Public Finances: To spend, spend, spend in a fragile economy, the deficit takes the strain

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Indy Politics

The public finances are now deteriorating to such a degree that the Government stands in danger of breaking both its fiscal rules. With little room to increase taxes, thanks to the fragile state of the economy, and still opportunity to renege on important public spending commitments on child poverty and other priorities, Alistair Darling indicated that he is going to let the budget deficit take the strain.

But while the Chancellor was able to report that borrowing this year will be slightly lower than the planned total – at £36.4bn against a target of £38bn – the news was much less good for the future. The rapid increase in borrowing envisaged by Mr Darling in the Budget – peaking at £43bn next year – leaves little space for a change of plan if the economy grows even slightly less rapidly than he expects.

Weaker tax revenues are already built into the Budget forecasts, but analysts say that they could be even lower than the Treasury expects, as could growth, if the credit crunch proves more vicious than it has already been. If so, then the sustainable investment rule – where the total of public debt is kept below 40 per cent of GDP – and the "golden rule", where the Government is obliged to borrow only to invest and balances the Budget over the economic cycle, would both be violated.

Mr Darling plans to borrow £13bn more next year than was estimated when Gordon Brown delivered his last Budget last spring. On average, the Chancellor plans to borrow £5bn more each year over the next four years than he thought when he prepared his pre-Budget report last autumn. Thus borrowing, for the period to 2011-12 has been revised up by £20bn from the forecasts for those years in the pre-Budget report and by £32bn from the forecasts for those years in the 2007 Budget. This has few precedents in recent history.

Some of the more apocalyptic analysts raised the possibility that Mr Darling may end up borrowing more than £50bn in 2009 – as much as his ill-fated predecessor Norman Lamont in the recession of the early 1990s. However, it is fair to point out that, even if this were to come to pass, the economy is larger now, and more able to deal with that burden. Indeed, Mr Darling's borrowing is not scheduled to exceed 3 per cent of GDP, a relatively moderate pace.

Mr Darling also announced an upward revision to the central government net cash requirement (CGNCR). This technical marker is more closely linked to sales of government securities, or gilts. The new forecasts place the CGNCR substantially higher than the previous forecast at £59.3bn for this year (against an official projection in the pre-Budget report of £38bn). Some of this at least is down to the new funding arrangements for the nationalised Northern Rock bank, but in any case it will present the Government with something of a challenge to raise those large sums in the markets. In gross terms, ie not allowing for redemption of expiring gilts, the Debt Management Office said that it planned to sell a record £80bn worth of gilts in the coming year.

However, in spite of these remarkably large revisions to the deficit forecasts, the Treasury expects the overall net debt to GDP ratio to remain below the 40 per cent threshold necessary to comply with the sustainable investment rule, set by Mr Brown 10 years ago, and a central plank of the Government's economic strategy. On its latest figures, the ratio climbs to within a whisker of the barrier – to 39.8 per cent in 2010-11, up from the 2007-08 forecasts of 37.1 per cent. All of that is without taking into account the additional liabilities of Northern Rock. The Office for National Statistics has not yet completed the work needed to put these on the public accounts. When it does so the Government will report public finance data with and without the Northern Rock contribution.

The figures for borrowing would be still more challenging if Mr Darling had not taken the opportunity to lightly raise the tax burden. In terms of the "fiscal stance" – the effect the Budget has on the economy as a whole – it is slight either way. There will be a net easing, or stimulus, to the economy – £740m in 2008-09, followed by a tightening of £1.1bn in 2009-10 and a more significant negative effect of £2.8 bn in 2010-11.

But the tax rises in areas such as alcohol duty and vehicle excise duty are balanced by a general slowdown in receipts because of the downturn in economic activity, especially in the shops and in the City. Stamp duty is projected to run lower, reflecting lower transactions in property and City share trading, while lower VAT receipts will follow the decline in consumer confidence and spending. Expected current revenues have been lowered by around 0.5 per cent of GDP over the next few years as a result of the expected downturn in growth. The tax to GDP ratio will rise over the next five years, from 39.1 per cent of GDP to 39.8 per cent.

The Centre for Economic and Business Research added: "Whilst some of this is due to the downgrading of UK growth forecasts, it is clear that the problem is that – now that the UK's tax regime is much less competitive than it had been previously – it is getting harder and harder to keep taxable revenue in the UK."

On public expenditure, total government spending as a share of GDP will peak at 44.8 per cent this year, but much lower increases in following years will constrain this trend. In contrast to the very generous rises in public spending over the second term of the Labour government (2001-05), rises for the next few years will be just 2.2 per cent, 1.9 per cent, 2.4 per cent and 1.8 per cent respectively. The Chancellor has set a Budget total of £618bn for next year, up from £586bn this fiscal year. The NHS budget next year will rise by 6.4 per cent, following an 11 per cent rise last year. Education will see a 7.5 per cent rise, but, somewhat surprisingly, Defence will endure a 7.4 per cent fall.

One area of the government finances that attracted a particularly sceptical view yesterday was the reality of "efficiency savings". Michael Saunders, of Citi European Economics said: "Documents accompanying the Budget claim that efficiency savings under the 'Gershon' process have reached £23.2bn per year, exceeding the planned target of £21.5bn set for 2007-08 in 2004. However, these supposed savings are largely unverified."