The pounds 14 billion hole in the public purse

The next government will inherit a financial position so bad that it will need to cut spending, or raise taxes by up to pounds 14bn, according to authoritative research due to be published next month.

This is the equivalent of more than 8p on the basic rate of income tax, or the entire budget of the Department for Education and Employment or the Scottish Office.

The present plans to bring the budget deficit down to pounds 19.2bn by 1997/98, which the Shadow Chancellor, Gordon Brown, has promised that a Labour government would stick to, do not go far enough to stop interest payments on government debt running out of control.

If the new government does not take additional action to cut spending or increase taxes, higher interest payments will eat into spending plans anyway.

The warning comes from the National Institute of Economic and Social Research, an independent and highly respected economic think-tank headed by Martin Weale, an adviser to the Treasury.

Its forthcoming report warns: "The choice is not between adjusting fiscal policy and not adjusting. It is simply between adjusting now and adjusting in the future."

The report adds that the financial plans set out in last November's Budget, showing government borrowing falling gradually to zero, are not plausible. It says that expenditure is likely to rise faster and taxes more slowly than shown in the plans, without extra measures. Mr Weale said yesterday: "The new government will have to raise at least pounds 7bn to pounds 10bn in extra tax. It is what the Chancellor should have done in the last Budget and it is the only sensible thing to do."

What he describes as "Britain's budgetary mess" arises from the fact that the shortfall between government spending and tax receipts has been very slow to fall despite more than four years of economic recovery.

Faster growth normally brings in more tax revenues and reduces government spending on items like social security and unemployment benefit.

Kenneth Clarke, the Chancellor of the Exchequer, cut taxes last year despite tax revenues some pounds 5bn lower than the Treasury had originally predicted.

High levels of borrowing mean that the national debt has doubled since John Major became Prime Minister. It now stands at about pounds 6,000 for every man, woman and child in the country. Interest payments on the debt are the fourth biggest category of government expenditure.

According to Mr Weale, government borrowing has been higher than you would normally expect given the stage of the economic cycle since 1992. There is a "structural" deficit equivalent to 2 per cent of Gross Domestic Product (GDP), or about pounds 14bn.

The National Institute's views are seen as by no means exaggerated by other experts. Simon Briscoe, a former government economist now working at the Japanese investment bank Nikko, said yesterday: "You would certainly have thought that after four years of growth we would have seen the government deficit fall more."

James Barty, an economist at the City bank Deutsche Morgan Grenfell, said: "There is a lot of truth in the National Institute's argument. If the Government has only reduced borrowing this far when the economy is near the peak of its cycle, things could go horribly wrong when the economy is in a downturn." He added: "If Gordon Brown wants to establish his credibility with the financial markets, he will have to increase taxes."

The Government's present spending plans, to which Labour has committed itself for the next two years, envisage bringing the deficit down to just under 3 per cent of GDP or pounds 19bn in 1997/98 and falling further in subsequent years. A combination of tight spending control and fast-growing tax revenues is meant to deliver this.

The National Institute's paper comments: "Deficit reduction to 3 per cent of GDP does not go far enough ... The budget deficit has to be reduced by means of spending cuts or tax increases by 2 per cent of GDP as compared with the situation in 1996/97."

It argues that the present plans are not plausible. Tax receipts will only grow so quickly if the Treasury is right in its forecasts of economic growth.

Planned spending growth of 0.5 per cent a year after inflation compares with average growth of 2 per cent a year in the 18 years of Conservative government.

Most economists are doubtful whether any government could meet the tough expenditure targets set out in last November's Budget. The City greeted Mr Brown's recent pledge to implement the Conservative plans with scepticism.

The National Institute will be one of the leading contenders for the contract to take over the Treasury's economic forecast if a study at present being undertaken by the management consultants KPMG concludes that this is feasible.