2.5bn pounds of tax rises expected: Economic group forecasts cut in interest rates to sweeten the pill

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THE CHANCELLOR is likely to raise taxes by an extra pounds 2.5bn in his November Budget but will sweeten the pill with a half-point cut in interest rates, according to one of Britain's leading economic forecasting groups, writes Robert Chote.

The National Institute of Economic and Social Research forecast that the fall in borrowing costs could be short- lived, with interest rates rising again early next year as underlying inflation breaches the Treasury's 4 per cent target ceiling. It stuck to its long-standing forecast that the economy would grow by 2 per cent this year, but argued that recovery would start to lose momentum next year.

The institute also concluded in its latest Economic Review that while the Government's tax and spending policies had put the public finances on a sustainable path, it would for some years continue to break the 'golden rule' by borrowing to pay for public sector running costs as well as investment in projects providing a long- term return.

It predicted that government borrowing would stabilise at about 2.5 per cent of national output by the late 1990s, with gross government debt tending to a level of about 50 per cent of national output. The public sector borrowing requirement is forecast to be pounds 46bn this year and pounds 36bn in 1994/5, both figures that are more optimistic than the Treasury's Budget projections.

But the institute argued that the ratio of debt to the publicly owned capital stock would be higher at the end of the decade than at any time since the 1960s. It said that only about a quarter of the deterioration in the budget deficit since 1988/9 was the automatic result of the recession cutting tax revenues and raising benefit spending.

The trend fall in government borrowing as a proportion of national output since the 1970s was largely the result of lower net capital spending. This may have to be reversed if the ageing public sector capital stock is not being replaced.

'It will now be more difficult than in the past to reduce the PSBR to GDP ratio as temporary influences on the public finances disappear. If the PSBR is to be reduced it will have to come about as a result of greater control over current spending and tax revenue', the institute concluded.