Chancellor to take on his critics as fears mount over tax rises to fill 'black hole'

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The Independent Online

Gordon Brown will use a keynote speech to MPs to launch a counter-attack on his economic record in the face of mounting speculation that he is set to break his own rules on public finances.

The Treasury is growing increasingly annoyed at a rash of speculation in the City and the media that it is facing a black hole that will have to be filled by new taxes on anything from home sales to children's clothes.

The Chancellor of the Exchequer, who is currently on paternity leave, will come out fighting in December when he delivers his pre-Budget report (PBR) to Parliament. He is determined to scotch rumours that he is on track to break his own rules governing fiscal policy because of the scale of the economic downturn.

Reports at the weekend warned the public deficit was rising so fast it would breach the "golden rule" requiring him to balance the books over the economic cycle.

A senior Treasury official said: "Whatever we say at the PBR, we will say how wrong these people have been. We have to produce our own forecasts that have been audited by the National Audit Office and we will set out what [assumptions] they are based on."

The Government has also been forced to rebut a series of claims that it is planning to use the PBR or next year's Budget to raise tax. These include capital gains tax on the profits from home sales, VAT at 20 per cent and higher airport tax.

The rumour mill has gone into overdrive since official figures showed that, with just half of the financial year gone, Mr Brown has racked up more than four-fifths of the total £27bn deficit he forecast in this year's Budget. Spending is running at an annualised rate of more than 11 per cent, compared with a Budget forecast of about 7 per cent. Meanwhile, a slump in corporation tax revenues means receipts are growing by less than 6 per cent a year compared with a Budget target of 7 per cent.

But the Treasury dismissed attempts to extrapolate from current figures into an estimate for the public finances for the next two years. While the Treasury believes the deficit will start to narrow next year to £24bn, the City expects it to widen to £35bn from £31bn this year. Instead the Chancellor will say that as the economy rebounds, the Treasury's coffers will fill up, eroding the deficit.

The official said: "We have had a year with a very high level of current [non-investment] spending because of the developments in Iraq and other one-off expenditure, so next year we would expect to see a restoration of the balance. Do people think that tax receipts will not recover if the economy recovers?"

The Treasury believes the economy will grow more than 2 per cent this year and by more than 3 per cent - above the long-run trend rate - in 2004 and 2005. Mr Brown may cut those estimates in December's PBR but is already on track to meet this year's target.

But even if, as most analysts believe, he can meet his fiscal rules in the current cycle without raising taxes, he will be faced with mounting deficits when the new cycle begins in 2006. Michael Saunders, an economist at Citigroup, said the Government will "eventually" have to cut spending or raise taxes by 1 per cent of GDP or £10bn.

STICKING TO THE RULES

Golden rule: Over the economic cycle, the Government will borrow only to invest and not to fund non-investment spending. This means that averaged out over the years of the cycle the current budget must stay in surplus.

Sustainable investment rule: Public sector net debt as a proportion of GDP will be held over the cycle at a stable and prudent level. Gordon Brown interprets this as, other things equal, net debt will stay below 40 per cent of GDP.

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