Tighter spending 'will pay for tax cuts'

Kenneth Clarke, Chancellor of the Exchequer, should not cut taxes in next month's Budget, but probably will. Even so, he will be able to publish plans showing the Government's budget balancing at the turn of the century by pencilling in spending cuts, according to an independent analysis published yesterday.

The respected annual Green Budget, by the Institute for Fiscal Studies (IFS) and investment bank Goldman Sachs, predicts tax cuts worth pounds 3bn, equivalent to 2p off the basic rate of income tax, and the same size as last year's giveaway.

"We do not recommend tax cuts but we expect them," said Gavyn Davies, chief economist at Goldman Sachs. He said tax cuts would not jeopardise the Chancellor's aim of achieving budget balance by 2000 because they would be paid for by further cuts in planned spending. The key question would be whether the Government could hit its spending targets.

Mr Davies said: "This is not the go-for-broke, tax-cutting package that the right wing of the Conservative Party would like to see."

The Green Budget forecasts show a profile for future public borrowing similar to the Treasury's latest forecasts, regardless of which party wins the General Election. In fact, its figures are more optimistic, putting the public sector borrowing requirement at pounds 26bn in the current financial year and pounds 21.5bn in 1997/98, compared to the pounds 26.9bn and pounds 23.1bn in the Treasury's Summer Forecast.

It assumes there will be a reduction in income tax equivalent to 2p off the basic rate but possibly taking the form of an increase in tax allowances or widening of the lower-rate tax band instead.

Of the three options, raising the personal allowance helps the poorest income groups the most. An increase of pounds 175 would reduce the number of taxpayers by 500,000. A reduction in the basic rate is least helpful to the low income groups.

Shadow chancellor Gordon Brown's proposal for a 10p lower rate of income tax would be of greater value to poorer households than a reduction in the basic rate, according to the Green Budget, although still not as effective as a higher personal allowance. Best of all for the low-paid would be a reduction in VAT.

Dramatic changes in corporate taxation are unlikely this Budget, beyond further steps to close tax loopholes, the report argues. The IFS warned investors to watch out for a reduction in advance corporation tax if the lower rate of income tax falls, because a lower ACT rate raises revenue from tax-exempt and top-rate shareholders.

It also expects higher vehicle excise duty and a rationalisation of alcohol duties to bring tax on spirits closer into line with duties on wine and beer.

The Green Budget recommends a phased abolition of profit-related pay. "Tax relief on PRP schemes should never have been allowed to get out of hand in the way it has," it says.

The outlook for the public finances depends on economic growth and inflation as well as the Government's tax and spending plans. The Green Budget forecasts inflation staying at 2 to 3 per cent and GDP growth of 3.5 per cent in 1997, falling to a still-buoyant 2.8 per cent thereafter. Healthy growth should help tax revenues.

However, yesterday's document raised questions over the Government's ability to meet tough spending targets. Low inflation means that public expenditure has grown faster than planned in real terms.

The Green Budget predicts there will not be any pressure on public sector pay after the election, as long as numbers employed in the public sector continue to fall. The continuation of the private finance initiative will allow public sector investment spending to shrink further.

It scotches the myth that local authorities have a pot of accumulated capital receipts from council house sales to spend. The receipts have either been spent on investment projects or used to build up local authorities' financial assets, reducing past PSBRs in either case.

The difficulty on the public spending front is the longer term one of pressures on the social security, health and education budgets. These three account for almost 60 per cent of total expenditure, and their share has risen steadily at the expense of other areas.

Economic view, page 28