LETTER : Whoever wins, taxes will have to go up

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Sir: Gavyn Davies (28 April) is normally such a level-headed commentator that it is disappointing to find him indulging in wishful thinking. But his argument that taxes will not need to rise after the election really does not pass muster.

Mr Davies says, and it is hard to disagree, that it is very hard to imagine a Labour chancellor sticking to the very low planned growth figures for public spending. He then argues that this is not really a problem because the Government is assuming that the public finances would go into a budget surplus of 2 per cent of GDP in 2001-2, the last year of the next parliament. If the new chancellor set a budget deficit of 1 per cent of GDP - which would meet the "golden rule" of public finance whereby the Government should only borrow for capital investment - then he would be able to add 3 per cent of GDP to public spending, or some pounds 27bn. And if this is spread over five years, the growth rate of spending can go up to 2 per cent.

There are two problems with this argument. The first is that the Government has probably been over-optimistic about its revenue projections, because it has assumed that the economy will continue to grow at 2.5 per cent a year. A more realistic long-run growth path would probably be 2.2 per cent. So there will be less tax revenue than projected, even if the recent holes in VAT and excises are plugged.

The second problem is that the extra spending can only be spread over five years if borrowing is higher in the early years than is currently planned. This is not sensible, since the economy is already showing signs of overheating (with pay pressures rising, for example). A more relaxed fiscal stance would risk raising interest rates compared with what they would otherwise be. It would also risk raising the exchange rate, which is already more than 16 per cent higher than it was at the end of 1995, and is hurting many exporters. Such a dose of "Reaganomics" would impose a cost in terms of our long-run growth prospects.

There is only one option which will deliver both credible spending plans and a better-balanced recovery which does not hit the tradeable sector, and that is to finance extra public spending through higher taxes rather than more borrowing.


Economics Director, IBCA Ltd

London EC2