View from City Road: Crack the tax whip but don't scare the horses

The Bank of England's judgement about what the Chancellor should do in the Budget looks thoroughly sensible. Kenneth Clarke faces a dilemma. He needs to sustain the recovery, because if he does not he will find it increasingly difficult to cut Britain's sky- high borrowing requirement. So the first priority if the public finances are to be restored is that growth should continue and the Treasury's revenues should swell.

However, it is equally clear that the current level of public spending cannot be financed by the current level of tax rates without bequeathing an unsustainably large budget deficit in the mid-Nineties, even after growth has whittled it down. On the Treasury's Budget forecast, which is unlikely to be revised dramatically next month, borrowing will still be nearly 3.75 per cent of national income in 1997-8.

If the Chancellor is merely to stabilise the national debt as a share of national income - a mild fiscal objective - and if he is to hit the mid-point of his 1 to 4 per cent inflation target, he needs to cut borrowing to 2.5 per cent of national income by the time the economy is growing normally again.

This implies a tax increase (or spending cuts) of some 1.25 per cent of national income. Throw in a little for the enormous margins of error involved, and give the Chancellor the benefit of the doubt on a bit more, and you get the Bank's answer: tax increases or public spending cuts worth 1 per cent of national income.

The Bank advocates proceeding even with this increase slowly, so as not to startle the horses. This was the Norman Lamont strategy, and it is also sensible on economic grounds. Lurches of policy in one direction or another should be avoided if at all possible. Moreover, high debt may mean that it is difficult to offset the depressive effects of tax increases by cutting interest rates.

However, this is one aspect of the Bank's advice that the Chancellor may be tempted not to heed. After all, the political incentive is to get the bad news out of the way quickly, long before a likely 1996 general election. Moreover, the lesson of Mr Lamont's VAT rise on fuel may be that it is better to move quickly, and hope that people reconcile themselves to unpopular changes. If the Chancellor decides to risk a bigger tax increase, he may also give us a full-point cut in interest rates.