Brown premiership 'faces economic pincer movement'

Gordon Brown would have to fight his first general election against a background of slower public spending growth and the threat of tax increases, the Institute for Fiscal Studies warned yesterday.

The economic pincer movement may begin immediately as the Chancellor works to ensure he hits his golden rule on the public finances over the economic cycle that ends in March, it said.

The IFS also revealed that the vast majority of the package of money for education had already been announced in the March Budget.

In its response to Wednesday's pre-Budget report, the IFS said the Government was forecasting that real growth in public spending would slow to 1.9 per cent a year between 2008 and 2012, less than half the average since 2000. "This suggests Mr Brown is ready to fight the next election presiding over a steady fall in public spending as a share of national income," said Robert Chote, its director.

Other economists agreed. Michael Saunders, senior economist at Citigroup investment bank, asked: "How can Labour achieve their social and political aims while sticking with the fiscal projections, which indicate a sharp slowdown in real public spending growth in the next few years?"

The Chancellor used the PBR to announce £7bn of tax rises and £7bn extra borrowing despite saying he believed the economy was capable of higher growth rates than had first been thought.

The IFS said this pointed to a greater structural - rather than cyclical - deficit, which would require tougher action to remove. Mr Chote said: "The gods of fiscal misfortune have returned for Mr Brown to demand another sacrifice."

Mr Chote said the Treasury was now looking at a surplus on current spending of 0.6 per cent of GDP by 2011 rather than the 0.8 per cent it had forecast in March's Budget. "This will require increases in tax of an equivalent of £9bn in today's money combined with cuts of public spending equivalent to the same amount," he said.

Next summer the Government will publish a Comprehensive Spending Review to set departmental spending limits between 2008 and 2011.

On Wednesday Mr Brown announced a 5 per cent real-terms cut in the budgets of nine small departments and 3.5 per cent cut for the Department of Constitutional Affairs.

Carl Emmerson, the IFS's deputy director, said assuming a real-terms freeze for other major departments and a 4.4 per cent increase for the NHS, in line with the Wanless Review, this would constrain the education budget to annual growth of just 2.0 per cent. Even capping the NHS to 3.1 per cent annual growth, in line with the average of the 18 years of Conservative rule, would limit education to just 3.8 per cent annual growth. "This looks like a tough decision for the Chancellor between the two departments," he said. "The third way would be to allocate the money and then top it up in future years."

He said this was done in previous CSRs as the economy turned out better than expected. However, given the growth forecasts were already optimistic, any extra money would have to come from further tax rises. The IFS added the change in the timing of the economic cycle meant there were just five months until the Treasury had to say whether it met its golden rule to borrow only to invest over the cycle.

Christine Frayne, its senior research economist, said spending growth between now and March would have to post its smallest increase since 1998 to ensure Mr Brown hit his target.

The IFS report also showed the impact of PBR measures were neither as "green" nor as supportive of education as the Chancellor had made out. It said that of the £36bn of capital investment in education only £2.2bn for universities, colleges and early learning centres over the next four years was new. It added that £180 of the £200 of extra cash per state school pupil was also a reannouncement.

Meanwhile, the decision to raise petrol duty in line with inflation had followed six years of falls in green taxes as a share of GDP. Even after the decision, real levels of fuel duty are 16 per cent below their 1999 peak.

George Osborne, the Shadow Chancellor, said: "Gordon Brown's pre-Budget report is unravelling just a day after it was delivered. It turns out Gordon Brown raised the expectations of parents in his speech and then cruelly dashed them in the small print. He has taken from Tony Blair the title of 'master of spin'."