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Expert View: On a Treasury hunt for a missing £6.5bn

Bill Robinson
Sunday 21 March 2004 01:00 GMT
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This was a significant Budget because of what it did not do. Gordon Brown's seven-year stewardship of the economy divides neatly into two phases. In phase one, he established himself as the prudent Chancellor by sticking to the Conservative spending plans, running up fiscal surpluses and repaying debt. Then global recession struck. The economic imperative was to spend money to sustain demand. This chimed well with Labour's commitment to better public services ahead of the 2001 election. So we entered phase two, in which the prudent Chancellor justifiably loosened the purse strings, and promised 7 per cent real growth in health spending. As a result the UK weathered the recession better than any economy in the G7.

This was a significant Budget because of what it did not do. Gordon Brown's seven-year stewardship of the economy divides neatly into two phases. In phase one, he established himself as the prudent Chancellor by sticking to the Conservative spending plans, running up fiscal surpluses and repaying debt. Then global recession struck. The economic imperative was to spend money to sustain demand. This chimed well with Labour's commitment to better public services ahead of the 2001 election. So we entered phase two, in which the prudent Chancellor justifiably loosened the purse strings, and promised 7 per cent real growth in health spending. As a result the UK weathered the recession better than any economy in the G7.

Now we enter phase three. The recession is over. The Chancellor's forecast of 2-2.5 per cent growth in 2003 has proved correct. But the Treasury now expects revenue for 2003-04 to come in at £6.5bn less than expected a year ago, while current spending is £6bn over budget (£2.5bn due to the Iraq war). Fiscal forecasting is notoriously difficult but, crucially, the Chancellor can't blame the economy for the revenue shortfall. GDP growth was in line with expectations. Tax revenue was not.

The prudent response to an unexplained revenue shortfall is to cut back spending or raise taxes. I therefore expected this Budget to signal a modest tightening of the fiscal stance (without putting up any headline tax rates). The usual trick is to freeze allowances while indexing duty rates. That, plus the well-trailed crackdown on tax avoidance, would have signalled the necessary change of course.

Instead, the Chancellor chose to do the opposite: index the tax allowances, but freeze some duty rates. This decision, plus the £500m gift to the pensioners, made this a (mildly) expansionary Budget for 2004-05. And the Budget speech put heavy emphasis on maintaining government spending plans, borrowing as necessary. Britain's underlying economic strength, and its low level of public debt, make this a feasible, if risky, strategy.

To avoid economic crisis, Mr Brown needs to maintain credibility. That is why he attaches so much importance to meeting his Golden Rule - borrow only to invest, and make sure that current spending is paid for by current income over the cycle. On the Treasury's figures he is on course to do that. But others are less optimistic. What is at issue here is the underlying cause of the missing revenue. Outside commentators do not accept the Treasury view that the past two years' missing revenues will be recouped in due course.

One thing is certain. Real public spending growth will fall back towards the underlying growth rate of GDP - around 2.5 per cent. Yet the promises of higher real increases in health and education spending remain in place. Real spending growth in other departments is likely to be very modest as a result. That is why Mr Brown is now promising to deliver £20bn in efficiency savings. Can he really achieve that? Watch this space.

Bill Robinson is a director at PricewaterhouseCoopers

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