Hamish McRae: Gradually Miss Prudence becomes Mr Spend-a-lot

This is not a black hole in the Government's finances, nor indeed in Gordon Brown's reputation for fiscal probity. Rather, both face a steady relentless deterioration, a gradual chipping away of what was five years ago an extremely strong position and is now becoming a progressively weaker one.

The poor growth figure for this year is old news. By acknowledging that growth this year would be about 1.75 per cent instead of the 3.0-3.5 range he predicted at the time of the Budget, he was simply bringing the Treasury forecast into line with the independent ones. The odd thing is that he persisted for so long with an over-optimistic line. Two months ago, he was still talking growth of 2-2.5 per cent.

The newer news is the implication of slower growth on public finances for the fiscal year that ends next April. He planned to borrow £32bn, the so-called Public Sector Net Cash Requirement. Now he admits that this looks as though it will be £37bn. If that were a one-off error, I suppose one could let it go. The trouble is (in the phrase attributed to the US Senator Everett Dirksen, "A billion here, a billion there, and pretty soon you're talking real money") that each year for the past five years, things have turned out a few billions adrift.

There is every chance they will continue to do so, because even the newly revised growth figures may be too optimistic. Next year, the Chancellor expects growth to be 2-2.5 per cent. That is in line with the consensus of independent forecasters, so he can take comfort from that. But the very latest data from the shops suggests these may be revised down. Consumption growth is very weak at the moment and the overhang of personal debt is worrying the banks that have lent the money as well as the people who have borrowed it.

Put it this way. That forecast may turn out to be all right but the dangers are on the downside, not the up. So, too, are the dangers on tax revenues.

We all think taxes are going up, but actually the Inland Revenue is struggling to get the money in. Each year at this time, the Treasury publishes a learned paper called the "End of year fiscal report". A quick flip though shows that in 2003/4 (ie, two years ago), tax revenues were more than £9bn down on forecast, while last year they were £6bn down. This shortfall happened in years when growth was quite good. The Government is also having to cut its capital spending in order to pay for an overspend on current spending. Current spending was nearly £4bn too high in both years, while net investment spending was £5bn and £3bn below target.

How much does all this matter? Well, it is the billion here, billion there, problem. You can always manage to overspend for a while without disaster and borrow a bit more to cover the gap. We have all done it in our daily lives from time to time. In public finance terms, the gap is not that enormous. The problem is it just won't get better. Even on the Chancellor's own predictions, the deficit comes down very, very slowly. That is because despite having less revenue than he expected, he has persisted in maintaining spending at a pre-set rate. Most of us, when we have less money coming in than we expected, figure out some way of doing things a bit more efficiently. He has failed to do that.

Why? I think it is a combination of two things. First, in his early years as Chancellor, revenues came in consistently above budget. This made him over-confident. It enabled him to spend little extra dollops of money and yet meet his own rules. Those were the years of "I can do more". I suspect he thought that, sooner or later, as the economic cycle progressed, there would be a return to these glory days. Now, year after year, the reverse has happened.

The second is a deep-rooted belief that increasing public spending, if properly controlled and audited, is the most efficient way of improving the condition of the nation. This was sharpened by the arguably too-tight squeeze on the public sector under the previous government.

You could see that in his speech yesterday. It was the familiar emphasis on public investment only taking place if it was properly controlled, as he said: "At every point matching investment with reform."

The trouble is that while some public sector interventions have indeed been successful overall, public sector productivity has almost certainly been falling in recent years. There are problems of measurement but even allowing for improvements in the quality of public services, independent studies of the efficiency of the UK public sector puts us a bit below the middle of the developed countries. We are not the worst but we are pretty poor. And we are losing ground. Because the public sector is such a large part of the economy, this is becoming a real drag on our overall performance.

Of course, Gordon Brown understands all this and I would imagine he finds this lack of performance very frustrating. There is nothing new here. I recall in the early years of Labour a top Treasury official moaning to me about the money wasted by the London Underground. "We give them all this money to improve the service and they waste it on cost overruns on the Jubilee Line extension." That was why the private sector was called in, not that successfully, you might add.

The problem is, the Chancellor finds it hard to be flexible. You could see that yesterday with this plan to use the money in dormant bank accounts for sports facilities for the young. That is an admirable aim, but you have to wonder whether this ought to be a Treasury decision. It is not public money raised in taxation. It belongs to individuals who cannot be identified. While it is quite reasonable that the money should be used for communal purposes, it is odd that the priorities should be determined by a finance minister. It is nothing to do with him.

In a less centralised society, the banks, a committee representing the unknown owners and some elected officials would distribute the money for whatever projects applied for it, probably on a local basis reflecting where the accounts were held. As it is, it reflects a deep-seated view that somehow Gordon knows the best priorities for the nation.

You can see a tragedy slowly unfolding. The Chancellor's understanding of the need for macro-economic stability meant he correctly focused on that. He understood the need for an entrepreneurial and well-educated workforce and has used public money, sometimes wisely, sometimes less so, to this end. But because he had a pre-set, rigid faith in the ability of the Treasury to micro-manage an expanded public sector, he has ended up with a wider-than-expected deficit that will eventually threaten the very stability he sought to create.

The final irony is that even on his own plans, after next year the expansion of the public sector will be over. As the Institute for Fiscal Studies points out, he may find himself fighting the next election as a prime minister planning to cut public spending as a proportion of national income.