Why Major's tax promises just don't add up

The state of public finances has left the Chancellor with very little room for manoeuvre to satisfy conference expectations. Paul Wallace explains

All chancellors have to speak with forked tongue, balancing messages of financial sobriety for the City and barnstorming euphoria for the voters. The dilemma is always at its most acute at conference time, when the audience being addressed is party activists.

But seldom has a chancellor faced a greater test of verbal dexterity than Kenneth Clarke will when he stands up to make his speech tomorrow in Blackpool. On the one hand, he has to boost morale with a pledge of tax cuts - or face the wrath of the party. On the other hand, he also knows he can't afford them. No wonder the speech has apparently gone through extensive drafts.

Two weeks ago, the City fired a sighting shot, warning of the barrage it could lay on a lax Budget. For the first time ever, it did not buy all the new government debt the Bank of England was trying to sell in one of its regular bond auctions to finance public borrowing.

That auction was for pounds 3bn, but the Government may have to raise 10 times that in the current financial year. This week the Ernst & Young Item Club forecasting group, which uses the Treasury model, projected a deficit of pounds 27bn, much more than the pounds 21.5bn the Treasury anticipated last November. Worse still, even without tax cuts, it forecast a deficit of pounds 25bn for next year, 1996-97, almost double the pounds 13bn the Chancellor projected in his last Budget.

The deterioration in the public finances has come for two principal reasons. One is that tax revenues have proved disappointing in the current recovery. In June, the Treasury conceded that VAT, income tax and corporation tax were coming in below the levels it had anticipated at the time of the last Budget. These lower receipts would "knock through" into next year's tax revenue.

The second reason is the slowdown in the economy. Just as higher-than- expected growth in 1994 brought down borrowing more than had been forecast, so this year's unexpected economic slowdown has forced up public borrowing. The effect is to leave the Government much further from its objective of balancing the books by the end of the Nineties. It also imperils the objective of bringing the deficit as a percentage of national output down to 3 per cent by 1997, a condition for eligibility to participate in European monetary union. Disconcerting though it may be to the predominantly Euro- sceptical delegates at the conference, the Government wants to keep its options open on EMU.

Against this background, there can be little doubt about the mood music Mr Clarke would seek to strike if his audience this week were sober-suited City bankers at the Mansion House. In between the quaffing and guzzling, there would be much solemn intoning about the need to abide by the sacred principles of sound finance. But Mr Clarke's audience is the Tory faithful, who will want a much more upbeat tune about tax cuts.

There is only one way to square the circle: spending cuts. The trouble is that this is much easier to promise than it is to deliver. Mr Clarke talks tough on spending, but in practice he has found it just as difficult to deliver real expenditure cuts as his predecessors.

In his November 1993 Budget, for example, the Chancellor said he was going to cut the "control total" - the key spending figure targeted by ministers - by 1.25 per cent in real terms. That was the plan; the reality was that by the time all the bills had come in it turned out to have risen by as much.

Even before the current drive for new spending cuts, the Treasury's plan to limit growth in the control total next year to less than 0.5 per cent was extraordinarily tight. This would be ambitious for a normal year: on average, public spending has grown by just under 2 per cent over the past 15 years. But this Budget is for a pre-election or maybe even an election year, when largesse with the public purse has historically been the order of the day. In 1992-93, for example, the control total rose by almost 5 per cent in real terms.

With so little room for manoeuvre, what we may therefore expect is a piece of vintage Treasury legerdemain. Tax cuts are coming and will be justified by notional spending cuts. The most likely rabbit Mr Clarke will pull out of the hat will be a cut in the contingency reserve - money held back for unbudgeted spending - which will then be allocated to tax cuts. Whether the magic will last is quite another matter. But then it is quite possible that it will be another chancellor who will have to pick up the bill if the spending cuts turn out to be strictly presentational rather than for real.