Cut in population growth forecast deals new blow to Brown's tax and spend plans

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Gordon Brown's attempts to scotch mounting speculation of a black hole in the public finances were dealt an embarrassing blow yesterday.

The Government's own statisticians slashed their population growth estimates, a move that threatens to undermine a key assumption behind the Treasury's optimistic growth forecasts.

Independent analysts warned it could force the Government to impose an extra £5bn of taxes by 2006 – about 2p on income tax – to avert a public finance crisis.

But Whitehall sources dismissed the warning, saying a smaller population would allow it to increase estimates of productivity growth. The Government Actuary's Department (GAD) cut its forecast for population growth over the next quarter century to 63.2 million from 65.0 million – a fall of 2.8 per cent. It has also cut its assumption for annual net immigration to 100,000 from 135,000.

The figures build on September's official census, which showed that the UK population was almost 1 million lower than previously thought.

In the April Budget, the Treasury increased its forecast for trend rate of growth to 2.75 from 2.5 per cent. It also increased the figure it uses for calculating the public finances to 2.5 from 2.25 per cent.

This revision – which received a sceptical welcome at the time – was based in part on the GAD's old 135,000 immigration forecast. But the Treasury went further, saying it believed this was "excessively cautious".

The Treasury used the old GAD figures for its revisions but the new GAD data for 2001 to 2006 shows the population would be 330,000 lower than first thought. This is the five-year period that the Treasury used for its upward revision.

John Hawksworth, head of macroeconomics at the accountants PricewaterhouseCoopers, said a lower population would cut GDP growth by 0.25 percentage points, effectively reversing the impact of the Budget revisions. "This would increase the cyclically adjusted budget deficit by around £1bn a year, accumulating to around £5bn by 2006/7," he said.

The latest setback would come on top of the £8bn PwC already believes taxes must rise to fill a black hole, taking the total bill to the taxpayer to £13bn.

Steven Bell, chief economist at Deutsche Asset Management, said the Treasury should feel "very nervous". He said officials were mixing up a temporary phenomenon with a permanent change. "They raised growth largely because of population and largely because of foreign workers," he said. "These highly mobile and highly paid people worked in sectors that are now in recession."

But Martin Weale, director of the National Institute for Social and Economic Research (NIESR), said he was sceptical about the elimination of a million people from the Census and urged the Treasury not to panic. "The answer is careful studies of areas of large populations falls," he said. "I would want to know that these follow-up studies had been done."

But Whitehall sources pointed out that if the population estimates had been cut this meant less workers had produced the same economic growth – so boosting productivity.

Yesterday's development follows warnings that a tumbling tax take will force the Chancellor to hike taxes to avoid breaking his "golden rule" of balancing the Budget over the economic cycle. As well as PwC, Ernst & Young's ITEM Club said tax revenues would undershoot by £7bn while the NIESR has said an extra £20bn tax hike would be needed by 2007 to balance the books.

A Treasury spokesman said it could not comment on its economic forecasts until the pre-Budget report, which is expected later this month.