The economic downturn has turned the 'prudent' Chancellor into a gambler

Mr Brown is gambling that the increases in taxation next year will hit neither personal spending nor employment

This afternoon, for the first time in his job as Chancellor of the Exchequer, Gordon Brown will have to explain why things are not going quite as well as planned. In his pre-Budget report today, he will have to admit that the Treasury's spring forecasts, both for economic growth and for public finances, have been too optimistic. And he will have to tell us what he intends to do about this.

The Chancellor has had an extraordinary run of luck, inheriting what was already Europe's fastest-growing large economy in the middle of its longest boom since the Second World War. He built on the tax and regulatory reforms of the Tories by giving the country something that they had failed to provide: macro-economic stability – with the combination of an independent Bank of England and prudent fiscal policy.

As a result the UK has avoided both the economic stagnation of much of continental Europe and the excesses of the boom of the US. So far, we seem to have come through the downturn in better shape than any of the other large economies. Faster growth has lead to higher tax revenues, which in turn have allowed big repayments of debt and, more recently, huge increases in public spending.

But that run of luck is coming towards a close. Today the Chancellor will have to acknowledge that growth this financial year is likely to be about 1.75 per cent at best, not the 2.5 per cent forecast in April. He will have to admit that instead of having to borrow £13bn this year, the Treasury will need at least £20bn. And he will have to give some indicator of what he will do if public finances continue to turn out much worse than forecast next year. The thing to watch for today will be his explanations on those three points.

As far as lower growth is concerned, expect the blame to placed on the stagnant world economy. That is reasonable enough, in the sense that we are dependent on global conditions. However, the slowdown was already evident in the spring. When the Treasury came out with its forecast of more than 2 per cent growth, no one in the financial markets really believed it. All that has happened is that the Treasury forecasters will be coming into line with everyone else.

But public spending and taxation plans are based on Treasury forecasts and, well, those spending and tax plans will now be wrong. It would be nice to know how wrong. Borrowing a bit more one year because the economy has grown a bit slower than expected is of itself no big deal. But the widening deficit may not just be the automatic effect of slower growth, something that will correct itself when growth picks up. There may be something more fundamental – and disturbing – starting to happen. Tax revenues may be falling by more than they "ought" to; and the Treasury may be losing its grip on spending.

Tax revenues since April have been disappointing. True, thanks to the retail boom, one of the big earners, VAT, is coming in very well. It is up about 9 per cent on last year, which is more than the Treasury expected. But corporation tax is way down, as you might expect, and more surprisingly, income tax is up by less than 2 per cent, even though earnings are up by more than 4 per cent and employment has been stable or rising.

The problem here is that this is paid disproportionately by the highest earners – the top 1 per cent of earners pay nearly a quarter of all income tax – and these are the same people who have been hammered by the downturn. Do not expect City bonuses to recover next year – and don't expect capital gains tax to be a great winner either.

Public spending, on the other hand, has been shooting up. The departments are spending 11 per cent more than the previous year – yup, 11 per cent – against a budgeted 8.4 per cent. Now maybe they will be clamped back into shape by the Treasury in the next few months. Meanwhile, it is very hard to believe that the Government can be getting value for money from what must be one of the largest increases in public spending in real terms that has ever taken place in peace-time.

For the time being, the Government can borrow without too much risk to its credit rating. It has paid back more than £50bn in debt over the past three years so the Chancellor could borrow quite a lot now and still stick to his "golden rule" that borrowing should be neutral over the economic cycle. But part of that £50bn of surpluses may be a one-off effect of the share bubble: the bank HSBC reckons that a third of it was. So maybe we could have a decent economic recovery and not have a similar buoyancy of tax revenues.

Much the same thing happened in the late 1980s during the Lawson boom. The economy was growing rapidly and this led to huge government surpluses. People began to speak of the entire national debt being repaid by the late 1990s. But, as we now know, this was an illusion brought about by the unsustainable nature of the boom. As the economy slowed and eventually plunged into recession, the deficit returned and taxes had to be raised to bridge the gap.

This may not be a problem for this year but it could be a huge one in the years ahead. HSBC thinks that in four years' time the spending plans already announced by the Chancellor could take the deficit up to 3 per cent of GDP, with little plan to get the accounts back into balance later. If that is right, one of two things has to happen: still higher taxation (and Labour has increased taxes by the equivalent of 2 per cent of GDP) or cuts in those spending plans.

So Mr Prudence is actually becoming a bit of a gambler. He is gambling that the world economy will indeed recover next year and the years beyond. He is gambling, too, that the increases in taxation he has already announced for next year, in particular the rise in both employees' and employers' national insurance, will hit neither personal spending nor employment. And he is gambling that we will all see some extra value for this huge increase in public spending that he has sanctioned.

On the world economy, it looks to me an OK bet. The world will manage some sort of recovery through the next decade and though it may be quite muted, the UK should continue to perform pretty well. More worrying is the impact of increased taxation. So far he has got away with it, but that was during the boom. Add to taxation when people are feeling less flush and you may meet some nasty surprises. Employers might, for example, cut back even more sharply on their staffing levels. Most worrying is that we won't get value for money – that the additional spending will just be frittered away. We will see what he has to say about that tomorrow too.