No scope for tax giveaways in budget

By Christina Fincher - Analysis

LONDON (Reuters) - As storm clouds gather over the global economy, Chancellor Alistair Darling must be wishing his predecessor, Gordon Brown, had saved more for a rainy day.

For the past seven years, the government has consistently borrowed more than it intended. Despite healthy economic growth, tax revenues have fallen short of expectations and the government has struggled to turn off the spending taps it opened with gusto in 2001.

In his inaugural Budget next week, Darling will have to admit growth will be slower, tax receipts lower and borrowing higher than initially forecast.

With the economy set to slow to a crawl this year, the government would like to be able to cut taxes and raise spending to cushion the impact of the credit crunch. The United States, for example, has already announced a $168 billion (83 billion pounds) fiscal stimulus package.

Unfortunately, the state of public finances leaves Darling with little room for manoeuvre.

The Institute for Fiscal Studies reckons the government should even be considering tax rises.

"Alistair Darling would need to announce fresh tax increases in this year’s Budget to keep public sector debt below the government’s self-imposed ceiling," it argues.

TAX HIKES, ANYONE?

Surprisingly perhaps, business .....continued below

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Although the government’s upwardly-revised borrowing target of 38 billion pounds for this year looks achievable, its projections for steady declines in future years look optimistic.

The Confederation of British Industry calculates the government could be forced to borrow 50 billion pounds more than forecast over the next five years unless measures are taken to put the public finances on a sturdier footing.

It recommends Darling pre-announce measures in this Budget to take effect next year, when the worst of the credit crunch may be over.

Most commentators think tax hikes would be political suicide at the current juncture. The government is lagging in opinion polls and must call an election by May 2010.

However, there is little room to rein in spending -- the government has already unveiled the tightest spending round in almost a decade -- so options are limited.

If something has to give it may be the government’s fiscal rules.

"Next week’s Budget will almost certainly see the fiscal rules being bent if not outright broken or re-written," says Andrew Smith, chief economist at KPMG.

RE-WRITING THE RULES

The government’s fiscal framework revolves around two key rules devised a decade ago by Gordon Brown.

The "golden rule" states that the government can borrow only to invest over the economic cycle while the "sustainable investment rule" limits public sector net debt to a "stable and prudent level"

In the last economic cycle, this was defined as 40 percent of national income. With the liabilities of the nationalised Northern Rock bank on the government’s books, this threshold is bound to be broken.

Even without Northern Rock, the government would find it hard to stay within its rules if the slowdown turns into a more pronounced downturn.

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