City fears tax cuts will hit capital spending

TAX CUTS are a racing certainty in next week's Budget. But industry fears that they will come at the expense of capital spending, and there are worries in the City that they will be justified by bogus spending cuts.

An expansion in the Private Finance Initiative, under which public investment projects are privately financed, is expected to camouflage an axeing of capital expenditure next year. This would be on top of the 7 per cent cut projected in the last Budget.

Capital projects could be sliced by as much as pounds 2bn fears Douglas McWilliams of the Centre for Economics and Business Research. The roads programme would be the main victim, but further savings would be made in public transport investment and housing, hitting the troubled construction sector hard.

Mr McWilliams also warned that a scaling back in the roads programme would eventually lead to huge congestion costs. These "could build up over time to about one and a half times that of a 1p cut in income tax".

The City is concerned that Mr Clarke will announce unrealistic overall expenditure curbs. The betting is that the Chancellor will cut the contingency reserve from pounds 6bn to pounds 3bn. In addition, he may be able to push forward an underrun in expenditure this year of about pounds 1bn. A squeeze on Whitehall running costs could cut spending by a further pounds 750m.

Local government spending will also be squeezed to the bone, warns Tony Travers, an expert on local government at the London School of Economics.

Some of these savings will go on big increases in health and education. Gillian Shephard has apparently won an extra pounds 800m for schools. But even with these boosts to spending, Mr Clarke could still end up cutting the "control total", a key measure of expenditure, by up to pounds 6bn. This would allow him to cut taxes by as much as pounds 5bn and still claim that he was taking no risks with the public finances.

"The acid test is the Public Sector Borrowing Requirement," says Bill Martin, chief economist at UBS. "In effect, the tax cuts will be financed by higher borrowing." Mr Martin argues that the Chancellor's spending cuts will be reductions in expenditure in 1996/7 from the amount planned at the time of the last Budget. By that token, borrowing, too, should fall from the pounds 13bn forecast for 1996/7 a year ago. Yet the Treasury lifted that forecast to pounds 16bn in June and is expected to raise it further next week.

Some pounds 3bn of the spending cuts will essentially be adjusting cash totals for the fact that inflation has been lower than the Treasury expected last year. The rest are needed to compensate for the fact that economic growth is no longer generating as much tax revenue as in the past.

One coup Mr Clarke may be able to announce is an additional pounds 2bn proceeds from privatisation next year.

He is expected to sell off the Housing Corporation's loan book for about pounds 1bn, and there is pounds 1bn of privatised utilities debt that could be sold.