Timing is key to Lamont's last chance

THE ODDS are that Tuesday's Budget is not going to take much out of the economy, but that does not mean that Norman Lamont will be boring. All chancellors have the happy capacity to shuffle the fiscal furniture, producing gasps of pain and pleasure from their audience. This year, the results could be dramatic.

But first the overall balance of taxes and spending. The reason for ignoring the advice of Tim Congdon, the seventh wise squabbler, is simply that raising taxes or cutting spending now would imperil any recovery. The sharp fall in interest rates and sterling are producing green shoots. But they are not yet more established than in the autumn of 1991.

At that time, both the CBI industrial trends survey and the Gallup consumer confidence survey had been improving sharply. Manufacturing output appeared to have hit a floor in April and May, and rose by 0.3 per cent comparing the three months ending in July with the previous three. On the same basis, retail sales volume was up 0.1 per cent.

Together with other indicators, this was enough to persuade the Treasury to write in November: 'The balance of evidence suggests that GDP . . . stabilised during the summer and may since have been rising.'

My point is not to rub the Treasury's nose in it, since I am in no position to do so. I thought the economy had stabilised too. My point is that we have been through periods during this recession just like the present one: the data appear to be turning, and then the evidence of recovery vanishes like a morning mist.

Four short-term indicators are currently better than they were in the summer of 1991: car sales are rising; the growth of cash in the economy is up; retail sales volume growth is marginally stronger at 0.2 per cent comparing the latest three months with the previous three; and the CBI trends survey is more positive.

But three indicators are still worse than they were then: manufacturing output has fallen by 0.2 per cent taking the last three months on the previous three; the EC Gallup index of consumer confidence shows a balance of minus-18 compared with minus-10 in October 1991, and bank accounts (and thus M4) are growing less strongly.

The interpretation of these mixed signals is all the more difficult because the Thatcher-Lawson boom has destroyed parallels with past recoveries. The debt burden of both people and corporations is unprecedentedly high. Unlike previous post- war recoveries, house prices are falling, reducing the value of most people's biggest asset. As a result, the security on many business loans is shrinking, raising questions about whether the banks will fund the working capital needed for an upturn. NatWest has reported that nearly half of its pounds 1.23bn provisions on branch banking business are on loans of less than pounds 50,000.

Precisely because there is no past experience to guide us, the only honest economist is the two-handed one: on the one hand, on the other. And policy-makers should be guided by the balance of risks. Are the risks of a sharp rise in inflation really greater than those of renewed stagnation? The movement in the consensus forecasts, shown in the graph, suggests otherwise.

The machismo of bond analysts who want immediate tax increases is all the more extraordinary given the performance of their market. If there is a crisis looming because of the scale of the Government's borrowing, why are the markets lapping up gilt-edged stock? The yields on long-term gilts (ie their fixed interest rate expressed as a percentage of the market value) fall when gilts are popular. They are now at their lowest level for more than 20 years.

All of which suggests that Mr Lamont should not radically alter the balance of taxation and spending in 1993-4, but he can still make a splash. Indeed, he has every interest in doing so. The Government needs to bolster confidence, and the maligned Mr Lamont also needs a success. This is either his last Budget or it is his last chance to ensure that it is not his last Budget.

My information is that the Chancellor seriously considered, before the Autumn Statement, a sharp rise in National Insurance contributions. If so, he may be doing so again.

The idea was to raise both employees' and employers' National Insurance contributions by 1 per cent, and to impose just the 1 percentage point increase even on incomes above the employees' ceiling ( pounds 420 per week in 1993-4). This was to be presented as a first step towards sorting out the anomalies which exist between our two income taxes: NICs and the better-known one. It would raise about pounds 4.5bn a year.

It may be that the good news on inflation has persuaded the Chancellor to turn his attention to VAT instead. An extension of the VAT base with a low 5 per cent rate on newspapers, fuel and food would add about 1 per cent to prices and would raise pounds 3.4bn, according to the Institute for Fiscal Studies' calculations. The net gain might be a little less after a rise in benefits to protect the less well- off.

There are two other obvious cash cows. The Chancellor could restrict the value of all income tax allowances to the new, low 20 per cent rate, thus halving their value to top- rate taxpayers. This might raise another pounds 5bn. Mr Lamont could also argue that public spending should be cut to reflect the improvement in the outlook for inflation: with inflation forecasts down by 0.9 of a percentage point since the autumn, the New Control Total could be cut by pounds 2.5bn in 1993-4 but still keep real spending at the same level.

In short, it is not difficult to imagine the Chancellor raising a hefty sum - up to pounds 15bn a year - to fund a few lollipops. One possibility, mooted by Andrew Dilnot of the IFS, is that Mr Lamont could use some of his gains to extend radically the band of income on which 20 per cent is payable: a rise of pounds 10,000 would cost some pounds 6-7bn. This might allow him to claim that the basic rate had been cut from 25p to his long- term target.

The way to please both those economists who worry about the recovery and those who worry about the deficit is to legislate for permanent increases in tax revenue alongside merely temporary increases in spending or tax reliefs. Thus the Chancellor may offset tax increases with spending measures which phase out after a certain amount of time, leaving him with an improvement in the deficit.

One obvious runner is a spending package to train the long-term unemployed, but I suspect that this will be disappointingly small and cosmetic. In the present economic environment, the Department of Employment does not believe that special measures help people get back to work.

The other runner is a housing package. Although there are some signs of a revival in sales, most first- time buyers are rightly scared that a further fall in prices would soon mire them in the debt trap (where their mortgage is worth more than their house).

As a result, housing chains cannot form and others cannot move. The low level of transactions hits consumer items such as carpets and furniture on which people spend money when they move. Mr Lamont could do more to underpin the recovery in this area than anywhere else. He would be wise to offer a once-off rebate of tax - perhaps worth pounds 4,000 in line with a typical deposit - to first-time buyers to encourage them to enter the market.

The Chancellor would win both ways if he announced that any subsidy would be temporary, and would be withdrawn when the market revived. He would encourage buyers to move house quickly, and he would also ensure that there was no lasting damage to the budget deficit. This year, timing will be all.