Brown can't afford a tax-raising Budget

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Clever but inexperienced people make mistakes. Our clever but inexperienced Chancellor has made one small mistake, and is in danger of making a rather bigger one. The small mistake was, of course, in the setting of the new inflation band for the Bank of England; the danger of the bigger one comes in the forthcoming Budget.

On the face of it, the setting of the Bank's target band for inflation (excluding the impact of mortgage rates) at 1.5 to 3.5 per cent might seem completely reasonable. It is certainly reasonable that there should be a bottom end to the band. There is no case for monetary overkill, and some indications that central bankers' instincts are to err on pushing prices to the downside of the acceptable range. They would argue, with some justification, that the dangers are asymmetric: that the costs of getting inflation back down to a target range once it has exceeded it are much greater than the costs of undershooting the target in the first place. Nevertheless, the message that the Bank should not be as concerned at undershooting as overshooting is perfectly proper.

The actual range, too, might seem reasonable. This is not just that one percentage point on either side of the present target sounds sensible, though it does. It also appears reasonable that the UK should aim for the international developed country norm. In 1995 the average inflation in what the IMF calls "advanced countries" was 2.6 per cent, in 1996 it was 2.4 per cent, and the forecast for both this year and next is 2.5 per cent.

So what is up? Simply that a top end of 3.5 per cent is too high. The average for the major economies, the Group of Seven, was 2.2 to 2.3 per cent, not 2.5 per cent, and if you look at the countries which last year had inflation above, say, 3.25 per cent they were: Italy, Spain, Greece, Israel, South Korea and Hong Kong. All the rest were below that. By setting the top end of the range at 3.5 per cent, the Chancellor was signalling that he would not get too fussed if the UK was in that company. Not a great signal. The Chancellor should have been thinking in terms of a centre point of 2.25 per cent, to bring us into line with the G7 average rather than the average of the developed world as a whole.

This is only a minor mistake for a number of reasons, and the markets - though a little tetchy - were quite prepared to accept it. For a start our retail price index (even allowing for the distortion caused by mortgage rates) almost certainly overstates inflation. Think how much you have spent on things like computers, new cars and airfares over the past few years. Did you know that they are not in the retail price index? The harmonised consumer price index calculated to put European prices on the same basis shows that our inflation was 1.6 per cent. There are (rather complicated) reasons why this harmonised rate may understate inflation, so this is not necessarily a call to move to an alternative measure. It is to point out that there could be a bit more leeway than you might imagine.

There are other reasons for believing that the mistake over the target will not matter too much. The Chancellor specifically stated that this was not "a range" as such; the bands have soft edges. And if things go well, the bands can be reduced. So not a bad mistake; but a mistake none the less.

Now to the Budget. The potential mistake is that he will tighten policy too much. It is difficult, working on out-of-date figures, to write with any great confidence about what the Chancellor should or should not do. This does not stop organisations like the CBI calling for a modest cut in the borrowing requirement, which since Mr Brown has said that he will stick to the last government's spending plans also means a rise in taxation. The CBI is not alone: there is a consensus in the City that there ought to be some tightening, and again, since no one seems to believe that somewhere among the hundreds of billions of public spending there might be the billion or two which might be saved, this view translates into a call for an increase in taxation.

Then there are layers of argument which the economists can display in support of this view: the fact that a small increase in taxation will reduce the need for rises in interest rates; the argument that a rise in rates would strengthen sterling further which would squeeze the wrong bit of the economy, the export sector, rather than the right bit, which is the rest of us; that the last government laid some time bombs in its spending plans so the Chancellor needs to finance the "real" spending plans of the Tories, not the published ones; and so on.

There is, however, a very simple counter argument to all this, and it starts with this short sentence. They don't need the money.

Leave aside the windfall tax and the way in which this is to be spent. That is a clear political commitment and whatever views one might have about it, that policy has to be carried through. As far as general revenues are concerned, they are coming in well over budget. The more buoyant economy is producing more tax revenue and cutting some spending on social welfare. The deficit in the last financial year was 3.1 per cent of GDP, lower than that of France, Germany and Italy. This year it will be well below that: on unchanged policies around 2 per cent. The IMF is forecasting a surplus by the early years of the next century - ie within the life of this Parliament.

The deficit in any case is small enough to comply with the Chancellor's "golden rule" that the Government should, over the economic cycle, only borrow for investment, not for current consumption. This is a wholly admirable rule, but as you can see by the chart, the Government already seems to be within a billion or two of hitting it this year, and will do so next. This sort of difference is well within the margin of error in public finances, and it is perfectly possible that revenues will continue to be stronger than expected through the rest of this year. Anyway, while there could be an accounting case for increasing taxation by the one or two billion, no one is going to worry if the Government hits its target in the first full year of office, the financial year that starts next April, rather than scrambling around to try and do so this year.

But the truly overwhelming reason why the overall burden of taxation should not be increased is that before the election the Labour Party said it would not do so. There are very good reasons for seeking to rebalance the tax system, for example to reduce the burden on low-wage working people and to get it to lean harder against things which the Government should wish to discourage, like pollution. If there were an overriding need to raise additional revenues then that should be explained. But there isn't. In the absence of such a need, any overall increase in taxation would be a breach of trust. They should not even think of it.

The potential damage of such a breach would be enormous. At the moment the Government carries great goodwill in the country as a whole, but it only carries the cautious approval of the business community. It needs to deepen and secure that approval. It needs to do so in its own political self-interest, specifically because many of its new initiatives require co-operating with the business community, but more generally because it cannot continue to build a successful economy with distrustful business people. No government, here or anywhere in the developed world, has done so. And now, more than ever before, business can walk.