No stardust left to sprinkle

With falling tax revenues and soaring public spending, the outlook for this year’s Budget is bleak

Alistair Darling has been Chancellor for less than two years. Yet, in conversation, he is able to let drop an unusual boast – in that time he has made more statements from the despatch box than any holder of that office in modern times, including his ubiquitous predecessor Gordon Brown. This is all rather surprising. In his previous great offices of state as Treasury chief secretary, secretary for social security, work and pensions, transport secretary and secretary at the then Department of Trade and Industry, Darling’s main task was to take on a complex portfolio after some kind of political row, such as the botched nationalisation of Railtrack in 2005, and smother the storm.

At No 11 this has never been possible. He has skidded from one crisis to another: the politically poisonous abolition of the 10p tax band for the lowest-paid (a legacy from Brown’s last Budget); the case of the missing income-tax CDs; the failure and the eventual nationalisation of Northern Rock; and the stumble into the worst economic and financial crisis since the 1930s.

Darling’s reputation has not been assisted by some calamitous forecasting. It is hard to believe that just over a year ago (well after the collapse of Northern Rock and the freeze in the credit markets), the Chancellor in his first full Budget was predicting a mild slowdown in 2008 and a robust recovery to 2.5 per cent growth in output in 2009. It has proved to be the most misjudged official economic forecast in living memory, and demonstrated a breathtaking complacency about Brit­ain’s economic and fiscal prospects.

What is absolutely clear is that Darling and those around him have learned bitter lessons. When the Chancellor delivers his second full Budget on Wednesday (22 April) the rose-tinted spectacles will long ago have been consigned to the scrapheap. It will be a very different Budget, delivered against a very different background.

The Treasury may shy away from using the wartime word “austerity” to describe its content. But once the gee-wizardry of the green car revolution and other eye-catching tax devices are swept away, the arithmetic behind the Budget will be seen to be truly horrible.

It could not be any other way. The hopelessly complacent economic forecast of last March and again in November 2008 – when the downturn for 2009 was pegged at just 1 per cent – has given way to a new reality. In the final months of 2008 and the first quarter of this year the economy slid at an eye-popping 1.7 per cent. The International Monetary Fund estimates that, by the time this year is over, roughly 3.7 per cent will have been knocked off national output, one of the poorest outcomes for Britain in the post-Second World War period. It may not be a depression (classified as a 10 per cent fall in per capita national income), but it will be what the IMF managing director, Dominique Strauss-Kahn, has called, in a reprise of the 1930s, a “great recession”.

The social consequences of such a downturn are already being felt. Here in Britain the unemployment rate has soared above the two million mark and could easily hit three million before this is over. So far the protests have been confined to picket lines at oil refineries and the G20 demonstrations in the City, but it may not require much of a spark for the tinderbox to ignite.

The deterioration in the real economy of manufacturing and jobs has had a calamitous effect on previously near-pristine public finances. As chancellor, Gordon Brown was often accused of fiddling his Budget rules to keep them on target. But as his former top aide Ed Balls liked to point out, Brown succeeded in changing the debate. It was all about holding the national debt at or around 40 per cent of gross national product and ensuring that the government borrowed for investment only, not for current spending.

These rules are now dead meat and the public finances too ghastly to contemplate. The background documents to the Budget will show Darling caught in a pincer movement from falling tax revenues and surging public spending. In

addition to this, the Chancellor has had to accept a ruling from the semi-independent Office for National Statistics that the larger element of the cost of bailing out the Royal Bank of Scotland and the Lloyds Banking Group will have to be counted as part of the national debt.

The crisis in the City and slow growth have taken a chunk out of the government’s tax estimates. Revenues from financial services, 25 per cent of the nation’s tax base, have been savaged by the credit crunch. Stamp duty revenues from housing transactions have virtually disappeared with the crash in residential prices and income from consumer taxes such as VAT has been hit hard by job losses and brakes on consumption.

On the spending side, the “fiscal stabilisers”, which are meant to rebalance the economy during hard times, are working with a vengeance. Unemployment benefit and social security payments are soaring as the public seeks to make ends meet. The result is that a Budget deficit for 2008-2009 projected at £43bn in March 2008 and £78bn in November is likely to be closer to £90bn in the Budget. Looking ahead to the current fiscal year, which began on 5 April, the kindest estimates by the Institute for Fiscal Studies suggest a deficit of £150bn. Some private-sector forecasters believe the outcome could be even worse, with the deficit soaring to £200bn.

Even if the lower figure is correct it gives Darling no room to manoeuvre at all, with the deficit running at close to 10 per cent of GDP, which, by way of comparison, is more than three times the 3 per cent figure required to become a member of Euroland. In the November pre-Budget report, Darling opted for a temporary £12bn cut in VAT in an effort to prevent calamity on the high street. Analysts at the Centre for Economics and Business Research believe it made a real difference.

Yet Darling has made it clear that there is no room for a second fiscal stimulus of the kind that Brown wanted. He has been helped in maintaining this difficult position by the rare intervention of the governor of the Bank of England, Mervyn King, into budgetary policy.

Instead, the Chancellor is counting on policy steps already taken to stimulate output. These include a £75bn programme of “quantitative easing” adopted by the Bank of England; automatic fiscal stabilisers (which have already pushed up the deficit); and the $1trn (£750bn) of new lending to emerging markets agreed at the G20 summit. This, he believes, will stimulate trade and ought to help Britain take advantage of the de facto 25 per cent devaluation of the pound.

Given that the government has expended billions on the banks, it will not be that surprising if Darling manages to find new cash to help bail out the car industry and to support the housing market. However, the Chancellor is determined that, in the process, Britain’s reputation for fiscal probity should not be totally destroyed despite the outrageous Budget deficit.

There will be much talk of restoring “medium-term sustainability” to the public finances, which will almost certainly mean a freeze on public spending, as well as tax increases. With such a bleak future in sight, Darling will have little stardust to sprinkle.

Alex Brummer is City editor of the Daily Mail