Economic truths: Time to reach into the war chest - Tax payers, businesses, and consumers of health, education and transport services will soon benefit from the Government's giveaway phase

Economic truths: Time to reach into the war chest - Tax payers, businesses, and consumers of health, education and transport services will soon benefit from the Government's giveaway phase - For the past few months, a strange little ritual has been taking

Last Updated: 31 Aug 2010

For the past few months, a strange little ritual has been taking place. Every time figures appear which suggest the public finances are getting healthier, the Treasury finds a new reason for treating the figures cautiously.

Suggestions that the chancellor is building up a 'war chest' for a grand pre-election giveaway are dismissed with Lady Windermere-like disdain.

Getting the public finances into good shape only to fritter them away is, according to New Labour orthodoxy, the kind of late '80s Tory thinking that gave us boom then spectacular bust, and a near pounds 50 billion budget deficit in the early 1990s.

For those of us who have seen too many governments, not least the last Labour one, getting into serious budgetary difficulties, this is very welcome. The fact that, in launching his pre-budget report in the House of Commons last November, Gordon Brown announced a cumulative pounds 28 billion improvement in the public finances alongside one small spending 'lollipop' - free TV licences for the over-75s - was little short of astonishing.

Treasury officials have few qualms about urging caution on their political masters. They know the budget deficit or surplus is the difference between two very large numbers - public spending and taxation - and the scope for error is huge.

There are also genuine worries about the long-term erosion of the tax base. The exchequer is already losing up to pounds 2 billion a year from cigarette and alcohol smuggling. There is also concern here and elsewhere about how to protect revenues in the era of e-commerce.

None of this disguises the fact, however, that the public finances are extraordinarily healthy. Even on the chancellor's conservative assumptions, current budget surpluses will average more than pounds 10 billion a year over the next five years.

The sources of this improvement, incidentally, are threefold. The first, and most significant so far, was the decision to stick with (and in fact undershoot) the Tories' tight public spending plans during Labour's first two years in office. This improved the public finances by the equivalent of 2% of GDP, or pounds 17 billion. Second, Labour inherited some tax increases from the Tories, such as the over-indexation of tobacco and road fuel, and added its own, notably the abolition of the dividend tax credit and mortgage tax relief.

And third, the fact that the economy has performed better than the Treasury expected has maintained tax revenues and held down the unemployment-related elements of social security spending.

I also think that, between them, Treasury officials and the Brown entourage deliberately overstated the extent of the public borrowing problem Labour inherited. That budget deficit was well on its way to elimination as a result of the actions the Tories had taken. Brown could have got away with hardly raising taxes at all.

Why, having got into this position, should the chancellor not ride out the political pressure to show some pre-election largesse, in line with the stern advice of the International Monetary Fund? After all, it would appear that Labour does not need a giveaway to secure a large parliamentary majority for its second term.

This Government does not, however, like to take risks. One of the Labour party's folk memories is of Roy Jenkins, now Lord Jenkins of Hillhead, who on some interpretations (not his own) lost the 1970 election as a result of his over-orthodox stewardship of the public finances after the 1967 devaluation.

A charge the prime minister and chancellor have found difficult to shrug off is that the tax burden has risen significantly under Labour. Given that the Tories raised taxes sharply in the 1993 to '95 period this should not have been a political problem. But it is, and the Government will want to offer a clearer demonstration that it is a tax-cutting party. As for public spending, voters' demands for more for health, education and transport can never be satisfied, but it is clear that Labour's additional spending in these areas is coming nowhere near doing so.

That is why I expect to see the chancellor reaching into the war chest twice this year. The first will be in the March budget. The basic rate of income tax is already due to come down from 23% to 22% in April. Given that a 20% basic rate is a political totem, not least for the Tories, I would expect Brown to signal a further move towards it. In addition, having cut corporation tax while increasing overall business taxes significantly, the chancellor will also want to do more to ensure that he keeps business on board.

The second piece of largesse will come in July, when the Government announces its spending plans for the next three years. Demands in this area are never satisfied, but expect some increases for health, education and public transport.

Will all this mean Brown is falling into the trap of his predecessors?

I think not. This Government's strategy of austerity first, giveaway later, represents a break with the past. And come the expected election victory, the return to fiscal discipline will be rapid.

David Smith is economics editor of the Sunday Times.

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