Public sector savings to fund Clarke tax cuts

Kenneth Clarke, the Chancellor of the Exchequer, is aiming for a cut of pounds 3bn to pounds 5bn in public spending next year to pay for tax cuts and highlight the Conservatives' long-term aim of shrinking the public sector.

Independent economists assumed that last week's worse-than-expected Government borrowing figures would rule out tax cuts, but ministers are determined to make a firm pre-election promise of lower taxes paid for by savings achieved in the present round of talks between the Treasury and spending ministers.

The prospect of tax cuts is regarded as so electorally essential that Treasury ministers hope they will act as a strong discipline in the annual ritual of the spending round, already well under way.

The Cabinet is due to decide the overall level of spending cuts when it meets on Thursday. Ministers held the first pre-Budget meeting with officials at Chevening, the Foreign Secretary's country residence, on Friday and Saturday to discuss the scope for reductions in the existing expenditure plans.

Cuts of up to pounds 3bn have been earmarked because inflation has turned out lower than expected over the past year. That means that the same level of spending in real terms can be achieved with less cash.

However, ministers also want to emphasise their philosophical shift on the size of the state - a shift they accept many New Labour politicians have also made. The Government is seeking further "sensible" spending cuts this year as a first step on the road to cutting back the public sector. With the resultant savings, they hope to reduce taxes and lessen the uncomfortably high Government borrowing requirement.

These cuts are intended to promote the pre-election message that taxpayers can do better than the state when it comes to underwriting their welfare.

Ministers describe the growth in government during the past 30 years as an aberration and want to return it to mid-1960s levels.

That would mean eventually trimming the share of public expenditure in the economy from its 42 per cent (and the 40.25 per cent projected for 1997-98) to less than 35 per cent.

The Government sees this as consistent with protecting fundamental public services such as health and education, arguing that, for example, the massive expansion of higher education in the 1960s took place when the state was much smaller. This implies that most of the long-term adjustment would entail shrinking social security spending, which accounts for nearly one-third of all government spending. Tony Blair has said that a Labour government's aim would also be to shift resources from welfare to education spending.

Behind the ritual posturing, the present spending round is as difficult as any other. Even though spending departments were asked not to submit their usual annual letter bidding for funds, several did so anyway.

Some departments face acute pressures on their budgets, including the Ministry of Agriculture - due to the beef crisis - the Home Office, because of growing prison costs, and Education, where Gillian Shephard argues that a generous settlement is critical in an election year.

The Treasury believes there is scope for cuts across government, including further reductions in Whitehall running costs. Last week it raised its forecast for public sector borrowing by more than pounds 4bn to pounds 27bn.