Robert Chote: Brown banks on his fiscal fortunes taking a turn for the better

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The Independent Online

For the past five years, Gordon Brown has had to admit in every Budget or pre-Budget report that the public finances have turned out weaker than he hoped. If the Treasury's fortunes as a fiscal forecaster are about to take a turn for the better, the political pay-off for Mr Brown could be considerable.

That has not happened yet, although the Chancellor did get away yesterday without having to reveal any nasty surprises. The outlook he predicted for both the economy and the public finances was almost identical to that which he presented in December's pre-Budget report. He is still signalling that he is ready to fight the next general election with a rising tax burden and a squeeze on public spending.

The tax and spending measures he announced in the Budget make little difference to the picture. Taken together they will raise only £415m in 2007-08. This is less than a quarter of the amount he raised in the supposedly less significant pre-Budget report. The biggest money raisers are £760m from tackling "tax avoidance" and £155m from the introduction of Real Estate Investment Trusts. The biggest giveaway was £440m for schools.

The Chancellor fractionally increased his December forecast for public sector net borrowing this financial year to £37.1bn or 3.0 per cent of national income. Borrowing is then expected to decline steadily to £23bn or 1.5 per cent of national income over the following five years, again very much as expected last year.

Tax revenues are expected to be slightly higher than thought in the pre-Budget report. The strength of the stock market and slightly higher oil prices will bring in more, although this will be offset in the short-term by the impact of lower oil production and weaker-than-expected growth in wages and salaries. On the spending side, lower wage growth also appears to be pushing up spending on the Child and Working Tax Credits.

Mr Brown's famous "golden rule" allows him to borrow to pay for investment, as long as the current budget - the gap between tax revenues and day-to-day spending on the likes of public sector pay - is kept in balance or surplus on average over the ups and downs of the economic cycle. The Chancellor increased his forecast for the current budget deficit this year by £800m to £11.4bn. Looking ahead, the Chancellor is expecting the current budget to move from a deficit of 0.9 per cent of national income this year to a surplus of 0.8 per cent in 2010-11.

The Treasury's forecasts now imply the Chancellor will meet his Golden Rule with £10bn to spare over the 12-year economic cycle that the Treasury says will run from 1997-98 to 2008-09. He cited a figure of £16bn in his speech by assuming that he will not need to spend his contingency reserve for unexpected events. But yesterday he needed to find an extra £1bn for next year for international commitments including Iraq and Afghanistan, so this may be optimistic.

This £10bn cushion is slightly smaller than the £12.7bn he had at the time of the pre-Budget report. Any fiscal forecast is uncertain, especially over three years. Given the Treasury's past forecasting performance its best guess implies a 55 to 60 per cent chance of meeting the golden rule in the absence of further policy changes over the remaining three years of the economic cycle.

The Chancellor also has fractionally less room for manoeuvre against his second key goal, the sustainable investment rule. This requires him to keep public sector net debt below 40 per cent of national income. The Chancellor now expects public sector net debt to level off at 38.4 per cent of national income, up from 38.2 per cent in the pre-Budget report.

The growth forecast for this year is in line with the predictions of outside experts. But the City scribblers are less convinced that the economy can sustain growth as strong as the Treasury hopes thereafter without pushing up inflation. Fortunately for Mr Brown, the Bank of England seems happy with growth returning to 3 per cent or so.

Although the Treasury is sticking with its growth forecasts, it has slightly changed its estimates of the amount of spare capacity in the economy. This determines how much of the deficit in any given year is attributed to temporary "cyclical" factors and how much to the underlying strength of the public finances.

The Treasury now estimates that activity in the economy is running 1.2 per cent below the level consistent with stable inflation this year. This " output gap" is expected to widen to 1.4 per cent next year and then to all but disappear over the following two years. This implies that the Treasury is expecting a "structural" improvement in the budget balance of 0.7 per cent of national income (about £8.5bn) next year, followed by a further 0.3 per cent in 2007-08 and little thereafter.

Whether the improvement in the current budget materialises as the Chancellor hopes thus depends on two questions. First, whether there is as much spare capacity in the economy as the Treasury thinks? Second, whether the structural improvement over the next couple of years will be as strong as it believes? This could depend significantly on the strength of tax revenues from the City and North Sea oil companies. The other key factor will be whether Mr Brown is happy to stick with the squeeze on public spending.

* Treasury Budget site

* Chancellor's Statement in full

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