Spending cut better than tax rise - IMF

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Gordon Brown should look to cut spending rather than tax rises to avert a breach of his fiscal rule governing public debt levels, according to internal thinking within the International Monetary Fund.

Documents from the global financial watchdog show that without swift action public sector debt will hit 43 per cent of economic output by 2010.

The report, by two IMF economists, says delaying action to correct the public deficit is worse for the economy as it raises long-term debt interest costs.

"There are significant potential benefits from early fiscal adjustment," the report said. "The long-term gains of preventing a rise in government debt more than outweigh the short-term costs of fiscal adjustment. Reducing government spending on goods provides larger gains than raising taxes. In particular raising corporate or personal taxes creates larger distortions."

The work will be applauded by business groups such as the CBI, which recently urged Mr Brown to reduce his spending plans £10bn a year by limiting planned growth in spending over the next two years from 12 per cent to 10 per cent, rather than impose tax rises.

The March Budget forecasts net debt rising from 36.4 per cent in the current fiscal year to 38.4 per cent by 2011, well below the 40 per cent limit set by Mr Brown's sustainable investment rule.

A Treasury spokesperson said: "Since 1997 the Government has met and will continue to meet strict fiscal rules to ensure sound public finances and to underpin the public spending framework. As the IMF themselves note 'the [UK] fiscal framework is at the forefront of international best practice'."

Meanwhile the CBI said optimism among businesses had risen over the past sharp six months despite growing worry about the impact of soaring energy costs on their profit margins. Its poll of 3,000 businesses found the number of companies suffering a fall in profits had increased since the last survey six months ago.

Despite this, orders, output and jobs all continued to increase over the past year, while firms' expectations for the coming 12 months had increased.

The survey is the latest to convey the mixed message from industry of a rebound in activity that is under pressure from the attack on profit margins. "The prospects for Britain's economy are brighter than they were six months ago," Doug Godden, the CBI's head of economic analysis, said. "At the same time, firms face a tighter squeeze on profits from higher energy and staff costs."

The biannual survey, with Regional Development Agencies, found that 41 per cent of respondents said staff costs were the most significant upward cost pressure. Energy was just behind, cited by 33 per cent of firms.