Memo to Brown: don't do too much in March

News Analysis: IFS Green Budget points to pitfalls ahead

WHEN Gordon Brown delivered his pre-Budget statement back in November, it was widely seen as strong on rhetoric but short on substance. There were plenty of persuasive words about the need to boost productivity and "steer a course of stability" for the UK economy, but a perceived lack of detail about exactly how these aims would be achieved.

In March, when the Chancellor opens his Budget box, business and the City will be waiting to see if he can translate words into action. What precisely is the Chancellor likely to do, and how sensible are his plans?

Yesterday the Institute for Fiscal Studies (IFS) released its annual assessment of what is likely to be - and what should be - in the Chancellor's Budget. The so-called Green Budget - probably the most authoritative of any of the pre-Budget submissions - raises important questions about many of November's proposals. It also contains an extensive assessment of the UK's economic prospects, which are not as rosy as the Treasury would have us believe.

According to the Green Budget - produced in collaboration with Goldman Sachs - the UK economy will "flirt with recession" in 1999. The economy is predicted to grow by just 0.4 per cent - substantially less than the 1 to 1.5 per cent forecast by the Chancellor in November. "Many of the characteristic early features of past recessionary episodes are now apparent," the IFS warned.

Over the medium term, however, things look a little less bleak. Like the Chancellor, the IFS believes the economy will bounce back sharply towards the end of the year, thanks to a combination of looser fiscal policy and lower interest rates.

What does this mean for the public finances? In November, the Chancellor insisted that his two fiscal rules - only borrow to invest, and keep the debt-to-GDP ratio at a "stable and prudent" level - would be met.

Despite the gloomy outlook for growth, the IFS believes the Chancellor will meet his rules, but only just. Any unexpected downturn in the economy, no matter how slight, could knock the public finances off course. The implication is that there is little scope for further loosening fiscal policy. "The Chancellor should essentially do nothing to change the overall tax burden," said David Walton of Goldman Sachs, a co-author of the Green Budget.

This does not, of course, preclude the Chancellor from shifting the balance of the tax burden from one part of society to another. So Labour's long- standing promise of a 10p starting rate of tax could still become a reality - it would simply be financed by raising taxes elsewhere rather than hiking borrowing.

Although the 10p tax rate may still be feasible, it is not necessarily desirable, says the IFS. The Green Budget argues that the 10p tax rate would neither promote employment - which is primarily influenced by the structure of the benefit system - nor help those on very low incomes who pay no tax at all. Far better would be to replace the 10p promise with a commitment to raise tax allowances.

Where does the IFS stand on the centrepiece of Mr Brown's pre-Budget statement: meeting the UK's "productivity challenge"? In November the Chancellor outlined a range of measures designed to close the UK productivity gap. Experts at the IFS, however, have doubts both about the scale of the problem and the effectiveness of Mr Brown's proposals.

According to the IFS's Rachel Griffith, the factors most likely to influence UK productivity - education, training and regulation - lie outside the Chancellor's control. What's more, the measures Mr Brown has proposed are almost exclusively focused on smaller firms. As the bulk of research and development and capital investment is undertaken by larger firms, the Chancellor's initiatives are unlikely to impact on overall levels of R&D and capital expenditure. Specific tax incentives also run the risk of introducing undesirable distortions into the market place and encouraging tax avoidance.

Proposed environmental taxes, by contrast, were broadly welcomed by the IFS. In November, Lord Marshall, the British Airways chairman, published the results of an extensive study of environmental taxes, and came out in favour of an energy tax for industry. Mr Brown is generally expected to follow Lord Marshall's recommendations, a move which could be "highly effective", according to IFS experts.

A tax based on the carbon content of fossil fuels, for example, would be simple to apply and well-targeted, the IFS believes. The main difficulty with an industry energy tax - that it undermines UK competitiveness by raising business costs - could be solved by reducing business taxes in other areas.

The main message from the Green Budget seems to be that in many areas Mr Brown would be best advised to do nothing. Any alteration of the overall tax burden could jeopardise the fiscal rules, while specific tax breaks designed to boost productivity could introduce unwanted distortions.

The implication is that if the Chancellor's Budget in March follows the tone of his pre-Budget statement - strong on rhetoric, short on substance - it may be no bad thing.