfare. So it is a double whammy for the public finances.

In the current financial year and in 2008-2009, the public finances will be particularly vulnerable to difficulties in the Square Mile. Profit write-downs will deal a heavy blow to corporation taxes and the only bonus in many City houses in the year ahead will be keeping your job. A possible salvation will come from record oil prices, which briefly touched $100 a barrel at the end of last year, providing large and North Sea oil producers with an unexpected windfall. The Anglo-Dutch giant Shell has already reported UK record profits of $31bn (£16bn), a chunk of which will be repatriated to the Exchequer.

But this will not be enough to spare the Chancellor from harsh decisions. The Institute for Fiscal Studies, headed by the fiercely independent Robert Chote, says in its "Green Budget" that an £8bn tax increase - equal to a rise of at least 2p in the basic rate - will be needed if the public finances are not to deteriorate further. The IFS forecast has to be taken seriously. The think tank repeatedly pointed out in 2003 and 2004 that recent rates of growth in public spending were not sustainable and would have to come down sharply.

In last autumn's Comprehensive Spending Review, the government did precisely that - slashing the rate of growth in expenditure to just 2.1 per cent, less than half the increases the country has become used to. Ministers usually raise taxes when an election is some time away. Labour's biggest tax increase, a 1 per cent rise in National Insurance contributions, took place in 2002 and was wrapped in the "feel-good" language of more investment in the NHS. Raising new taxes as the economy is slowing removes spending power and could accentuate the slowdown.

Stimulating growth

Among the best ways for governments to avert a recession is to spend their way out of it. President Bush, after years of stalemate with Congress, secured support for a $150bn stimulus package that offers companies and individuals tax rebates and beefs up welfare benefits.

Ideally, the Chancellor would be seeking to put cash back in people's pockets or raise spending at a faster pace. But Darling is boxed in by the fiscal rules established by Gordon Brown. The huge rates of extra spending in recent years mean overall expenditure and borrowing are high at the very moment the tax take is under pressure.

Net borrowing by the government reached £41.4bn in the past calendar year, which is 2.9 per cent of national output. The IFS and other forecasters fear that the "golden rule", which allows borrowing only for investment, could be breached and that debt levels could rise above 40 per cent.

Only last week, in a change of heart, the IMF suggested that the right policy for western governments facing more difficult economic times was to increase spending.

But Britain is a unique case. A study by the OECD shows that between 1996 and 2007, 16 countries improved their level of public debt compared with the UK, giving them the headroom to increase spending or lower taxes to offset the threat of a slowdown.

One solution would be to keep fiscal policy tight - by raising taxes and keeping the lid on spending - but cutting interest rates decisively, like the Federal Reserve in the US. But that option looks closed, too.

The recently reappointed governor of the Bank of England, Mervyn King, has made it clear that while there is room for modest cuts in rates, the inflation threat from higher fuel and food prices is too great to loosen the monetary straitjacket.

Darling's first full Budget, therefore, looks certain to be a peculiarly glum affair. He will seek to place the blame on global conditions. The reality is that Britain's problems are home-grown.

Alex Brummer is City editor of the Daily Mail

This article first appeared in the 11 February 2008 issue of the New Statesman, Now it gets really dirty