Bank report warns of 3p tax rise if Britain joins euro

The Chancellor of the Exchequer Gordon Brown will be warned that he may have to raise taxes by the equivalent of 3p in the pound if Britain joins the single currency.

Goldman Sachs, the investment bank, predicts in a report to be published next month that the Government will either need to raise taxes or cut public spending by about £8bn. Since joining the euro will require a fall in interest rates and the exchange rate, fiscal policy will have to be tightened to prevent a surge in inflation, it will argue.

With the Government committed to raising spending on health and education, it would be almost impossible for the Chancellor to cut public spending, leaving tax rises as its only weapon against inflation. But that would involve high political risks because taxes will already rise by £8bn next year. The Treasury is taking a close interest in the study and will take its findings seriously. Gavyn Davies, a former partner at Goldman Sachs, was an influential adviser to Mr Brown until he was appointed chairman of the BBC last year.

The report will be seized on by Labour opponents of an early referendum, who will warn that joining the euro could scupper the Government's plans to improve public services. It echoes the views of Ed Balls, Mr Brown's closest ally and chief economic adviser at the Treasury, who has already urged Labour to focus on public services rather than the euro in this Parliament.

Lord Owen, the former Foreign Secretary, who opposes early euro entry, warned that Tony Blair would lose his job within nine months if he lost a referendum. "You cannot go to the country on a major issue as Prime Minister, be defeated and then expect to carry on in the same way. That is the risk of a referendum," he told GMTV's Sunday. "It really does destroy the personal authority of a Prime Minister if they lose." But John McFall, Labour chairman of the Commons Treasury Select Committee, said he believed there should be a referendum on joining the euro next year.

He told the BBC's On the Record: "There is a window of opportunity for this referendum to take place, within this Parliament and next year it's recognised that that is that time when it should take place."

John Edmonds, leader of the GMB union, warned that taxes would rise if the Government delayed euro entry, because manufacturing industry would continue to slide.

He said: "The numbers that Gordon Brown has will begin to fall apart, and there will be choices about higher tax rates." He urged Mr Blair to show "political courage" by calling a referendum.

Meanwhile, in a speech in Berlin today Jack Straw, the Foreign Secretary, will urge the European Union to head off opposition to its expansion into eastern Europe from populist Eurosceptic parties which made electoral gains in France and the Netherlands. He will say: "The original mission for Europe remains valid. But it is no longer enough. We need to offer our electorates new arguments, not least because the EU is now facing a test of leadership and legitimacy."

Mr Straw will add: "We have to work together to convey a simple message: a united Europe will not be a superstate, but a Europe united across the old divide by common values and common identities."

To win the battle for public opinion, institutions will need to reform and to demonstrate the EU can deliver the policies people want, he will say.