Lamont may raise taxes to fight slump

THE PRIME Minister and the Chancellor are considering a fundamental shift in economic policy to stave off the threat of deepening slump. The change would involve further cuts in interest rates balanced by higher taxes.

Although Norman Lamont would continue to stress the importance of keeping inflation within his 1-4 per cent target range, there would effectively be a shift of emphasis towards stimulating recovery and jobs.

Ministers were shaken last week by the bleak economic news and the mutinous reaction of the Tory heartlands to the coal closures. With redundancies sweeping through business, a new downturn in factory output, and an acceleration in unemployment, the pressure for going 'back to basics' has become overwhelming.

Senior policy-makers now concede that this recession is quite different from its predecessors because of the high level of indebtedness inherited from the 1987-89 property boom. There is a danger of a spiral of 'debt deflation' not seen since the Thirties, as people try to repay their borrowing rather than spend.

With mortgage lenders still repossessing homes and selling them cheaply, and with first-time buyers too scared to enter a falling market, the drop in house prices was a record 3.1 per cent in September alone, according to the Halifax index. More than a million people probably now have houses worth less than their debt.

The housing slide has helped to undermine consumer confidence, which plunged to its lowest level since November 1990 in the latest Gallup survey for the EC Commission.

Three times as many people expect the economy to deteriorate in the coming year as expect it to improve. Other evidence of a deteriorating economy includes:

A sharp acceleration during August and September in unemployment, now rising at a monthly rate of 32,000. The proportion of men out of work is now 13.4 per cent, a post-war high.

In August, manufacturing output dropped by 0.3 per cent. With CBI surveys showing stocks of unsold goods rising, the drop is expected to continue.

Factories shed 51,000 workers in August, the worst monthly total since the recession began. They followed 47,000 job losses in July.

The wave of redundancies is expected to continue. BT is cutting 30,000 jobs and Lucas Industries 4,000. BP and British Aerospace (including Rover cars) are also expected to cut back, and thousands of jobs may go at the Rosyth naval base.

Britain's export markets are beginning to shrink. The US recovery has failed to lift off, and Germany is going into recession. Export volume dropped by 3 per cent in August.

An increasing number of forecasters expect unemployment to pass 3 million next year, with some pessimists projecting that the total will exceed the previous record of 3.1 million in July 1986 (on figures consistent with the current definition). Bill Martin of UBS Phillips & Drew predicts that unemployment will reach a peak of 3.6 million in 1994.

But some policy-makers warn that a rapid move to cut interest rates could lead to a sharp fall in the pound, which would require a damaging reversal. Others were encouraged by the modest drop in sterling after the 1 percentage point cut in base rates on Friday.

There is a strong Treasury group arguing that a sharp cut in interest rates would have to be balanced to some degree by tighter control over public spending and even tax increases in the Budget.

Their views were reinforced last week by the sharp worsening in the Government's own finances. Spending exceeded tax revenue by pounds 4bn in September, far above market expectations. City analysts now openly tout the possibility of a pounds 35bn borrowing total this year compared with a pounds 28bn Budget forecast.

Tax possibilities include a broadening of the base of value- added tax to include such items as fuels or newspapers. Another option is a surcharge on the higher rate of income tax.

Tax increases are on the agenda in part because of Chief Secretary Michael Portillo's difficulties in keeping spending ministers within the pounds 244bn planning total for the next financial year, 1993-4. The plans assumed unemployment would average 2.4 million (excluding Northern Ireland), but the total has already reached 2.74 million. Each extra 100,000 on the dole queues adds some pounds 350m a year to public spending.

Any 'rebalancing of policy' would be a reversion to the days of Margaret Thatcher and Sir Geoffrey Howe in 1981, when a tough Budget raised income tax. At the same time, interest rates and the pound fell. Tax increases would be certain to cause protests from those who argue that policy should not be tightened during a slump.