Rising deficit endangers Brown's 'golden rule'

Public borrowing is set to balloon over the next few years, Gordon Brown admitted yesterday, triggering speculation of further tax increases to prevent a "black hole" emerging in the public finances.

Tumbling tax receipts and a surge in spending have forced the Chancellor to raise his forecasts for the government deficit for the third budget in succession.

The massive increase in the deficit puts him perilously close to breaking his "golden rule" - to balance the books over the economic cycle - which would force him to raise taxes. The Government will now borrow an additional £34bn over the next five years on top of the £47bn extra cumulative borrowing he announced in this year's Budget and in the pre-Budget report a year ago.

But even his new forecasts were several billions less than the City had forecast and speculation mounted that Mr Brown will have to raise taxes to meet commitments on public spending.

In his Commons statement, Mr Brown rushed through his new forecasts, knowing that opposition parties would seize on signs of weakening public finances. But he defended the deficits, saying they were "substantially below" the average of the G7 nations and half the level of the United States.

Mr Brown insisted his plans kept him within his two fiscal rules. The golden rule is that the budget must balance over the economic cycle, and the sustainability rule says debt should not exceed 40 per cent of GDP.

While he passes the sustainability rule, the golden rule will trigger huge debate among analysts and opposition politicians. Whereas the Budget said that the current budget was "comfortably positive" by a margin of least 0.5 per cent of GDP, the PBR admits the margin is just 0.2 per cent.

"We not only meet the golden rule, but even on cautious assumptions we have an average annual surplus over the whole cycle of around 0.2 per cent of GDP - meeting our first rule in this cycle by a margin of £14bn," the Chancellor said.

The report showed that public sector net borrowing (PSNB) for the tax year ending next April would come in at £37bn rather than the Budget's £27bn forecast. Going forward, the PSNB, with Budget forecasts in brackets, rises to £31bn (£24bn) next year, £30bn (£23bn) in 2005-06, £27bn the following year (£22bn) and £27bn (£22bn) for 2007-08.

The revisions put the Treasury much closer to the gloomy forecasts that the major City banks have been producing for several months. The Treasury's own survey published last month showed the average prediction is for £33.4bn this year and £35.2bn in the following fiscal period.

John Hawksworth, head of macroeconomics at accountancy firm PricewaterhouseCoopers, said the chances of hitting the golden rules were "hanging in the balance".

"If the Chancellor is to retain credibility with the financial markets, he is unlikely to be able to avoid taking tough decisions on tax and spending at some point," he said.

He warned that tax rises of up to £15bn - equivalent to 5p on income tax - would be needed unless the Chancellor clamped down on spending when he announces his three-year review next summer.

David Walton at Goldman Sachs said he believed the Chancellor would come closer to breaking the golden rule than he has hitherto admitted - forecasting a wafer-thin surplus of 0.1 per cent of GDP by the end of the cycle - but had some comfort for Mr Brown. "Our projections are more pessimistic than the Treasury's but we do not share the widely held view that there is a black hole in the public finances," he said.

Most economists believe any increases in taxes will come the other side of a likely general election in 2005. "He will be able to get away with avoiding tax rises this side of the election," said Ross Walker, an economist at Royal Bank of Scotland.

Anti-euro campaigners immediately seized on the fact that, as a share of GDP, this year's deficit is set to exceed the limit of 3 per cent set by the eurozone's stability pact, hitting 3.4 per cent. "This reaffirms Treasury fears that in the euro we would need to choose between investing in public services or trying to fit into a straitjacket," said a spokesman for the No Campaign.

The Treasury blamed a shortfall in tax revenues compared with its Budget assumption. Receipts are growing by only 5.4 per cent, some 2.5 per cent below Budget forecasts.

In addition, departmental spending was running above budgeted levels during the first seven months of 2003-4. Spending has been running 12 per cent higher than last year rather than the 6.5 per cent forecast in the Budget.

Going forward, the Treasury now expects income tax receipts to come in more than £3bn lower than it had predicted in the Budget in both the current fiscal year and in the one that begins in April. Corporation tax revenues have been cut by a total of £3.6bn over the next two years, although some of this is offset by an unexpected rise in VAT receipts and the 30 per cent surge on the stock market since the Budget.

Revisions were inevitable after the running monthly total for public borrowing showed that by October the deficit had risen to a total of £21.1bn.

In other words, with only a little over half the year gone, the deficit was well on the way to hitting the target for the year, leaving Mr Brown little choice but to concede that it will be higher than expected.