COMMENT: A fantasy fund to meet any contingency

"Chancellors routinely proclaim their success in cutting public spending. The odd thing is, it keeps on going up in the only terms that matter - real terms."
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What a splendid thing. The Chancellor has apparently found a secret account which he can raid to fund tax cuts. It is called the contingency reserve, and provided spending ministers stick to their budgets, it will be there and ready to boost Tory fortunes in the run-up to the election. If that is what Kenneth Clarke really thinks - so it has been reported - it is, unfortunately, largely fantasy.

Every Budget, the Treasury announces its expenditure plans for the next three financial years. Like any prudent housekeeper, it keeps some money in reserve for unforeseen calls on the public purse, to be allocated to departments as and when necessary. As a rule of thumb, it withholds about 1 per cent of planned total expenditure for the coming financial year, 2 per cent for the next one and 3 per cent for the third year.

In the last Budget, this translated into a reserve of pounds 3bn for the current financial year, 1995/6, pounds 6bn for next and pounds 9bn for the year after that. It is this pounds 6bn for 1996/7 that the Chancellor is apparently waving as a possible source for tax cuts. The hope is raised by the fact that in the past two Budgets, planned public spending has been cut by reducing the reserve and not allocating the reduction to departments. So, repeat the trick and use the money saved to finance tax cuts. Easy. So easy in fact, that you wonder why we aren't already enjoying a high summer of tax cuts this year from the reductions in the reserve in the last Budget. Maybe it isn't so easy after all.

Chancellors routinely proclaim their success in cutting public spending. The odd thing is, it keeps on going up in the only terms that matter - real terms. What they are brandishing is cuts in plans made a year or more ago, plans made on the basis of projections for price and wage inflation that have become out of date.

When inflation falls by more than had been anticipated, spending departments get a windfall. This means the Treasury can cut planned expenditure without too many howls of anguish: with lower inflation you can buy more services, pay more public servants. In practice, the fact that inflation has surprised by coming in lower than expected has turned planned austerity into a much less rigorous regime. For example, in November 1993, the Treasury was promising us the pain of a 1.25 per cent cut in the key control total for 1994/5. But as it revealed on Wednesday, the outcome was altogether less bracing: spending on this count increased by 1.25 per cent in the last financial year.

Inflation is now rising; so the question is whether it rises faster than expected. The Treasury anticipates that inflation will run at 3 per cent for the current financial year and 1996/7. Many, not least the Bank of England, believe that inflation will rise by more. If it does, that alone will lead to a call on the reserve by departments having to shell out more than had been priced into their budgets. That is only the half of it, however. Suppose the Treasury's inflation sums turn out to be right. The current plan for control total spending next year, including that famous reserve of pounds 6bn, assumes growth of just 3 per cent, or no growth at all after factoring in the official inflation forecast. What that means is that if the reserve were to be allocated to tax cuts rather than to departmental budgets, there would be a fall in spending in real terms.

Now that really would be one for the books. As the Institute for Fiscal Studies revealed last year, total public spending has increased at an annual rate of nearly 2 per cent in the past 15 years. In pre-election years like 1991/2, it rose by nearly 3 per cent.

The idea that public spending will fall in real terms in the run-up to the election is fanciful. So too is the idea that the Treasury has stashed away a miracle reserve fund for tax cuts. Both are flights of midsummer madness.

Branson enlivens the cinema scene

Richard Branson appears to have got a likely winner in MGM cinemas, even if he had to pay what his team admits was "the full and fair price". Against the odds, and with considerable skill by all accounts, Mr Branson's chosen head of Virgin Communications, Robert Devereux, managed to clinch a deal in the wee hours of Thursday morning after a race that has hailed at least three false winners over the past month, including Michael Green's Carlton Communications. It remained only to convince the French government, which is overseeing the divestiture campaign launched by MGM's sellers, the distressed state-owned bank, Credit Lyonnais. The French took the money and ran.

The precise configuration of Virgin's consortium was in doubt until the very last days of the hotly contested auction. Rank Organisation was in the bidding group for at least a time. Reading, the US vehicle of cinema owner Jim Cotter, was also a Virgin partner, but bowed out late in the day.

Financing help came in the form of TPG, a leveraged buy-out company whose principals, David Bondiman and Jim Coulter, led the reorganisation of American West and Continental, two struggling US airlines. Having heard that Virgin was in the running for MGM, the team called Mr Devereux last Sunday, and offered to come in. Mr Coulter, who was in the south of France, flew in to London the next day.

When the dust had cleared, Virgin ended up with management control (four seats to TPG's 3), and 50 per cent of the equity of a new company set up to buy the cinemas. The purchase will be leveraged, with Bankers Trust throwing in 60 per cent of the purchase price. Financing the deal should be no problem. Even before the cinemas get the full Virgin treatment - refurbishment, better food, a games arcade and a trendy restaurant nearby - they are already throwing off pounds 25m in net cash flow annually.

Virgin and TPG intend to spend "tens of millions" on the improvement plan.Will the audiences buy it?

Despite a sudden drop in cinema attendance in the first six months of 1995, there is probably little cause for concern. The National Lottery sucked some disposal income away from movie-going.There has also been a dearth of blockbuster films to pack cinema seats of late. That is about to change, with mega-hits Batman Forever, which took in $52m in its first weekend in the US, and Disney's animated Pocohontas, about the open here. But the real growth potential comes in attempting to change the habits of British cinema-goers. Americans go to the movies more than twice as often as the Brits, and Virgin reckons it can narrow the gap.

Virgin's other edge comes from its undoubted ability to brand products and services (radio, airlines, PEPs, cola) and to use innovative pricing schemes to attract custom. The staid cinema market could do with some shaking up along Virgin's lines.

It can only be hoped that Virgin keeps the house ads to a minimum. Are we to be subjected to adverts for Virgin cola every time we go to the cinema?

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