'Granny bond' plan to help pensioners with fuel bills: Clarke expected to announce surprise reduction in public expenditure to limit Budget tax increases to pounds 2- pounds 3bn

SENIOR Cabinet ministers expect the Chancellor to target help at pensioners with savings as part of the pounds 500m compensation package for VAT on fuel in the Budget.

Kenneth Clarke's Cabinet colleagues are urging him to create a government 'granny bond', offering premium rates of interest, to help the elderly who have seen their savings income drop with cuts in interest rates and who will be hit by VAT on fuel bills.

'What we are talking about is 8 per cent on fuel bills,' said one Cabinet minister. 'It is about pounds 60 a year - that's not the end of the world but, coming on top of cuts in interest rates, many elderly people will regard it as the last straw.

'There should be room for ingenuity. A granny bond will be the perfect way of targeting it,'

In a surprise move Mr Clarke is expected to announce an overall reduction in the pounds 253.6bn total for expenditure next year as part of his strategy for 'nurturing' economic recovery by limiting the extent of further tax increases to pounds 2-3bn.

That was seen by Tory right wingers yesterday as total vindication for Thatcherites in the Cabinet, including John Redwood, who were criticised in the summer for calling for cuts in public expenditure rather than tax increases.

Mr Clarke will be able to cut the spending total below the ceiling set by the Cabinet in July because unexpectedly low inflation means the same amount of services can be bought with less cash. Economists at James Capel argue that cutting the assumption for inflation in 1994-95 from 4.25 to 3.5 per cent would allow pounds 1.8bn to be shaved off spending plans.

The pounds 7bn contingency reserve could also be cut without increasing departmental spending to the same degree. This would help to bring spending below target.

The Chancellor made it clear in the Commons last week that recovery was too 'fragile' to risk substantial tax increases on top of the ones already put in the pipeline by Norman Lamont. But this does not rule out a Budget in which the Chancellor takes large amounts of money with one hand and gives most of it back with the other.

City forecasts of the amount the Chancellor will raise in the Budget in the coming financial year vary from pounds 1bn to pounds 5bn, centering on pounds 2bn. Nearly 70 per cent of City economists polled by MMS International expect the Chancellor to move closer to the Government's aim of a 20 per cent basic rate of income tax by widening that tax band and pulling some taxpayers down from the 25 per cent band.

More than 40 per cent of City economists expect this to be paid for by limiting the value of personal tax allowances - the slice of income on which tax does not have to be paid - to the 20 per cent tax rate. This would hit basic and higher rate taxpayers.

The Cabinet was not informed before the cut in interest rates to 5.5 per cent last week. The Cabinet does not see any reason for any further cut in rates, but believes cutting the spending total will help to reassure the financial markets that Mr Clarke is determined to reduce the pounds 50bn borrowing requirement.

Many elderly people with savings, regarded as typical Tory voters, would be denied VAT compensation if it was limited to those on income support.

Mr Lamont, the former Chancellor, yesterday warned Mr Clarke to extend the compensation package on VAT to the 'nearly poor', including those on housing benefit.

The Budget will include confirmation of the Cabinet's widely trailed decision to raise in the next century the women's retirement age to 65 to comply with a European court ruling. It will affect women now aged 44 or below.

Gavyn Davies, page 25