Clarke juggles the options

Personal Finance
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The Independent Online
THE Budget is beginning to cast its shadow over financial planning for the coming year. The pressure on the Chancellor to cut taxes and produce a package to reflate the housing market remains as strong as ever. But the prospects for outright tax cuts look less hopeful than they did, after the latest figures showing the borrowing requirement actually running ahead of last year in the five months to the end of August.

The City might forgive the Chancellor for taking a little risk and cutting taxes anyway, by perhaps pounds 5bn, but the international markets are less sentimental and would almost certainly attack sterling if they thought he was putting politics ahead of economics.

If he were forced by market pressure to put interest rates up to protect the pound and compensate for risky tax cuts, he would offend as many people as he pleased and still have failed in the primary duty of a Chancellor.

In the circumstances, investors, including people with shares and unit trusts as well as mortgages, might well have more to thank the Chancellor for if he produced a cautious Budget with significant spending cuts and token tax cuts that promised to cut the borrowing requirement substantially in 1996/97 - in the process increasing the possibility of a further reduction in interest rates.

After their recent unilateral cut in mortgage rates, there is no guarantee this time that mortgage lenders would immediately be able to follow a small cut in base rates. But with the housing market flat, they might feel obliged to do so to retain market share in highly competitive marketplace.

Lower interest rates mean lower returns for net savers, however, including many pensioners. But say it softly, they are less vocal and therefore less influential than borrowers. It also has to be admitted a drop in interest rates would be less likely to damage the economy than a cut in taxes.

That still leaves scope for some tinkering with taxes, and the promise of real cuts in 1997 if things go well. It seems probable that he will increase tax breaks for private health, education and pension provisions, because they will cost more in the future than the present. Ideally, he would like to increase incentives for savers, although the fact that Tessas, PEPs and Corporate Bond PEPs are already in place limits his room for further manoeuvre.

There have been recurrent rumours that he would abolish a tax to improve his free-market credentials, perhaps inheritance tax or capital gains tax, which are not very high yielders. Abolishing inheritance tax might go some way to placate wealthier families threatened with selling the parents' home to pay for long-term health care. But it would hardly help those whose assets are already below the inheritance tax threshold of pounds 154,000 and still face seeing their assets wiped out to pay for care. Over-indexation of the threshold looks more likely than abolition.

The abolition of long-term capital gains, and the taxation of short-term gains as income also looks more plausible in spite of arguments that it would create a fertile ground for the tax-avoidance industry to find ways of converting taxable gains into tax-free ones.

Special help for the housing market could include the restoration of tax relief at 20 per cent or 25 per cent of interest payments. But it would be another U-turn to explain. The fact that several lenders have started giving low-cost or free mortgage-protection policies to help borrowers who lose their jobs has already partly offset the reduced state benefits for home-owners that take effect in a week's time. It leaves a cut in stamp duty, permanent or temporary as the most likely contribution to a feel-good factor in the housing market - apart, that is, from another cut in interest rates.