Diane Coyle: Gordon Brown's credibility is slipping away

Tomorrow will be an exciting day for those of us who find fiscal policy stimulating. We'll be poring over the Chancellor's Pre-Budget Report for news of changes in tax rules and, above all, for evidence that the iron in Gordon Brown's soul is turning rusty. In years gone by, Mr Brown was widely praised for keeping the Government's finances in unmistakably good shape. Now many economists believe his luck has run out, and his judgement is being distorted by politics. Is his famous prudence on the wane as the next election approaches?

Tomorrow will be an exciting day for those of us who find fiscal policy stimulating. We'll be poring over the Chancellor's Pre-Budget Report for news of changes in tax rules and, above all, for evidence that the iron in Gordon Brown's soul is turning rusty. In years gone by, Mr Brown was widely praised for keeping the Government's finances in unmistakably good shape. Now many economists believe his luck has run out, and his judgement is being distorted by politics. Is his famous prudence on the wane as the next election approaches?

The forecasts in tomorrow's report will hardly admit to the Chancellor's breaching the rules he set himself back in 1998 on the level of government borrowing. There are two of these. The Golden Rule says that over the course of a full economic cycle, the government can't borrow money to pay for day-to-day spending, only for investment. The second (known as the sustainable debt rule) limits the amount it can borrow even for investment by saying the national debt must be kept low and stable.

It sounds simple enough, but there's a fine art in judging whether or not these rules are being met. For they apply over the course of a full economic cycle. We only know when these ups and downs begin and end with hindsight: the figures on growth are published with a lag, and then revised, and then revised again. Besides, the economy has not shrunk for a single quarter in the past 14 years. In the bad old days of boom and bust at least it was easy to spot the turning point in the business cycle, but it's trickier now.

One easy fudge on the Golden Rule would be to extend the assumed end of the current cycle out another year beyond 2005/06, its presumed end-point in the last Budget. Other Chancellors have been masterly at this kind of tactic. Kenneth Clarke for one always promised to balance the books in the medium term - he just kept postponing it by a year.

Mr Brown has scope for another possible sleight of hand. In any particular financial year, deciding whether the government is spending too much more than it is raising in taxes depends on where you think the economy is relative to its long-term trend. Is it operating at full capacity, or with plenty of spare capacity? If the latter, the economic slack justifies a deficit that year. But if times are good, the public finances should be in surplus. This way surpluses and deficits should even out over the whole economic cycle. So, if you raise your estimate of the economy's potential capacity, you create some instant slack, and lessen the potential for embarrassment on the Golden Rule.

We can stir in the presumption that there will be some populist gimmicks in the months ahead of the election - a new energy allowance for those on low incomes? An extra credit for the hard-working poor? A cut in a minor tax? A freeze on fuel duties? Some bashing of unpopular corporations supposedly avoiding their taxes? Treasury civil servants have certainly been casting around Whitehall for good wheezes.

At any rate, it should be clear by now why the economic cognoscenti find the Pre-Budget Report such fun. The Chancellor will claim that, oh yes, he is going to meet his rules, his critics will say, oh no, he's not - and pantomime season will have started.

Two more or less hard facts stand out in this debate. One is that government finances in the UK are by a long chalk the healthiest among the leading economies. Whether in the US or in the rest of Europe, other finance ministers have binged on debt. Mr Brown has had the courage to raise taxes as a share of GDP in order to finance extra spending on public services; and Labour has taken this choice successfully to the electorate.

The second point, though, is that the situation is far less comfortable than it used to be. The Chancellor previously over-achieved on the Golden Rule but has used up all the margin of error. In past years he also relied on optimistic forecasts for the economy. The rosy forecasts turned out to be more or less right, confounding his critics. But he could be wrong this time, if the US economy weakens, if the plunging dollar dents British exports to the US, or causes another Asian economic crisis like the turmoil in the late Nineties. Perhaps the seven fat years since Labour came to power in 1997 will be followed by seven lean ones.

Add to this the likely timing of the election for next spring, and it's clear why the Chancellor's credibility is dribbling away.

There is certainly no crisis in government borrowing. But neither is this the kind of prudence that helped establish his enviable reputation amongst voters as a man you really could trust to take painful decisions and run the economy for the long term. It feels like we're back to running the economy on the very short term of the electoral cycle. Perhaps this is a cynical view which will be proved wrong either tomorrow or in the Budget next spring. I suspect that the striking voter aversion to politics as normal means anything too blatant would backfire at the ballot box anyway.

More importantly, the Golden Rule might yet turn out to be self-enforcing. It's almost impossible to exaggerate how embarrassing it would be for Mr Brown to breach his own rules, especially when he's made such a point of lecturing the rest of Europe about the superiority of the British model. He faces an enormous amount of public scrutiny, and with respected forecasters such as the Institute for Fiscal Studies on his case, the Treasury's wiggle-room is quite limited. Perhaps the official forecast could get away with being a few billion pounds out on the government deficit - forgiveable when you have a target for the difference between expenditure and revenues of around £400bn each - but not very many billions.

The other limitation will stem from the Bank of England's reaction to the prospect of higher government borrowing. The Monetary Policy Committee would be more likely to raise interest rates if the Chancellor decided to borrow much more to stimulate the economy. Their decision is out of Mr Brown's hands, and he wouldn't want to provoke them into doing anything that might risk a housing market crash or too much gloom on the high street next spring.

If it's right to see the Golden Rule being bent, perhaps, but not broken, we might still get a Pre-Budget Report with a gamy pre-election flavour. But there are some clear implications for post-election budgets. One is that tax revenues will need to rise in 2005/06, although perhaps not by so much that it will involve headline increases. The other is that the increase in expenditure on public services of recent years will come to a halt. The rises in spending on health and education announced so far might require cuts in other departmental budgets. Improvements in service delivery beyond the next election will certainly depend on efficiency in the public sector, and not on spending more money.

Will the limits be spelt out clearly in tomorrow's report? Don't hold your breath. The Treasury can't change the reality but is masterly at airbrushing harsh figures. The portrait of Gordon Brown in the Pre-Budget Report will paint him as prudent as ever.

diane@enlightenmenteconomics.com

The writer is an economic consultant and author