Caution will be Brown's motto in the Budget run-up

NEWS ANALYSIS: The Chancellor is unlikely to take any risks when he issues his report tomorrow
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The Independent Online
SO JUST how big is Gordon Brown's war chest? This question is tantalising economists, businesses, trade unions and Labour backbenchers in the run-up to the Treasury's pre-Budget report, which is published tomorrow.

Almost everyone agrees that the recovery in the economy, which is accelerating much faster than forecast, has delivered a rosy outlook for public finances. Rather than a deficit of pounds 4bn as predicted in the Budget this year, estimates for the largesse vary from a modest pounds 1bn up to pounds 20bn.

As the prospect of a general election gets nearer, this surplus takes on a new importance - as a war chest that the Government can use to offer bribes to the electorate ahead of polling day. This makes the size of the Chancellor's pot of cash less important than what he plans to do with it.

But first, the numbers. It has been a good year for Mr Brown and when he unveils the report he will have a good helping of humble pie to dish out to the experts who derided his forecasts of a year ago.

Back in autumn 1998, with the Russian and US hedge fund crisis threatening, Mr Brown was ridiculed for forecasting GDP growth of 1-1.5 per cent this year and 2.25-2.75 per cent in 2000. While City forecasts put GDP growth in 1999 at zero to 1 per cent, the latest figures indicate a figure of around 1.7 per cent is more likely. So Mr Brown was wrong, but only by under-estimating the recovery. All of this good fortune leaves the public finances looking benign, especially compared with the Government's own forecast of a pounds 4bn deficit a year ago.

Philip Shaw of Investec said: "We see the outcome at a surplus of pounds 10bn although Mr Brown will be more conservative - possibly a prediction of pounds 5bn - to reduce pressure for an increase in his spending plans." But all of these figures would have looked conservative if the Government had upgraded its assumption for long-term GDP growth. The Treasury is expected to change the assumption to 2.5 per cent from 2.25 per cent, but it will not use them for compiling their forecasts for the public finances.

But with or without this creative accounting, Mr Brown will be able to claim he has stuck to his two fiscal rules - borrow only to fund investment and keep net debt below 40 per cent of GDP - in this short economic cycle. "Higher spending or tax cuts worth pounds 4bn-pounds 5bn could be introduced without remotely threatening his fiscal rules," said Richard Iley of ABN Amro. "But the Chancellor is unlikely to want to risk shedding his hard-won image of fiscal prudence."

Business groups support this, with the Confederation of British Industry, British Chambers of Commerce, and Institute of Directors lining up to appeal for restraint. As the IoD puts it: "Any fiscal stimulus would only be countered by higher interest rates, which could only underpin the high value of the pound."

This issue was thrown into sharp relief last week by the rise in rates. The hike brought howls of outrage from business groups who said northern manufacturers were yet again paying for the inflationary house price boom in the south. Their leaders are anxious to move the debate on into a wider consideration of the British economy and the structural divide between north and south and between manufacturing and services. Before his annual conference last weekend, CBI director-general Adair Turner told The Independent the Government needed to consider fiscal measures to dampen down the housing market, if that was what was driving the Bank of England to hike rates.

Last week other groups highlighted the growing north-south divide and suggested raising the rate of stamp duty on high-price homes as a first step to bring the two economies into line. This is unlikely to go down well at the Treasury, which is still smarting from a report by the Organisation for Economic Cooperation and Development that said taxes in the UK were rising at the fastest rate in Europe. And, to be fair, the housing market only plays one part in the thinking at the Bank, which has also said it is worried about the labour market and the rapid recovery in global demand.

Business organisations stress that while they don't want to see consumer tax cuts or a public spending binge, any room for manoeuvre should be used to help industry. The CBI has called for tax cuts for businesses, and abolishing the fuel duty escalator that is making it difficult for the UK road haulage industry to compete with Europe. It also wants targeted spending increases, particularly on the road network and expanding the rail freight system.

Trade unions and Labour backbenchers, on the other hand, want to see some benefits delivered to their members or constituents who they feel have borne the brunt of Mr Brown's prudent fiscal stance in the early years of the Government.

The political pressure is intense. With two or three years until polling day Labour still has to meet its targets in two its highest spending departments - on National Health waiting lists and school class sizes. Naturally the Treasury will pursue its own agenda and this year this will focus on enterprise. "There will be meaty issues that will surprise people," it said. Last year that led to 10 per cent corporation tax, capital allowances and a research and development credit.

The Chancellor has already made political capital out of apounds 40m scheme to give tax breaks to small entrepreneurs, ostensibly to help foster growth in the high-tech innovation sector. Other "big bang" measures on these lines can be expected.

But whatever is in tomorrow's statement, it is unlikely to throw up many clues about the headline-grabbing measures -- such as surprise cuts in personal taxation - that will actually be announced in the Budget.

Until then caution is still the watchword. At the CBI conference Mr Brown said he would not be tempted to repeat the mistakes of the Eighties when a cyclical improvement was mistaken for structural change. Whatever surprises Mr Brown pulls out of the hat next March, he will undoubtedly ensure they are made up for with offsetting tax cuts to ensure he does not offer any hostages to fortune. A "neutral" Budget is the most likely outcome.