Darling 'will need £9bn tax raise in Budget'

The UK's public finances have deteriorated so badly that the Chancellor Alistair Darling will have to raise taxes by £9bn in his next budget, a leading independent think-tank has warned.

The National Institute for Economic and Social Research (NIESR) said the public finances were in "rather poor shape" and said the Government would need a major tax hike in order to stay within its self-imposed fiscal rules following the Budget, which the Treasury said yesterday would be unveiled on 12 March. However, the NIESR called on Mr Darling to resist the temptation to raise taxes and instead revise its "inflexible", "badly designed" and "discredited" fiscal framework to avoid damaging the economy.

The think tank's warning follows a very similar alert from the Institute for Fiscal Studies, which said an £8bn tax rise would be required to keep the Government within its own rules.

But Martin Weale, director of the NIESR, was strident in his criticisms of the Government's economic performance, accusing it of being so concerned not to raise taxes that there had been a "great missed opportunity" during the recent boom to strengthen the fiscal position.

Mr Weale said the impending crunch in the public finances was partly a result of "the capacity of the Prime Minister to believe something will turn up at the end of the rainbow". He added: "Fiscal policy should be about saving up for a rainy day; now we have a rainy day – but no savings".

Shortfalls in corporation tax and VAT receipts compared to Treasury expectations are responsible for most of the most recent deterioration, but the position could become even more serious because of the Northern Rock crisis, the NIESR warned. If £30bn of the stricken bank's liabilities were to be guaranteed by the Government and placed on the UK's "balance sheet", this would bust the Chancellor's sustainable investment rule.

Nevertheless, the NIESR forecasting economic growth in the UK of 2 per cent for 2008 and 2.6 per cent for 2009. It expects inflation to rise to 2.6 per cent over 2008, peaking at just below the 3 per cent level that would trigger an explanation from the Governor of the Bank of England to the Chancellor. The think tank also thinks house price inflation will remain positive, with a 1 per cent gain over the year as a whole.

The NIESR was also upbeat on the prospects for the world economy during 2008, forecasting 4.4 per cent growth internationally and 2.2 per cent for the US. Mr Neale said he expected the US to escape a formal recession, though he warned a worsening of the banking crisis could trigger a downturn.