Brown faces a £7.5bn black hole

New figures reveal public finance shortfall

The gloomy economic outlook will be reinforced today by a British Chambers of Commerce (PA)

The Chancellor is facing a £7.5bn black hole in his Budget for next year as a result of the economic downturn, an analysis of Treasury figures for The Independent has found.

The black hole means that Alistair Darling will either have to raise tax, cut spending or borrow more. Borrowing such sums risks stoking inflation and a further rise in interest rates.

The black hole is the equivalent of cutting 57,000 teaching jobs, cancelling the two giant aircraft carriers ordered by the MoD, and closing five hospitals. It is also the equivalent of adding 2p to the basic tax rate.

The figures, given exclusively to The Independent by the National Institute of Economic and Social Research (NIESR), will increase the fears of Labour MPs that they are heading for a general election with the public finances in chaos.

The NIESR predicts that the slowdown in the economy will cut at least £8bn from the tax revenues that Mr Darling predicted in his March Budget while the slump in house sales will halve the Chancellor's stamp duty receipts to £3bn.

The only respite for Mr Darling as he prepares the pre-Budget report is the £4.5bn windfall in receipts in duty as a result of the soaring global price of oil.

The gloomy economic outlook will be reinforced today by a British Chambers of Commerce (BCC) survey warning that the UK is now "at serious risk" of recession as falling orders and rising costs tighten the squeeze on business.

Services firms saw "alarming" declines in the second quarter of 2008, with those reporting lower orders outnumbering those recording rises for the first time since 1990, its survey of almost 5,000 firms found. The director general of the BCC, David Frost, said: "The temptation for the Government will be to raise business taxes because the exchequer is running out of money. This would be a catastrophe. To put more pressure on business would not only restrict growth and hit the consumer hard, it would further crush what our economy is based on – confidence."

This is the first time in more than a decade that a chancellor has had to face the prospect of rising unemployment and falling receipts. Mr Darling is faced with an unpalatable choice of raising taxes or cutting public spending – both of which risk pushing Britain into recession. Mr Darling is expected, however, to take the softer option of raising borrowing. But that will almost certainly breach the "golden rule" imposed by Gordon Brown when he became chancellor a decade ago.

Simon Kirby, research fellow at the NIESR, said Mr Darling was having to deal with past errors by his predecessor. "The public finances are in this state due to overly optimistic forecasts for tax receipts allowing the previous chancellor to go on an exuberant spending spree: since 2000-01, total public sector expenditure has grown by an average of 6.9 per cent per annum," he said. "The 'golden rule' of only borrowing to invest over the economic cycle will probably be broken in the absence of tax increases or spending cuts."

Philip Hammond, the shadow Chief Secretary to the Treasury, said: "This report underlines the parlous state of the public finances and shows how poorly prepared Britain is for the economic slowdown. The report's prediction of higher government borrowing, collapsing stamp duty receipts and lower than projected growth next year are the latest manifestations of Gordon Brown's economic incompetence."

Vince Cable, the Liberal Democrat Treasury spokesman, warned that the economy was facing a "prolonged crisis". Delivering the annual lecture to the Institute for Fiscal Studies, Mr Cable said: "A bursting property bubble and a commodity price shock may well cause a deep and prolonged crisis for the British economy. The Government is being utterly complacent." He urged the Chancellor to relax the "golden rule" by running a £5bn-a-year surplus over the cycle.

"A squeeze in current public spending and possibly a rise in general taxation in the medium term are not likely to be embraced warmly by Government or opposition," he added. "Perhaps this is the time to face that reality."

Senior ministers confirmed that the housing crisis has slashed the Chancellor's forecasts for receipts from stamp duty. The Bank of England has reported that mortgage approvals have fallen by 50 per cent in the first five months of the year.

* Yvette Cooper, Chief Secretary to the Treasury, announced measures to soften the blow to families facing repossession. A £12m scheme to give free advice on family finances in the North-west and the North-east will be launched next year. Children will be given lessons in handling student loans and taking out mortgages.

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