Deficits could bring toll roads and wider VAT

THE PUBLIC SECTOR Borrowing Requirement, excluding privatisation proceeds, has moved since 1988-89 from a surplus of 1.5 per cent of GDP to a deficit of 7.5 per cent. Given the likelihood of a reasonable recovery in demand, further large public sector deficits will lead to upward pressure on interest rates and/or a widening current account deficit as the private sector saves less and invests more.

Moreover, with the other main European economies pursuing fiscal consolidation in order to meet the Maastricht guidelines, it will not be possible for the UK to re-synchronise itself with the continental mainstream without taking similar steps at home.

Considerable fiscal tightening has been built into this forecast, over and above the future tax hikes set out in the March budget. This brings the PSBR down to pounds 23bn in 1996-97, pounds 12bn less than the Treasury's own projections but still uncomfortably large. Tax increases and/or public expenditure cuts, while painful, would create room for lower interest rates alongside similar moves on the continent, and would counter-balance the rise in private sector demand.

One obvious candidate is the removal of the remaining fiscal privileges enjoyed by home-buyers. It is possible that a recovery in the whole economy could lead to rapid increases in house prices, even given the substantial changes to housing finance over the last two years. However, subsidies to owner-occupiers are now substantially less than only a few years ago. The most controversial, mortgage interest tax relief, will cost the exchequer only pounds 3.5bn in 1994-95, compared with pounds 8bn in 1990-91.

The chancellor's decision to broaden the scope of VAT to include domestic fuels has proved unpopular, but may nonetheless signal further extensions of the VAT base to categories such as transport, books and newspapers, perhaps even to food. The EC's proposals for a Europe-wide carbon tax (on firms as well as households) can be expected to resurface once the European economy returns to growth.

Another option is more privatisation. The Government might possibly go beyond its latest plans and look at its remaining assets. Where outright sales to the private sector are not feasible, the Government could look for other ways to yield a return on its prior investment. One example would be road pricing - motorway tolls, charges for movements within cities. This could be combined with joint ventures with the private sector to build more roads. Such schemes would have several advantages: they would raise revenue, reduce congestion, facilitate further road-building and create employment. Also, by raising the cost of road transport (economically justifiable in terms of social costs) such schemes will make the privatisation of British Rail more attractive.

On public expenditure, a rising proportion is devoted to social security (pensions, unemployment and child benefits) and although it would be difficult to cut the real level of many of these benefits, there is an increasing realisation across all political parties that paying such benefits to everyone is perhaps inappropriate. While any changes on this score are likely to be phased in, they would have major long-term implications for spending and the deficit.