Rising UK deficit may force tax increases, warns OECD

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Tax increases or spending cuts may be needed before the next election, a leading global think-tank warned yesterday.

The Organisation for Economic Co-operation and Development said the public sector deficit had "widened considerably" and a surge in household debt had raised the spectre of a crash in house prices.

The OECD said the deficit "may call for a slowdown in spending or a rise in taxes during the current upswing to avoid a destabilising adjustment later on".

In an ironic echo of Gordon Brown's catchphrase, it said he would be "prudent" to act before the current economic cycle ends - predicted in 2005, the most likely year for an election.

The Chancellor will use next month's pre-Budget report to tell Parliament he will miss his target £27bn deficit this year by up to £10bn.

But he will insist he will not break his "golden rule" to borrow only to invest - a claim the OECD agreed was "arguably" true.

The Conservatives seized on the OECD report. Oliver Letwin, the shadow Chancellor, said: "So long as the Government refuses to contemplate real reform of public services, we will be locked in a vicious circle of ever-higher taxes and failure to deliver the improved public services that everyone wants to see."

The Treasury said the OECD was forecasting above-trend growth for the UK and had praised it for showing "greater resilience" than other countries.

"We will continue to meet our fiscal rules and our spending plans are fully affordable," a spokesman said. "It is clear from the OECD report the Government's overall record on stability, growth, inflation, jobs and debt is outstanding compared with other major economies."

The OECD urged the Bank of England to order gradual interest rate rises to reduce the risk of another surge in house prices. "Households remain highly indebted and may suffer large income and wealth losses, especially in the housing sector, should interest rates increase abruptly," it said in its twice-yearly economic outlook.

The warning came as Capital Economics, a City analyst, predicted that 300,000 households would be plunged into negative equity - where the mortgage is larger than the property's value - by the end of 2006 as prices fell by 20 per cent.

There was better news for the Chancellor from the latest data on economic growth, which showed an unexpected surge over the summer that put Mr Brown on track to hit his Budget forecasts.

Government statisticians revised estimates for economic growth in the third quarter to 0.7 per cent, from 0.6 per cent and the strongest result for a year.

The annual rate of growth hit 2 per cent, putting it within Mr Brown's Budget forecast of 2 to 2.5 per cent, which was heavily criticised at the time.

But the growth came at the expense of imbalances within the economy which economists warned could jeopardise hopes of a sustained recovery.

While services and construction showed strong growth, production has fallen. And company profits rose at their slowest rate for a year.