Critics sure Brown's sums don't add up

Chancellor's forecasts on growth, investment, exports and consumer demand questioned

Is Gordon Brown's Budget about to come apart at the seams? As the Chancellor surfed the airwaves yesterday to declare that his optimistic forecasts for economic growth and the public finances were cautious and prudent, critics said the sums did not add up.

The Chancellor was eager to rebut accusations of gambling with the British economy. "I don't think people think of me as a gambler," he told GMTV.

The Institute for Fiscal Studies (IFS) did not stoop so low as to accuse Mr Brown of being a chancer but it was clear yesterday the respected tax and policy think-tank was concerned. Robert Chote, its director, said the Government would eventually have to hike taxes by £11bn – equivalent to 3p on the basic rate of income tax – to bring the Budget back into long-term health.

"The Chancellor may be right," he said. "But if he is not, then every Budget that goes by without a return to the degree of caution that he has made in the past makes the eventual adjustment ever more painful."

There are a number of areas that are troubling economists.

Economic growth

The first and most obvious is the strength of the economic recovery that the Treasury is now forecasting. Mr Brown admitted on Wednesday the economy would only grow by between 2 and 2.5 per cent. The average forecast in the City of London is for growth of 1.9 per cent with some economists forecasting disaster scenarios such as a 0.4 per cent contraction.

But the biggest worry is over 2004 and 2005, where the Chancellor has pencilled in growth of between 3 and 3.5 per cent in both years – well above the estimate of long-term trend growth of 2.75 per cent.

John O'Sullivan, UK economist at Dresdner Kleinwort Wasserstein is one of many to be taken aback by the degree of optimism. "From today's gloomy perspective, it is hard to imagine GDP growth of 3 to 3.5 per cent any time soon. The global and UK recovery is likely to be a more drawn-out and sluggish affair than the Treasury expects or hopes," he said.

These are key assumptions by the Chancellor as convention allows the Treasury to take the bottom of the range as the figure on which to base tax receipts. The IFS says a 1 percentage point fall in growth would add 0.7 per cent to the Budget deficit.

Mr O'Sullivan said: "The message is that if there is a problem about public finances, we'll worry about it later.".

The Treasury insisted that its forecasts were prudent. A spokesman said: "The big difference between 2003 and 2004 where we have the acceleration is with business investment coming back and an improvement in the net trade position."

Investment

The collapse in business investment has been one of the most serious impacts of the global slowdown. According to the Confederation of British Industry, business spending on equipment, training and R&D plunged 12.7 per cent – or some £15bn – during 2001 and 2002.

The Treasury believes that after two years of falls businesses will expand their investment budgets by about 5 per cent next year and in 2005. This acts as a positive driver to overall growth, adding 0.5 per cent next year and 0.75 per cent in 2005 However, investment is linked to companies' rates of returns, which are currently close to decade-long lows. Current share prices, which are based on future rates of return, are pointing to only a meagre profits recovery.

Phil Shaw, chief UK economist at Investec, said: "Fixed investment must rise very sharply to compensate for this slowing. Other than 1997 and 1998, these are rates of investment growth that have not been seen since 1989."

But the Budget document is forthright. "As the global recovery gathers further momentum into 2004, and international uncertainties recede, postponed investment projects are expected to come back on stream as the outlook for demand improves."

Exports

But will the global economy come to Mr Brown's aid? The Treasury is forecasting a massive rebound in export growth from the 2 per cent fall in 2002. It expects 8.5 per cent next year and 7.25 per cent in 2005.

The Budget "Red Book" said: "Exports are expected to strengthen considerably as the global recovery becomes more firmly entrenched and as the effects of ... the recent weakening of sterling feed through." In fact this would be close to the peak of export growth achieved in 200 when world trade enjoyed a massive 12.6 per cent growth.

The National Institute of Economic and Social Research is forecasting a 6.9 per cent growth of world trade – slightly more than half that peak level.

Simon Rubinsohn, chief economist at City stockbrokers Gerrard, said: "The 8 to 8.5 per cent rise in export volumes is asking a lot."

Consumer

One risk for the Treasury is that a massive slump in the pound would hit UK consumers as the prices of imported goods, which we are still being sucked in at a strong rate, shot up. The Treasury has assumed that consumer spending will moderate but at very gentle pace – from 3.75 per cent now it will be about 2.75 per cent in 2005 with no massive slump in the middle.

However, recent reports showed that retail sales growth has fallen to its lowest level for four years or even a decade, depending on the survey. Asking prices for houses are being cut across the South-east of England and some analysts are forecasting a price crash. One of those is Roger Bootle, economic adviser to Deloitte & Touche, who said Mr Brown was banking on consumer spending continuing to "grow at heady rates", adding that this was "unlikely".

Tax receipts

So where does this leave tax receipts. In his Budget the Chancellor slashed his forecasts for this year by £14bn. However, looking forward (as the table shows) by 2005 he believes receipts will be back at the level he expected before the global slowdown forced him to revise his forecasts.

The IFS said the Treasury was banking on a revival in the profits made by financial companies. In fact the table shows that the Treasury expects them to be contributing £5bn more in 2005 than they will this year.

Mr Chote said the Chancellor was effectively betting that firms in the City of London would swiftly return to the exuberant health they enjoyed at the peak of what the world now knows was a share price bubble. For this to be true Mr Chote said corporation tax revenues – which fell 9 per cent in the 11 months to February – must get back to 3.4 per cent of GDP.

"It has only got to those levels three times in the last 15 years. Unless you think that the economy is going to zoom or head back towards an M&A boom then 3.4 per cent does not look like the most cautious assumption you could make."

Revenue protection

But the real potential magpie lurking in these figures is an assumption extra enforcement by the Inland Revenue and Customs & Excise will net £4bn a year – or 0.4 per cent of GDP – by 2005. The Government is spending £66m over three years to tighten up collection of income tax and national insurance, which it believes will raise £1.6bn. It says new laws on VAT avoidance and fraud will net it £2bn a year within three years.

The Treasury said it had actually accounted for less of the benefits that it believed the moves would reap and said the independent National Audit Office had approved the package.

But Mr Chote said that section of its report had "more caveats" than any other. At one point the NAO says there are "uncertainties and judgements" underling the tax collection assumptions.

Edward Troup, head of tax at City law firm Simmons & Simmons and a former special adviser to ex-Chancellor Kenneth Clarke, sad he was "highly sceptical" the Government would hit these targets.