Is Brown mad or bad, or is it just that there really is no war chest?

Diane Coyle says the real choice is whether to raise tax
LEPRECHAUNS really exist, there is a pot of gold at the end of the rainbow, and Gordon Brown is hoarding pounds 50bn in a chest under his desk that he could be spending on schools and hospitals. Or so you would believe from some of the attacks in the past week on the Government's comprehensive spending review, due to be published next month.

On one flank the Chancellor is under attack from the Liberal Democrats, who have put the pounds 50bn figure on what they describe as a "war chest". Although the details of their recent document do make it clear that this is a theoretical future sum of money rather than an amount in the government coffers now, there is no doubt that their choice of the term is meant to make the casual reader - and who is not a casual reader when it comes to the details of the public finances? - think there is a secret stash in the Treasury.

The TUC has launched a simultaneous attack saying the state of the finances is prudent enough, and urging growth of public expenditure of 3 per cent a year in real terms. This would raise the share of government spending in national output from the present 40 per cent; the TUC ambition is something closer to the 50 per cent average in the rest of the EU.

No doubt the Chancellor is also under pressure from the Government's spending ministers and much of his own party to tone down his prudence rhetoric and find more cash for the front-line services the voters care so much about. From much of the comment a visiting Martian, or leprechaun, would be forced to conclude that Mr Brown is a deranged latter-day Scrooge, hoarding taxpayers' money for no good reason when there are starving orphans or at least cash-strapped schools and hospitals out there.

Are they right? Is Mr Brown either wicked or mad? The answer is of course not. Rather, the issues are far more complicated than his critics are prepared to admit in their bids for popular approval.

First of all, it is worth remembering that the Government inherited a real mess. The national debt had doubled during John Major's premiership, leaving interest payments the fourth biggest item in the government budget. The Conservatives had won the 1992 election on a tax-cutting and spending spree which meant, despite subsequent tax rises, that there has still been no annual surplus of revenues over expenditure after six years of economic recovery. This year could be the first of several - but the economy is now slowing down, removing the natural cyclical boost to the state of the public finances.

Secondly, the notion that the Chancellor is building up a "war chest" rests on the prospect that, on the assumptions for spending set out in the Treasury's Red Book last Budget, revenues will increase by more than enough to satisfy the "golden rule". This rule is the basic law of prudent public finances which says the government should borrow no more than it invests, and current spending should be less than or equal to tax revenues.

This week Mr Brown spelt out more clearly than ever his intention to have a surplus of revenues over current expenditure for the next three financial years. That is, year-by-year spending on items such as pay, benefits and running costs will have to be more than covered by taxes, whereas public investment can be financed by borrowing. The LibDems pounced on this as an admission that he will be even tougher than the golden rule, and urged higher spending instead.

But they ignore two caveats. One is that prudence is supposed to apply over the course of a full business cycle, and it certainly hasn't so far over this one. The other is that forecasts for public borrowing are notoriously unreliable. The average error in the Treasury's PSBR forecasts - and it does better than others - is approaching pounds 10bn either way. Past chancellors have erred on the side of massive over-optimism in their borrowing forecasts. Kenneth Clarke cheerfully postponed, budget after budget, the year in which he forecast a government surplus. All praise to Mr Brown for breaking with this dishonest tradition and erring on the side of caution. When he has more money than predicted in the bank, then he will presumably spend it - and if that happens to be close to the next election, his fraternal critics will change their tune.

The Red Book sets out a range of forecasts for the future borrowing requirement which vary according to the real spending growth they assume. The caution about growth in tax revenues is not spelt out explicitly, with just one possible path shown. The actual receipts might well be higher - or lower.

The highest path for spending in the Treasury's tables involves real increases of 2.25 per cent a year, the same as the economy's trend growth rate and therefore keeping the share of expenditure in the economy unchanged in the long run. This is low enough to meet the new pledge to have a surplus of taxes over current spending. It implies an increase in spending in cash terms of about pounds 12bn next year rising to nearly pounds 40bn by 2001/2002. That doesn't look too Scrooge-like, although the critics still argue that it is not enough to meet the needs of a starved public sector.

They might be right, but they need to come clean about the implications of spending more. In a nutshell, these are: either to be as carefree as the Tories about controlling government borrowing, and hang the future consequences for the interest burden and stability of the economy; or raise taxes by as much as you want to increase spending. Big government is fine as long as it is solvent government.

The TUC's document does not mention tax increases, on the apparent grounds that now Mr Brown has done prudence on existing spending plans there is no need to worry about sustaining it in future - even if spending were to expand faster. The Liberal Democrats still have a policy of putting a penny on the basic rate of income tax. This would raise about pounds 2bn a year. Useful, but scarcely a cornucopia for the health and education budgets.

There is a real political dilemma at the heart of the spending debate, however. We would all like to see an end to the resource squeeze in front- line public services. In wealthy countries, voter demand for extra education and healthcare services increases at a faster pace than the economy grows implying that when they are provided by the public sector there will be pressure for government spending on these areas to increase as a proportion of GDP. That implies that there is a choice to be made, once irresponsible borrowing is ruled out. Either taxes must increase to finance the extra spending, or private expenditure must plug the gap.

The Iron Chancellor has actually pushed through some tax increases in his two budgets, although so cunningly disguised that many City pundits, and the Liberal Democrats for that matter, have accused him of being too lax on consumers. But the Government has not yet made it plain to the electorate that if they want really big increases in their favourite types of expenditure they will have to vote one day for really big middle class tax increases. This is not an option we will find in next month's comprehensive spending review.