Brown's black hole needs a £10bn tax hike

Gordon Brown may have to raise taxes by at least £10bn and possibly as much as £15bn to fill a black hole in his financial plans.

That is the stark warning carried in a study published tomorrow by the Ernst & Young Item Club, the authoritative forecasting body that uses the Treasury's own economic models.

The Item Club believes that the UK economy will fail to grow by 2 to 2.5 per cent this year and 3 to 3.5 per cent next, as predicted by the Chancellor in this month's Budget. The Item Club's projection of 1.9 per cent growth followed by 2.6 per cent will not only embarrass Mr Brown but blow a massive hole in his finances.

The Item club reckons that he will have to raise taxes by £10bn if he is to avoid running up excessive government debt. This would be the equivalent of £170 in extra tax for every person in the UK.

But Professor Peter Spencer, the Item Club's economic adviser, warned that even this nightmare scenario may be too optimistic. He pointed to figures just released that show the UK economy grew by just 0.2 per cent in the first three months of this year and that average earnings are increasing by just 3 per cent.

"The Chancellor has set himself up for a bad profit warning in October, when he publishes his Autumn Statement," said Professor Spencer. "If anything, the situation is rather worse that even we have predicted."

Professor Spencer pointed out that the Treasury is expecting income tax receipts of £122.1bn this year, an increase of 7.7 per cent. The Item Club estimates are more conservative, predicting £120.5bn.

However, if income tax receipts increase by the same amount as earnings, the Treasury will only get £116.7bn, a £5.4bn shortfall from its estimates. This would imply the Chancellor might have to raise taxes by up to £15bn.

"The Treasury is gambling that there will be a big recovery in City bonuses this year to make up the income tax shortfall, but if anything they could be lower," said Professor Spencer.

It was the Item Club which, a year ago, first warned that the Treasury growth forecasts of 2 to 2.5 per cent for last year carried in the Chancellor's 2002 Budget were wildly optimistic. Mr Brown was forced to admit to this in the Autumn Statement in October, when he reined the forecasts back. In the end the economy grew by just 1.8 per cent.

The Chancellor has already had one knock to his forecasts when the Office for National Statistics warned that public sector borrowing was £1bn higher than the Treasury had said. The Treasury reacted angrily, saying the ONS had got its sums wrong.

However, Professor Spencer backed the ONS, saying that in all his time as a forecaster he had never seen the ONS forced to revise its borrowing figures.

The Item Club is predicting further falls in interest rates. Many expect the Bank of England's Monetary Policy Committee to cut rates next month, though a warning last week by the world economy body, the OECD, about rising inflation in the UK might persuade the MPC to wait.