David Hillier: The deficit can be finessed for now, but this will be the last of the fiscal-friendly Budgets

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The Independent Online

This Wednesday, the Chancellor, Gordon Brown, will make his last Budget speech before a general election that is widely expected to be held on 5 May. History has taught us that such circumstances usually tempt those in charge of the country's purse-strings to give too much away at times when they really shouldn't.

This Wednesday, the Chancellor, Gordon Brown, will make his last Budget speech before a general election that is widely expected to be held on 5 May. History has taught us that such circumstances usually tempt those in charge of the country's purse-strings to give too much away at times when they really shouldn't.

But Labour has made much of its management of the economy and adherence to strict fiscal rules over the past eight years. So, are we set for the usual pre-election giveaway, or is this to be one of the most restrained pre-election Budgets on record?

To answer that, let's start by thinking about the state of the public finances. In my view, little has changed on this front since the pre-Budget report back in December. The public finances remain a cause for concern - even though the borrowing figure for the current financial year looks set to turn out pretty much as expected.

The reason for my concern is that the Government looks unlikely to meet its so-called "golden rule" over both this economic cycle and the next one. The golden rule is important because it ensures that governments only borrow to invest over the course of the cycle. If the rule is met, future taxpayers will not be asked to pay for spending that would benefit only current taxpayers.

There are a number of different views on how you should calculate whether or not the golden rule has been stuck to. I prefer the simplest and most sensible approach - adding up all the actual and projected current budget deficits and surpluses and seeing what you end up with. If you do that, a deficit of around £5bn is recorded. In other words, the rule has not been met.

The Treasury prefers to use another approach, where deficits and surpluses are scaled by the level of GDP at the end of the cycle, and an amount of cash held in reserve to cover any surprises is thrown in - on the basis that this probably won't be spent. Neither procedure makes sense to me. Try running your bank account like this and see what happens. Anyway, this produces a surplus over the cycle of £8bn.

I have been in a healthy debate with the Treasury over which is the correct method. It seems obvious to me that mine is the one that should be used. But I don't want to get into that argument here - not least because there are bigger fish to fry as we approach next week's Budget. Indeed, my forecasts for the four major tax streams - corporation tax, income tax, VAT and national insurance contributions - suggest that tax revenues will be between £3bn and £7bn a year lower than the Treasury expects over the next five years.

The key reason for that is that the Treasury's projections for corporation tax receipts are, in my opinion, far too optimistic. The Treasury thinks these receipts will grow a rounded 26 per cent in 2005-06, then a rounded 17 per cent in 2006-07. And that's after growth of 15 per cent this year (see the chart on the left).

Those are fairly punchy numbers, to say the least. They reflect the Treasury's view that a higher oil price and a recovery in financial company profits will provide a boost to the level of corporation tax paid. They will, but will the impact be that high? I don't think so. My models suggest the receipts will be between £2bn and £5bn a year lower than the Treasury expects from 2005-06 onwards.

In the past, when I have had a different view on the outlook for the public finances, this has often reflected the fact that my growth forecast for the economy has been significantly different to the Treasury's. That's not the case this time. Although the Treasury's projected growth ranges for the next few years are more optimistic than the consensus numbers, they are fairly close to my own.

So, cut to the chase. What does this mean for the "big" fiscal numbers? Well, in my view, it means that the public sector net cash requirement will be £38.5bn in 2005-06, £39.4bn in 2006-07, and an average of £35.3bn over the following three years. These numbers are a rounded £4bn, £7bn and £8bn worse than the Treasury forecast in the pre-Budget report (see the chart on the right).

Borrowing requirements of this size will require offsetting tax increases unlikely to be announced in the Budget. Indeed, I expect the Chancellor to stick broadly with the borrowing numbers announced during the pre-Budget report and to "find" money to finance fiscal measures "worth" around £1bn to taxpayers.

Experience has taught me not to try to guess what the exact measures will be, but further winter fuel payments to pensioners, improved tax credits for working families or those with children, and an increase in the revenue support grant to boost the finances of local councils are all candidates.

If I'm right about this, then it will only be delaying the day of reckoning. If you ask me, the first issue that the Chancellor - whoever that may be - will face after the election is how to fill the ever-expanding "hole" in the public finances. Tax increases will be the order of the day. An increase in the rate of national insurance contributions above the upper earnings limit is the most likely change to be made.

This, and other measures will be trailed in the 2005 pre-Budget report, then introduced in 2006. Indeed, this week's Budget will probably be the last for some time that doesn't include some form of fiscal tightening.

David Hillier is chief UK economist at Barclays Capital

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