The National Institute of Economic and Social Research is warning against tax cuts even of pounds 3bn, which most political pundits believe is the least the Government can offer in order to win the next general election.
The institute says that cuts at this level would lead to the Government overshooting its key measure of spending by 3 per cent this year. The spending control total, which excludes cyclical social security spending and debt-interest payments, will rise by 2.1 per cent in real terms this year, it says. At the time of the last Budget, a fall of 0.9 per cent was forecast.
The institute says tax cuts might be justified if financed by spending cuts but is sceptical that sufficient reductions can be achieved. It argues that the question the Chancellor should address in the Budget is Britain's savings shortfall. A cut in government borrowing would lead not only to an increase in domestic saving but also to a rise in domestic investment.
The institute expects the Government to miss its inflation target of 2.5 per cent or less next year. It forecasts that underlying inflation - which excludes mortgage interest payments - will run at about 3 per cent at the end of 1996.
Growth in the economy is expected to slow to 2.4 per cent, with growth in domestic demand led by consumer spending and fixed investment. Unemployment will drop by 300,000 next year, partly because of the introduction of the jobseeker's allowance and the eventual impact of the new incapacity benefit.
The institute points out that the most striking aspect of the economy at the moment is that the rate of wage increases has been so subdued despite the sharp fall in unemployment.Real average earnings, it says, are likely to fall by 0.5 per cent in 1995.
By contrast when there was a fall in unemployment of similar size in 1987-88, real average earnings rose by 2.5 to 3 per cent a year. However, it cautions that part-time working has increased and unemployment among men is still close to 10 per cent, according to the Labour Force Survey.