Tax hike and wider VAT expected in Budget

THE CHANCELLOR has decided to unveil a tight Budget next week, with the Treasury increasingly convinced that the economic tide has at last begun to turn.

The main Budget decisions were completed last week and are believed to include plans to extend VAT to domestic fuel and power, which would raise pounds 2.5bn a year at the standard rate of VAT. Speculation has also grown that Norman Lamont will finance a net tightening of fiscal policy this month with an effective rise in income taxes.

Mr Lamont is expected to announce the VAT decision next week but implement it in his November Budget, the first to combine tax and spending measures. By acting in November, he can offset the impact of higher indirect taxes on poorer households with increased social security help.

The move would begin the widening of the VAT base that Mr Lamont must set in motion sooner or later, bringing Britain into line with the European Community. But it also reflects mounting concern in Whitehall over the long haul facing Britain in meeting the EC goal of stabilising carbon dioxide emissions by the year 2000.

The decision to tighten fiscal policy slightly this month reflects the Treasury's belief that the risk of derailing the nascent recovery is fading. Crucially, Prime Minister John Major has gone out of his way to underline his belief that the economic tide is turning.

The decision to tighten fiscal policy comes despite Treasury forecasts of a smaller than expected Public Sector Borrowing Requirement for 1992-3 and 1993-4. Last year's Autumn Statement forecast a pounds 37bn PSBR for 1992-3 and pounds 44bn for 1993-4. The Chancellor was urged to rein in the explosion of borrowing both at the recent London meeting of finance ministers from the Group of Seven industrialised countries and by senior cabinet ministers.

As well as reassuring the markets that borrowing will be curbed, the Chancellor must finance an employment package and help for small businesses. He has already said he will find pounds 750m in vehicle-related duties to pay for the cut in car tax; higher duties on petrol are widely expected. A 10 per cent increase in petrol and vehicle duties would raise pounds 1bn.

Higher duties and VAT would have a limited impact on inflation. The 22 independent forecasters polled by the Treasury on average expect headline inflation to reach 3.2 per cent in the fourth quarter of this year, and underlying inflation to climb to 4.3 per cent. Some of these forecasts assume higher indirect taxes.

Speculation is also mounting that Mr Lamont will raise income taxes either by freezing personal allowances - a measure worth around pounds 900m - or by restricting personal allowances to the basic rate of tax. This reform would net pounds 1.3bn, according to the Institute for Fiscal Studies.