Gordon's chance to clear the air on tax

We are not allowed to call it a Green Budget in case people think it is supposed to be kind to the environment, but let's welcome it all the same. One of the odd aspects of British fiscal policy has been the secrecy which has enveloped the whole process. In other countries any tax measures are widely discussed before they are enacted. Here the idea that people might avoid a new tax if they knew it was coming has supported the culture of budget secrecy - which meant that taxes had to be concocted without any discussion with the representatives of the people who would pay them.

But next Tuesday the Chancellor is - very sensibly - adapting the idea of the Green Paper, the discussion document in advance of the White Paper which sets out policy, to the budgetary process. It is particularly helpful at this time, for next spring will be his main shot: the Budget which sets out the big ideas that will characterise fiscal policy under this government. The last one was really just a tidying up operation - something to get the Government through the first year. This one will be the real thing.

Do not expect great detail on Tuesday. Instead look for clues. Here are five tests to apply, things to look for which will help us understand how the minds of these people work.

The first test is: is this a strategy for bad times as well as good? That might seem an odd way to start, but it is important to appreciate the unusually benign state of the economy at the moment. Glance at the charts, which set out this rosy picture. The borrowing requirement is running so far below last year (and much further still below the year before that) that it has to all intents and purposes disappeared. We will get a new estimate next week as part of the twice-a-year Treasury forecast, which will probably be in the pounds 6-8 billion region, but it is perfectly plausible that it could be lower still.

The reason for this is faster-than-expected growth - or rather faster than the Treasury expected, for most of the rest of us have been concerned about over-rapid growth for several months. In the middle chart you can see what has been happening to GDP growth, and to consumption, which has been driving that growth.

But unusually this rapid growth has not yet resulted in a balance of payments crisis, as occurred in all previous periods of over-rapid expansion. In fact (right-hand-graph) the current account has continued to improve right through the expansion.

This sounds wonderful. Trouble is, it won't go on. I don't know precisely how the present benign confluence will end, but I know it will. The bad news could come in many forms: a sudden dip in consumption here as the impact of the windfall gains ends; a much sharper downturn in East Asia than looks likely even now; a crisis of confidence in the European Union as unemployment continues to rise; a crash on Wall Street; or simply a surge in inflation here. The point is that neither we nor Gordon Brown should assume that the balance of news will continue to be so favourable. Any chancellorial crowing should put us on red alert.

The second test is whether the statement is sensitive to the needs of the next generation of working people. People entering the workforce at the moment are unfortunate in that they will need to save to pay for both their own retirement and pay tax to pay for the pensions of the previous generation. A pay-as-you-go system, where each generation pays for the previous generation's pensions only works if there are the same ratio of workers to pensioners in each generation. There won't be: the ratio in the 1960s was more than six workers to each pensioner, but by 2030 it will be about two-and-half.

We won't get details of the Government's ideas on pensions on Tuesday, but will get much more information in its plans for savings. Will the new individual savings accounts be in addition or instead of existing incentives to save, such as personal equity plans? Will tax incentives for personal pensions be further reduced? Somehow we will all have to be encouraged to save more and stay in the labour force for longer. The entire sustainability of the Government's fiscal policy depends on this. But will the Chancellor be honest about the harsh arithmetic? Is this really a policy for the long term?

The next test is the environment. One of the few additional sources of revenue over the next generation will be green taxes. The principle is that we should increase taxation on things that we don't want people to do, like polluting the environment, and cut taxes on things we do, like employing people. But when you apply the principle people get upset, because it means higher VAT on fuel, higher petrol prices, taxation on foreign travel and so on. If environmental taxation can be concealed so that ordinary people do not realise they are paying it (as is the case, for example, with the land-fill tax) then it is easy to introduce. But if significant revenues are to be raised, and just as important, pollution is to be discouraged, taxes have to be felt. Is the Chancellor prepared to be unpopular? You have, so to speak, to be cruel to be kind.

Test four is equity - fairness. It is one of the basic rules of a tax system that it should be fair, and nearly all tax systems are designed to appear fair. But if you look at the way taxes are actually raised, as opposed to the way they look as though they are raised, extraordinary anomalies emerge.

Take two examples. One is that the highest rates of marginal income tax are paid by the poor: as people move into jobs they lose benefit, with the result that their tax rate on each additional pound they earn is often more than 50 per cent. By contrast the top rate on earned income is only 40 per cent. The other example is in company taxation. British companies are taxed pretty normally by international standards, though they are in the bottom half of the scale. But a foreign company investing here, say a Korean one, makes no net contribution in taxation for a decade or more, such is the size of the inducements it is given. Is it fair to take money from British companies and give it to Korean ones? In other words, how do investment incentives really redistribute the cake?

Test five is transparency. Can voters see how money is being spent? One of the big changes that has taken place over the last 30 years has been the increased questioning by taxpayers of the legitimacy of taxation unless it is specifically tied to spending on things that people want. Otherwise people feel taxation disappears into a black hole.

Perhaps the most important thing that the Chancellor might be able to do is to restore the legitimacy of taxation: that money is going to buy things which people really want; that people get back what they put in. One way forward is hypothecation, tieing taxation to specific spending, a principle that the Government has already used with the windfall tax. Will it extend the principle? If so, where?

There are other tests we could apply, and we could refine those above. But I think the big message to look for is whether the tone of the message on Tuesday is the standard politics of the past: bossy, top down, arrogant, prescriptive, a sort of up-dated version of "Whitehall knows best". Or whether we are going to get something new: honest choices, proper accounting, the notion that public funds come from hard-working people giving up money they could otherwise spend for themselves. Fingers crossed.