Clarke could slash tax by 3p

The Chancellor could deliver a much bigger tax bonanza in next Tuesday's Budget than expected, according to City experts. Some are predicting up to 3 pence off the basic rate of income tax, with a giveaway worth as much as pounds 6bn rather than the prudent pounds 2bn- 3bn they previously anticipated.

Treasury officials were concerned earlier in the week that spectacularly good figures for government spending and revenues in October would increase the political pressure for tax cuts larger than the state of the economy justifies.

Steven Bell, chief economist at investment bank Deutsche Morgan Grenfell, said: "If the Chancellor can now keep the financial markets happy by forecasting lower government borrowing, and reduce taxes by pounds 4bn or pounds 5bn, there is no earthly reason he will not do it ahead of the election."

A tax-cutting budget would provide the tonic the Government desperately needs to lift the shaken morale of Tory backbenchers, who were threatening renewed rebellion over Europe. But senior party figures cautioned against an over-generous giveaway, which could turn sour if it led to inflation and increased interest rates before the election. "There have been a series of warnings on monetary aggregates and the increasing buoyancy of the housing market which should be heeded by the Chancellor," said one former Cabinet minister.

A ministerial source said the Chancellor was likely to concentrate on reducing the increasing debt burden, which had worried the City. But party sources are expecting a "inventive" budget by the Chancellor, an astute politician, who recognises it could be the Tories' last throw of the dice before the election.

The City economists calculate that better-than-forecast growth in tax revenues this year will last, giving the Government an extra pounds 6-8bn to split between bigger reductions in tax and a lower forecast for the public- sector borrowing requirement, without having to cut spending plans very much.

"He will be able to achieve all three things simultaneously," said Adam Cole, an economist at brokers James Capel.

The City's earlier calculations that the Budget would have to be very tight this year were based on ultra-cautious Treasury forecasts for tax revenues. In its summer forecast, the Treasury revised down expected revenues and revised up expected borrowing because of last year's "missing millions" in VAT and corporation tax receipts.

However, those missing revenues reappeared in October. Figures published on Monday showed a surge in taxes.

According to Mr Cole, if revenues kept up the same pace for the rest of this financial year, government borrowing could end up more than pounds 5bn under its pounds 27bn target.

Kevin Darlington at brokers Hoare Govett said Mr Clarke could credibly have an extra pounds 6bn next financial year, all of it available for tax cuts if he stuck to the same borrowing forecast as before. That would allow for 3 pence off the basic rate of income tax, although he thought a combination of smaller tax cuts and reduced borrowing more likely.

Most analysts had, until this week, been predicting that the Chancellor could trim at most pounds 2-3bn off taxes.

None of the City experts think that he should put more money in consumers' pockets, however. All put the unexpected upturn in the state of the Government's books down to the strong pick-up in spending, and argue that it should be used to get the public finances into better shape.

"The worst decision that can be taken at this stage of the cycle is to allow consumers to share in the benefits of an unexpectedly large reduction in the budget deficit," said Mr Jeffrey. That had been Nigel Lawson's mistake in the late 1980s, he said.