Election '97: Conservative's tax bombshell may explode in Major's face

The Conservative Party is fighting back against new Labour's manoeuvres to outflank it on the all-important issue of the economy. Yesterday's manifesto is a kind of back-handed compliment to Gordon Brown for the credibility he has established as the would-be Iron Chancellor. Its message to the voters is that there really is a difference between the two main parties over how they would manage the economy.

The document paints a contrast between a free-market, small government, entrepreneurial Tory Britain, and an over-regulated Labour Britain operating under the yoke of the Social Chapter and minimum wage. It promised tax cuts, getting the Government off the backs of the people.

But the Tories have to answer the same question they traditionally put to Labour politicians: how will you pay for it? The specifics in the manifesto cost money; how to find those billions is couched in generalities.

The three centrepiece tax proposals are the plan for married people looking after children to transfer their tax allowance to a working spouse, the target of a 20p basic rate of income tax, and a pledge to reduce the burden of capital gains and inheritance tax when possible. The first will cost about pounds 1.5bn according to the Institute for Fiscal Studies. A 3p reduction in the basic rate of tax would cost nearly pounds 6bn. And CGT and inheritance tax together raise pounds 4.5bn a year.

The Government is not promising to reduce taxes by pounds 12bn in one fell swoop if it wins the election - perish the thought that it could be so irresponsible.

So when would it be affordable? The trouble with the manifesto promises is that the Government has already done the most it thought possible in terms of reducing tax in the Budget only four months ago.

The plans set out at the end of November forsee tax rising as a share of national income in order to plug the gaping hole in the public finances. Tough expenditure limits are predicted to bring spending down as a share of national income. The plans were based on an already optimistic forecast for economic growth. Nothing has changed the arithmetic since then.

It is a matter of logic to figure out the possibilities for further tax cuts. The obvious one would be to increase other taxes. Kenneth Clarke and Mr Major when asked yesterday were careful not to rule out increases in VAT. The ghost of Geoffrey Howe's 1979 Budget hovers - a pre-election promise not to raise VAT was followed by its near-doubling a few weeks after polling day.

Another possibility would be to finance lower taxes by further reductions in public spending. But if the Conservatives said they were planning this they would meet with incredulity amongst independent experts. Economists to a person - and that includes the private opinion of Treasury officials - think it will be extremely difficulty to hit the existing targets.

Besides, the manifesto also promises higher spending on hospitals, schools and the police. That will have to be funded by reducing the social security budget - falsely claimed by the manifesto to be taking a declining share of national income. Its share has actually been rising steadily.

That leaves only two other options. Assume the economy will start to perform much better so tax revenues grow naturally - which would be a complete fudge. Or abandon the pledge of fiscal responsibility and let borrowing take the strain - the most likely outcome in practice, perhaps, but least attractive in terms of rhetoric.

So the Government has not told us how it would pay for the tax cuts and bits and pieces of higher spending dangled manifesto. It is an all-gain, no-pain set of proposals, and as such not a genuine economic programme.

But one area of genuine difference between the Conservatives and Labour over the economy does emerge very clearly in the absence from the manifesto of any discussion of income inequality or what Continental Europeans would call social exclusion.

It claims that the possibility for married couples to transfer their tax allowance would "provide a targeted reduction in the tax bill to families who need it most."

Not according to the IFS, whose researcher Paul Johnson said yesterday: "This will not help families at the bottom of the income distribution." And it will certainly not help single parents. It rewards a narrow group of people not facing particular hardship.

It will also sharply reduce the incentive for middle-class wives to take paid work. The tax treatment of second earners, mainly women, will revert to the pre-Second World War position - a real backward step for a government which claims to have created a dynamic economy with more working women than any other country in Europe.