Jaws of tax trap close on bickering Tories

As Conservatives bicker about who can promise the biggest tax cuts, the jaws of a trap are closing in on what they clearly see as their last remaining hope of averting a Canada-style wipe-out at the polls. From below: tax receipts that are unexpectedly coming in below target. From above: the near-certainty of public spending that comes in above target. The only way out of the trap is to junk the commitment to an early return to a balanced budget. No wonder the financial markets are rattled.

Presenting the Treasury's summer economic forecast, an aggressive Kenneth Clarke repeated his view that he was presiding over "the best combination of economic circumstances" he had seen in his political career. The trouble is that a virtuous circle for the economy has turned into a vicious circle for the Exchequer.

More by accident than design, the Government has engineered a "too-good- to-feel-good" export-led recovery in which consumption has done no more than limp along. But that hasn't set the tills ringing at HM Customs: stagnant retail sales and zero-rated exports have cropped VAT revenues.

Similarly, the flexible labour market so lauded by ministers is turning out to be no friend of the Inland Revenue, since lower earnings yield less income tax.

In its June forecast, the Treasury bowed to reality and lifted its public sector borrowing requirement forecasts to take account of the developing shortfall in tax receipts. These came in over pounds 3bn less for the past financial year than Mr Clarke had forecast at the time of the Budget. The Treasury now accepts that this pattern "will knock through" into tax receipts for this year and next.

Yet even this adjustment may be over-optimistic if wary consumers continue to keep their hands in their pockets in the months ahead.

Disappointing tax receipts are only half the problem any Chancellor will face after the leadership election - the other is public spending. John Redwood believes immediate, additional across-the-board savings of pounds 5bn are possible through an attack on waste.

By contrast, the Chancellor, in the Treasury's summer economic forecast, made much of his ability to deliver tough spending control. The task, he said, was for the Government to achieve "real spending cuts and then cut taxes".

In practice, the Government is hoping simply to keep public spending from increasing in real terms. The Treasury is forecasting that the "control total" for public spending, which excludes cyclical elements such as social security payments and debt interest, will not grow at all in real terms, this year and next.

Another way to look at the ambition of the spending plans is to consider it in terms of general government expenditure - total yearly outlays less privatisation receipts. This is set to grow in real terms over this and next year at an annual rate of just over half a per cent.

Yet, as the Institute for Fiscal Studies calculated last year, the average annual growth rate in real terms in this last measure of public spending was 1.8 per cent over the past 15 years.

An even more telling statistic is the usual pre-election display of largesse with the public purse. In 1991/2, public spending rose 2.8 per cent, and there were similar acts of generosity in 1982/3 and 1986/7. This pre-election year, we are assured, everything is different.

The commitment to forestall another burst of public spending is written, if not in tablets of stone, certainly in tough-sounding rhetoric. There is no point, Mr Clarke said in his Mansion House speech, in shaking this Chancellor's money tree.

There certainly is if you are the Health Secretary. Note how successfully Virginia Bottomley shook it this year. Spending is projected to rise this year at 3.8 per cent in cash terms, enough to fund the 3 per cent settlement for nurses, local pay element or no local pay element.

Next year, however, cash spending is forecast to increase by under 1 per cent - and this against a background of rising retail price and wage inflation. Pull the other leg, Chancellor.

The reality is that, for all his tough rhetoric, Mr Clarke has not in practice curbed real spending growth. In his first Budget, in November 1993, hepromised to reduce the control total for 1994/5 by 1.25 per cent in real terms. The outcome, revealed yesterday, was that it grew by 1.25 per cent.

All in all, it would be only prudent housekeeping on the part of the Treasury to expect at least a 2 per cent real increase in total public spending in 1996/7. Yet this would amount to additional expenditure of about pounds 4bn.

Add tax cuts of a further pounds 4bn - the scale that might go some way to satisfying fear-stricken backbenchers - and you are talking big money. The Treasury's increase in its forecast for next year's PSBR to just pounds 16bn looks extraordinarily optimistic.

Expect the commitment to move towards a balanced budget to take a back seat as tax cuts are made on account - with payment due in interest on extra debt that has piled up.

Only the markets will prevent the Tories from shaking that money tree for all its worth.