Tax rises on the cards: Government's advisers warned to expect Budget that adds inflationary pressure through VAT or excise increases

THE Government's monetary advisers have been warned to expect a Budget that will put more upward pressure on inflation, suggesting that further extension of VAT or increases in excise duties above inflation are definitely on the cards.

Informed sources in the publishing industry believe the Chancellor has already decided to impose VAT at 17.5 per cent on newspapers, but to leave magazines unscathed. This would come as a relief to publishers such as Emap and Reed Elsevier.

Kenneth Clarke is thought to have ruled out a special National Insurance surcharge on people earning more than pounds 22,000 a year, an early runner in the Budget stakes. Although a tax on the relatively highly paid appeals to Mr Clarke's instincts, he is thought to have jibbed at proposing policies advocated by Neil Kinnock before the last general election.

The Chancellor has also ruled out any large concession on corporation tax by extending higher investment allowances for industry. The Confederation of British Industry has pushed hard for a continuation of the temporary 40 per cent capital allowance, which ran out on 31 October, but Mr Clarke has decided that he should not go back on the Treasury's word.

The City expects Mr Clarke to improve the public finances by between pounds 2bn and pounds 3bn in his Budget on 30 November, in part by cutting public spending to slightly below its planned total but largely by increasing taxes. But Bill Martin, one of the two economists most highly rated by City fund managers, warns in a new study today that the Budget needs to be much tougher.

Mr Martin argues that the Chancellor needs to cut public spending or raise taxes by around pounds 40bn - nearly 7 per cent of national output - to promote a sustainable medium- term recovery.

'If Kenneth Clarke does not tighten fiscal policy, the economy is likely to experience another destabilising boom and bust with inflation rising potentially as high as 10 per cent in the medium term', he warned. But Mr Martin added that a more modest tax increase of around pounds 3bn was much more likely because the Budget 'will be an act much more of political artistry and presentation than of serious economics'.

As a way of seeking revenue from higher earners, the Chancellor is thought to be considering the restriction of personal income tax allowances to the 20p income tax rate, essentially making allowances less valuable to basic and upper-rate taxpayers.

The City fears that another target for the Chancellor's attentions may be pension funds. One possibility is a further cut in the tax credit given to funds to compensate for the advance corporation tax paid on dividends, but the former Treasury minister, John Maples, caused a flurry on Friday with an intriguing new plan.

He proposed that contributions to pension funds should be taxed, but that pensions should be paid tax-free. This contrasts with the present situation, where contributions are made tax-free out of gross income, but pensions are taxed.

Since the change would only affect pension contributions from now on, leaving existing pensioners paying tax, it would provide the Treasury with a pounds 7bn tax windfall. In effect, the change would involve bringing forward tax revenue. Mr Maples argues that the only losers would be the pension fund managers who would have fewer funds to manage.

The Treasury recently estimated that the standard VAT rate on newspapers and books would add some 0.3 per cent to the retail price index. The Government is thought to want to delay the VAT change for four months to allow newspapers time to adjust. Free newspapers will continue to be exempt.

The decision to exclude magazines is understood to have come about after fierce debate within the Treasury over the question of whether educational and business-to-business publications should be exempt. Those areas were too hard to define, so all magazines will remain zero-rated.

The CBI has not given up hope that Mr Clarke may make limited concessions on capital allowances focused particularly on small businesses. It wants him to continue with 25 per cent capital allowances each year but on a straight line basis, allowing the full amount to be offset against tax in four years.

The present reducing balance basis means that investment is never fully written-off, because a quarter is allowed against corporation tax in the first year, followed by a quarter of the remaining 75 per cent in the second year and so on.