Clarke does not need to make massive tax cuts

Sometimes economic prospects are - well, economic: dominated by great swings in growth cycles, price shocks, debt crises. Sometimes, like today, it is politics that seem to dominate the economic horizon. The United States is heading into the troubled waters of election year. Japan is struggling with the restructuring of its political economy as well as its industry, its businessmen engaged in unfamiliar Western-speak about the need for leadership. Most unsettling of all, Germany and France are rolling towards crunch point on their declared policy of currency union, driven by a fearful tangle of often-contradictory political and economic emotions.

The 1999 Maastricht deadline for economic and monetary union is now having a doubly malign influence on these countries. This date, on which all those signed up to EMU who meet the criteria must join, was shoved into the treaty at the last minute. As Jonathan Hill and I (a fly-on-the-wall at that extraordinary council) recount in our book*, the 1999 deadline was the result of a very last-minute "bounce" by the French and Italians - a classic Europloy, executed at the finance ministers' lunch at Maastricht itself.

The Germans always disliked the idea of an automatic deadline, rightly seeing it as designed to push them up against a brick wall. The British delegation was engaged in securing its own opt-out, and so was in no position to fight others' battles. The Germans gave way - something many privately came to regret, as did many Italians, when it became clear how hard they would find it to match the conditions in time. The deadline is now forcing the Germans to engage in doublespeak (notably about the Italians' economic performance), while putting an uncomfortable spotlight on core ERM exchange rates.

When political dialogue indicates that the Germans and French cannot or will not meet the deadline, the superglue in the exchange rate between them looks a bit chipped. When it suggests they will go ahead, analysts ask whether a big French devaluation wouldn't be needed first. Not that the mark is immune from speculation, since the French interpretation of a smooth path to monetary union is paved with euphemisms about easier European monetary conditions.

Thanks to its opt-out, Britain is decoupled from these strains, if not from the fall-out effects on our principal markets. But in the meantime, politics is on the domestic economic agenda, too. The switch in the Budget timetable has made heavy weather of early November for policy makers, with the legislative programme, departmental spending budgets and tax rates - the three big annual decisions of government - all to be settled in the same few frantic weeks.

Autumn Budget-making also means that the decisions the Chancellor has to finalise in the next few days will be his last big chance before the general election campaign. Next year he may still be able to affect opinion - as his predecessor did with a Budget announced only two days before the 1992 campaign started. But any changes made in the 1996 Budget will not reach pay packets before April-May 1997, when the sand will have run out of the parliamentary hour-glass.

The situation for Ken Clarke in 1995 could not be more different from what it was for his predecessor in 1991, the year before the last election. Norman Lamont had to put national taxes up sharply in the 1991 Budget - another 2.5 per cent on VAT - in order to take the heat out of the poll tax. All through 1991, the Government was pummelled by bleak economic news: national output fell over 2 per cent that year, unemployment rose by 625,000, house prices fell; the only sure sign of success was against inflation. Interest rates ended the year still in double figures. The Treasury kept on having to scale down its economic forecasts. Today the economy continues to expand, even if less than in 1994; output is 5 per cent above its previous peak, unemployment is down over 700,000 since 1992, bank base rates have been below 7 per cent for nearly three years and inflation is still moderate (look how stolidly labour markets are behaving, before you start panicking about the recent pick-up in retail prices).

Yet - and this is the frustrating paradox for the Government - through 1991 it scored well above Labour on the opinion poll measures of economic competence, while today Gallup continues to show the Labour Party in the lead even on this issue. That is the public mood Ken Clarke has to try to turn in this high-tension Budget.

The causes of that persistent feel-bad factor are not, in fact, hard to find. First, of course, the after-shock of the Government's ERM humiliation; second, the hike in taxes needed to rebalance the monetary loosening that followed Britain's exit. And third, the plain fact that economic success isn't always fun: control of wage costs is bringing British industry a new edge in world markets, but not a lot of joy to those whose pay-packets are barely keeping pace with inflation. The need for them to enjoy a bigger share in the benefits of economic growth, without squeezing it out of their wealth-creating companies, is the strategic reason why the Chancellor should seek to cut their tax burden in this Budget.

Budgets are always a three-card trick, and even more so now the Chancellor has to play them all together in one autumn Budget. He has to deliver more tax cuts than expected by the public, a lower public sector borrowing requirement than feared by the City, and all without raising the political noise to revolt-level by his treatment of public services. It was an easy trick to play in the late 1980s, when government revenues were soaring with an overheated economy: the Chancellor could simply stand at the door of the Treasury handing used fivers back to the taxpayer. It is much less easy today when slower growth delays the decline in public borrowing and revenues anyway continue to fall short of forecasts. But it is not impossible. The Micawber principle tells us that quite small changes can have big effects, and it has been some time since a Budget has been a positive rather than a negative event in people's lives.

Politically and economically, a good Budget is one that makes only a few strategic changes, following declared intentions, rather than sprinkling little bits of taxpayers' money across the waterfront. Politically and economically, that argues for doing what the Tories have said they believe in: bring down personal taxes, on income and saving.

Consistency is not just a virtue, it is a powerful tool. The simpler the Budget, the better. Provided the money is well targeted, the Chancellor does not need massive tax cuts to get his message across. After all, the 1992 Budget made a lot of noise with tax cuts totalling just over pounds 2bn that year because it concentrated on cutting the initial rate at which income tax is paid. Even in the darkest days of the 1993 and 1994 Budgets, the Government managed to keep down income tax rates and widen the 20p band; now, when the headlines are not pre-empted by tax increases elsewhere, is the time to follow through.

Admittedly, the impact of the 1992 Budget was magnified by the late John Smith's Shadow Budget, which threatened not only to reverse the Government's tax cuts but to add tax increases of Labour's own. But if Tony Blair's Labour Party has learnt not to repeat that trick, the unified Budget presents him with a different problem. His Shadow Cabinet team will be itching to attack every public spending cut announced by Ken Clarke. Tory pens will be poised to note down every rash comment-come-promise, and present Labour with the bill. The election battle of the budgets is about to begin.

Sarah Hogg is a Director of London Economics.

*Too Close to Call, by Sarah Hogg and Jonathan Hill (Little Brown, pounds l7.50).