Prudence prevails, despite the surplus

Economic forecasts

The Chancellor has faced an embarrassment of riches in drawing up the latest plans for the government finances, with overflowing public coffers raising hopes and expectations of a giveaway on many fronts.

The Chancellor has faced an embarrassment of riches in drawing up the latest plans for the government finances, with overflowing public coffers raising hopes and expectations of a giveaway on many fronts.

True to form, however, he insisted he would stick to tax-and-spending plans at least as prudent as those set out in the March 2000 Budget.

"I have decided, in the interests of keeping interest rates and mortgage rates as low as possible, to lock in over the coming years a fiscal stance that is the same or is tighter than we said at the time of the Budget," Mr Brown said.

Yet he also found at least £4bn a year extra for pensioners, children and tax cuts and incentives. Adding in the transport measures still subject to consultation will take the giveaway up to nearly £6bn a year.

The additional money comes from two main sources. On the spending side, there are lower interest payments on the shrinking national debt and reduced spending on unemployment benefit. This year there will be a £28bn reduction in the Government's debt, much of it the proceeds of the auction of third-generation mobile phone licences, while the jobless total is more than 100,000 lower than assumed at Budget time.

And on the revenue side, tax revenues are running more than £4bn a year ahead of the Treasury's earlier forecasts.

Despite making full use of these funds, Mr Brown was yesterday able to announce slightly higher surpluses, or lower borrowing, than he predicted in March. Compared with the Budget, the fiscal stance is tighter this year and little changed in the years ahead, therefore giving the Bank of England no immediate cause for concern as its monetary policy committee votes today.

"The Chancellor has got the balance just about right. The MPC is unlikely to react in any way," said John O'Sullivan at Dresdner Kleinwort Benson.

But many economists believe there is still enough over-caution in the plans to leave scope for a further pre-election giveaway. "He will have quite a lot left up his sleeve for the next Budget," said Doug McWilliams of the Centre for Economics and Business Research.

This year's surplus on current, or day-to-day, spending compared to revenues will be £16.6bn - £2.6bn higher than March's figure.

In the Budget, the Treasury estimated that there would be overall net borrowing of minus £6bn this financial year and minus £5bn next. It predicted these would be followed by net borrowing requirements of £3bn and £11bn as the planned increases in expenditure, announced last July, turned surpluses to deficits. This year the surplus is now pencilled in at £10bn, and there are slight changes in future years.

Halfway through the financial year, the figures were already recording bigger-than-expected surpluses. The Government was in the black by £15.6bn in 1999-2000, £4.6bn higher than last March's Budget estimate.

So far, halfway through 2000-01, there is a cumulative £4.2bn surplus, although the spending increases announced this summer have barely started to have an impact yet. The net cash requirement (equivalent to the old public sector borrowing requirement) is even more bloated than the borrowing totals thanks to the £22.5bn proceeds of the mobile phone auction, and now stands at £28bn in the past six months. However, the Treasury rightly plays down this measure as a guide to fiscal policy.

Predicting borrowing involves the gap between two very large and uncertain numbers, government revenues and public expenditure, so it is never easy to get it right. The average one-year-ahead forecast error is £10bn.

Although bitter experience with past chancellors' overoptimism has made the Treasury err on the pessimistic side, many commentators now accuse it of going too far.

Geoffrey Dicks, UK economist at the Royal Bank of Scotland, said: "The Treasury will, for a second successive year, have underestimated the budget surplus by around £20bn. This is either deliberate, wilfully misleading, caution on its part or incompetence."

How much the Chancellor can afford to give away in tax cuts or public expenditure is very much a matter of judgement. The reason is that sensible fiscal policy depends on where the economy stands in relation to its long-term trend. There ought to be a surplus on the current budget in good times to offset deficits during a recession. It is hard to estimate how big the safety buffer needs to be because nobody can be sure how much above its trend the economy is operating.

Certainly, the tremendous buoyancy of tax revenues in the past few years suggests the healthy state of the government coffers is due mainly to the strength of the economy. The continued fall in unemployment to little more than 1 million claimants will also have reduced social security spending by about £500m in the full year. It will be impossible to tell how much of it is sustainable until growth slows.

Yet the Chancellor will not want to stash away this tax bounty indefinitely. After all, with a general election coming up he will want to announce tax cuts and defend himself against Conservative charges of having raised the tax burden.

In March's Budget the forecasts estimated taxes and social security contributions would amount to 37 per cent of GDP last financial year. John Hawkesworth, head of macroeconomics at PricewaterhouseCoopers, estimated the tax burden could reach 38.5 per cent in 2001-02, but yesterday's report predicted it would peak at 37.5 per cent in that year before declining again.