This could be last chance for Clarke

If new Labour paid homage to the memory of Harold Wilson in Brighton, the Tory party conference in Blackpool is haunted by the political grandmaster's most famous line - a week is a long time in politics. Alan Howarth's defection has shaken the received political wisdom that John Major's government can run till spring 1997. With only four by-elections necessary to destroy their outright majority, the Conservatives have now to reckon on a possible election next year.

The upshot is that when Kenneth Clarke addresses the conference today, he will do so in the knowledge that the ground has shifted under his feet since his trip to the International Monetary Fund meetings in Washington. Before Mr Howarth became the new Labour MP for Stratford, the working assumption was that the Chancellor still had two Budgets to go. Now Mr Clarke has to reckon on the possibility that this may be the only shot in his locker.

The changing odds on the electoral timetable seem certain to reshape the budgetary arithmetic. Yesterday's "green budget" presented by the Institute for Fiscal Studies and Goldman Sachs held out the prospect of a low-key return to tax cuts this November, worth no more than pounds 2-3bn. For the real fireworks, we would have to wait for the 1996 Budget, when according to Andrew Dilnot, director of the IFS, we could see "some really big tax cuts".

Charitable and broad-minded though Kenneth Clarke may be, he is unlikely to wish to endow Gordon Brown with such a handsome legacy. By highlighting the risk that this may be the Tories' last chance to restore their tax- cutting credentials, Mr Howarth has raised the likelihood that the Government will cut every conceivable corner to deliver the goods on tax cuts this November.

That is the political imperative, but not for the first time a Chancellor finds himself caught between a rock and a hard place. Two weeks ago, the City balked at a gilts auction for the first time. And yet the Bank of England will have to sell pounds 3bn worth of government debt every month - necessitating an extra auction next February - if it is to meet a borrowing requirement that has stubbornly refused to fall so far this year.

The "green budget" forecast of pounds 27bn for the current financial year, 1995/6, is a far cry from the pounds 21.5bn predicted by the Treasury last November, but is itself less than several City forecasts. Whatever the precise outlook for this year, it is hardly the most promising background for a Chancellor to play fast and loose with the public finances. The last thing Kenneth Clarke needs is a crisis in the gilts market accompanied by a stern lecture from Eddie George on the need for an offsetting rise in interest rates to make up for fiscal irresponsibility. The Governor of the Bank of England made such a warning explictly to the Treasury Select Committee over the summer.

One way or another, therefore, the Chancellor has to present a credible forecast for the public sector borrowing requirement next year which shows it continuing to decline. In last year's Budget, the Treasury projected a deficit of pounds 13bn, subsequently raised to pounds 16bn in its economic forecast in June.

The "green budget" forecast of a more or less acceptable pounds 17bn depends on achieving a real cut of half a per cent in the "control total" of public expenditure targeted by ministers in the public spending round. By contrast, the Ernst & Young Item Club, which uses the Treasury model, projected earlier this week a PSBR of pounds 25bn even without any tax cuts.

Faced with this prospect, it is no wonder that the mild William Waldegrave has been reincarnated in the unlikely guise of chief axe-swinger in his new job as Chief Secretary. Spending must fall: that is his battle-cry; that is the Cabinet's new faith.

Yet the idea that public spending will fall in real terms in an election year seems the height of implausibility. As the charts below demonstrate, Kenneth Clarke did cut public expenditure in his November 1994 Budget. But the cut was in the planned totals.

A similar pledge of a reduction in planned spending was made in the November 1993 Budget for the financial year that ended this spring. This was supposed to lead to a cut in real terms of just over one per cent in 1994/5. Instead, spending rose by that amount in real terms. Lower than expected inflation meant that the cash amounts available to departments bought more than the Treasury had planned.

In brandishing his cuts in planned expenditure in the last Budget, Mr Clarke in effect pushed the real cut forward to this year. Yet once again, lower than expected inflation is turning that real cut into a real rise of about half a per cent according to the "green budget". Even that modest rise has already made for huge unpopularity in key areas of public service - witness the revolt of parents this spring over cuts in education spending.

The reality is that no matter what Mr Waldegrave and Mr Clarke say, public expenditure will increase in real terms next year. Current plans for key areas like health belong in the fiction rather than non-fiction department of a library. The Government is not, in practice, going to blow its manifesto pledge with the current projected decline of one and a half per cent.

This would seem to leave the Chancellor with only one way out of his dilemma: to switch taxation. His apparent flirtation with the idea of a windfall utilities tax is suggestive of the potential for raiding the corporate sector to finance a hefty cut in personal taxation. Restoring the cut of 2 per cent made in corporation tax in the 1991 Budget would, for example, eventually yield pounds 2bn a year.

A political Budget this year has always been seen as a racing certainty. But nothing concentrates the mind like the prospect of execution. The odds on a Budget that moves heaven and earth to cut income tax without compensating cuts in public spending have drastically shortened.

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