Finances `mess' to drive up tax

A senior government adviser has warned that the public finances are in such as mess that taxes are likely to go up whichever party wins the general election.

That gloomy assessment comes despite expectations that the Government will receive a pre-Christmas boost to its electoral chances from a raft of favourable economic news this week.

Figures due in the next few days could show the number of unemployment benefit claimants dropping below 2 million for the first time in nearly six years, along with firm growth in high street spending and further signs of improvement in the housing market.

The Government is also likely to get a pat on the back for its policies from the Organisation for Economic Co-operation and Development in its half-year economic outlook at the end of the week, although the report is expected to sound a note of caution about the dangers of over-heating.

The one cloud will be tomorrow's figures for government borrowing last month, with a prominent City economist warning in a new paper today that taxes will have to rise next year whoever wins the election.

Bill Martin, an adviser to the Treasury Select Committee at the House of Commons and an economist at investment bank UBS, warns that the public finances are in such a mess that taxes are likely to go up whatever the outcome of the election.

He calculates that the underlying gap between public spending and tax revenues - that is, adjusting for the stage of the business cycle - is so high that the next government will face an unpalatable choice if it is to avoid a damaging level of interest rates and exchange rate. There will have to be further expenditure cuts or tax increases.

Mr Martin says the Treasury's forecasts that the public sector borrowing requirement (PSBR) is on a downward path make rosy assumptions about both the growth in tax revenues and expenditure control. He notes that the Treasury is assuming the trend decline in VAT receipts relative to the size of consumer spending will come to an end.

The Chancellor, Kenneth Clarke, also insists that his success in delivering tight spending control since 1993 means the Government can meet its current targets. However, Mr Martin points out that keeping the lid on spending growth is easy when the economy is recovering, as it has been since 1993, but will become much harder when it next turns down.

The damage done by excess government borrowing in terms of putting upward pressure on interest rates will be compounded if the private sector begins to save less. Higher house prices, making people feel wealthier, tend to reduce the savings rate.

City economists expect that November's PSBR will show a shortfall of about pounds 2.7bn, following the surprisingly big monthly surplus of pounds 4.4bn in October.

Worries about the PSBR contrast with news on both the housing market and high street spending expected this week. The latest research from Rob Thomas, a housing analyst at Swiss investment bank UBS, forecasts a 10 per cent rise in 1997 followed by a further 10 per cent gain in 1998. It will be the first sustained period of house price inflation since the market crashed in 1989.

London and the South-east are expected to see even higher price rises, reaching up to 15 per cent before tailing off in 1998. Growth in Scotland, Wales and the north of England is expected to average between 6 and 8 per cent next year.