Andrew Grice: Clegg is forced to eat humble pie over VAT increase

The carefully stage-managed picture of four men in white shirts sitting around the Cabinet table – George Osborne next to Nick Clegg, opposite David Cameron and Danny Alexander – told the story the coalition wanted: they were all in it together.

Although the photo-opportunity was on Monday, the two Tories and two Liberal Democrats had already signed off the Budget last Friday – without cameramen invited. That was unusually early for such a momentous event. No room for last-minute rabbits in the brave new world of coalition politics. It was genuinely a team approach, a far cry from the days when Tony Blair had to beg Gordon Brown for titbits about his imminent Budget.

A typical compromise came on the two-year pay freeze for most public-sector workers. The Liberal Democrats favoured a flat-rate payment for the lowest paid; the Tories a freeze for those earning more than £18,000 a year. The Liberal Democrats persuaded Mr Osborne to raise the ceiling to £21,000, with a flat-rate increase of £250 for those paid less.

Although the Tories and Liberal Democrats had their own priorities, they were not always coming from the different directions you would expect. Mr Clegg's party took a more hawkish line on restricting Mr Brown's tax credits. Mr Osborne was persuaded to lower the cut-off point from £50,000 (Tory policy) to £26,000 by 2012-13.

"It was a coalition Budget," said one insider involved in the talks. "Both sides brought something to the party and it was a better, more thought-out Budget as a result."

Vince Cable, the Liberal Democrat Business Secretary, told the Cabinet yesterday: "This is a Budget we can all be proud of." Clegg allies said it had "fairness at its heart" and highlighted the £1,000 rise in personal tax allowances – a big step towards their flagship election policy. But last night at Westminster, Tory MPs had more of a spring in their step than the Liberal Democrats. Conservatives were relieved that a clampdown on capital gains tax (a Liberal Democrat idea) was less severe than it might have been, while the Liberal Democrats were contemplating the pain as well as the gains.

The rise in VAT will be a hard sell to many Liberal Democrats. Mr Clegg is resigned to having to watch over and over again those TV pictures of him warning about the Tories' "secret VAT bombshell" during the election campaign. His aides pointed out that the Liberal Democrats never ruled out a VAT rise and always favoured tough action on the deficit, but pictures are often more powerful than words.

Mr Clegg insists that doing what is right for Britain – cutting the deficit – is more important than hiding his embarrassment. In any case, Mr Osborne would have insisted on banking such a solid stream of income (£13bn a year). "We only have one shot and we have to get this right," said a Tory minister.

The VAT increase will be hard for many Liberal Democrats to swallow. They don't buy the "progressive" spin put on the move by Mr Osborne, which looks questionable, and think it will be regressive.

Some of Mr Clegg's MPs will not vote for the Budget, and many Liberal Democrat activists will be uneasy about the benefits squeeze, finding it hard to square with Mr Clegg's talk about protecting the vulnerable. He may have been a deficit hawk all along but many in his party have other ideas.

The Treasury tables showing the pain shared across the income scale do not take account of the cuts averaging 25 per cent in most departmental budgets, due to be announced in October. These will hit the poorest people in the poorest parts of the country harder becaue they depend the most on public services.

Yesterday's official predictions about falling unemployment jar with the scale of the cuts ahead. It is hard to see how cuts of 25 per cent can be achieved without huge job losses. Labour is convinced the Liberal Democrats will pay a heavy price with voters, leaving the field clear for Labour to be the only "progressive" party on the market.

The Budget will not break the coalition but it will certainly test it. Most Liberal Democrat MPs will grin and bear it for now but Mr Clegg will have to watch his back in his own party, especially if he cannot deliver the prize of a reformed voting system.