Comment: The extra billions Clarke has up his sleeve

Ken Clarke will almost certainly stand up in tomorrow's Budget speech and claim that he is performing the Chancellor's hat trick - a simultaneous reduction in taxation, in public borrowing, and in public spending. He will also claim to be cutting the spending total while simultaneously ensuring that extra resources are devoted to the main government services such as health and education. In a sense, he will be right in claiming the hat trick. A combination of careful planning over a number of years, along with a certain amount of good fortune in recent months, has placed him in a position to substantiate the claim. But in order to understand what it will all really mean, we need to delve a little into the Treasury's conjuring box.

The first thing to realise about budgets is that the policy changes which are announced every November represent only a small part of what really determines changes in the public sector borrowing requirement (PSBR) from one year to the next. Typically, there is a table at the front of the official Red Book which summarises the impact of the Budget measures themselves. The net impact is usually very small. For example, last year the Chancellor announced new cuts in taxation which amounted to pounds 3.1bn, but he also reduced public spending by pounds 3.3bn, so the net effect of the Budget was to cut the PSBR projection by only pounds 0.2bn. But this was not really a fair measure of the impact of policy changes on the PSBR in 1996/97.

First, previously announced increases in the real level of duties on tobacco and fuel raised the burden of tax by several hundred million pounds in 1996/97, but this did not appear as part of last year's new Budget measures. Second, there was (as always) the "natural" growth in the tax take as percentage of GDP which follows automatically from real growth in the tax bases such as wages and consumer spending. (The Treasury indexes the tax system to eliminate the impact of price inflation, but it does not remove the effect of real growth in items such as wages.) This probably put at least another pounds 2bn into the Treasury coffers without the Chancellor needing to acknowledge it at all. And third, the baseline for public spending already included a large dose of fiscal restraint which had been announced in earlier plans. In fact, the control total for public spending was planned to fall by about pounds 8bn compared with the level which would have been reached on the "neutral" assumption that spending normally grows in line with trend GDP.

In total, this adds up to over pounds 10bn of fiscal tightening which was automatically due to take effect when the Chancellor stood up to speak last November. He then cut both taxes and spending by pounds 3bn, thus leaving the whole of this baseline tightening in place. In theory, then, if the economy had grown at its trend rate of 2.2 per cent this year, the PSBR should have dropped by pounds 10bn. In fact, it has only dropped by pounds 8bn, mainly because of a small forecasting mistake - the level of nominal GDP has been a little less buoyant than was expected by the Treasury last year. But this just demonstrates how unimportant the Budget itself can be compared to the built-in factors which change the PSBR without the Chancellor appearing to announce anything at all.

This year, the same forces will be at work, though to a smaller extent. On tax, real fiscal drag and the rise in tobacco and fuel duties will once again add pounds 2.5bn to the level of receipts next year, but pounds 1.5bn of this will be eliminated by the second year impact of the tax reductions announced in 1995. Thus the automatic rise in taxation is only about pounds 1bn. On public spending, the baseline cut in the real control total next year is scheduled to be about pounds 5bn, but privatisation is due to drop by pounds 2.5bn, leaving an overall cut in the spending total of pounds 2.5bn. Adding together these "automatic" changes in tax and spending, the PSBR will therefore decline by about pounds 4bn if the Chancellor simply stands up, says "a bit chilly for the time of year", and sits down again.

This figure should not be forgotten when assessing the impact of tomorrow's Budget. Almost everybody has recommended that the fiscal stance should be tightened, from the Treasury panel of "wise persons" to the CBI, to the Economist newspaper and Ken Livingstone himself. (Yes, Ken Livingstone. I mention him because his remarks on the BBC's Any Questions brought home how much the Labour Party - the whole Labour Party and not just the "new" wing - has really changed on fiscal rectitude. He said that, whoever wins the election, the next chancellor will almost certainly have to raise taxation by pounds 15bn in order to correct the problem of excess public borrowing and to bring down the national debt. This, from the unreconstructed "Left" of the people's party.)

Anyway, back to the Budget. The point is that Mr Clarke has squirrelled away pounds 4bn with which to tighten the fiscal stance. This will take effect even if there is no Budget at all tomorrow. So if he does what is generally expected, cutting the total tax burden by pounds 2-3bn, and also reducing public spending by the same amount, the fiscal stance will actually tighten by the same pounds 4bn between this year and next. In other words, a neutral package on the day will actually deliver the fiscal tightening which Mr Livingstone and other well-known fiscal hairshirts have been asking for.

This leaves the question of how he can appear to cut the public spending total while also announcing increases in the types of public spending which people actually like, notably health and education. Three factors help him here. The first is that last year's overall spending plans included a reserve of pounds 5bn which was not allocated to specific departments. He can now cut this to pounds 2.5bn, thus reducing the spending total without hitting any of the government departments. Second, unemployment has fallen much more sharply than expected last year, and this will take at least pounds 0.5bn out of the social security budget. It can be added to other departments, like health. Third, inflation is once again lower than expected a year ago, so there is less pressure on the wages of public employees across the board.

The combination of these factors means the Chancellor will be able to add considerable sums to health and education, compared to previous plans. But when listening to the Budget, remember that Mr Clarke will have to add pounds 1.4bn to his previous unrealistically low plans for the health department simply to allow NHS spending to grow in line with the rest of the economy. Anything less than this tomorrow means a relative cut in health spending.

A final point. Whoever wins the election, this is likely to be Mr Clarke's last budget. He inherited a PSBR of pounds 46bn, and he will bequeath to his successor one of pounds 20bn. Still too high, perhaps, but much better than it might have been.