Gordon Brown leaves tough fiscal legacy for successor

Whoever succeeds Gordon Brown as British Finance Minister will have to walk a tight-rope to meet the government's pledges on child poverty, health and education while sticking within its self-imposed fiscal rules.

The state of the public finances meant Mr Brown was never in a position to announce a give-away Budget this week. And he didn't.

He made a dramatic gesture with a two pence in the pound cut in the basic level of income tax and also cut the main rate of corporation tax.

However, these unexpected and headline-grabbing cuts were fully funded from changes elsewhere in the income and corporate tax system.

And for the seventh Budget in a row Mr Brown was forced to revise up projections for future borrowing, and to admit the deficit on the current budget is bigger than anticipated.

Mr Brown also confirmed that the forthcoming Comprehensive Spending Review will be the toughest in nearly a decade, leaving his successor to preside over a period of at least three years when government spending will fall as a proportion of national income. Brown blamed the deterioration on lower than expected revenues from North Sea oil and gas, a result of the pound's strength, higher costs, lower output and a falling oil price. But it is also the case that government spending over the past year has been higher than forecast.

Put simply, having opened the spending taps six years ago, the government is having more difficulty than envisaged turning them off.

"If Brown is finding it impossible to stay within the current generous public consumption envelope, isn't his successor sure to burst out of a tighter one?" said Peter Spencer, chief economic adviser to the Ernst & Young ITEM Club.

Data last week showed public spending growth has been running well above the government's five per cent target this financial year.

Government projections imply public spending growth will need to slow to just two per cent a year in real terms from 2008 to 2011, less than half the rate it has been for the past five years.

"Of one thing we can be sure: Labour's years of plenty are at an end," said Robert Chote, Director of the Institute for Fiscal Studies.

Mr Brown is widely expected take over when Prime Minister Tony Blair steps down this summer, after a possible election for the leadership of the ruling Labour Party.

If so, his replacement as Chancellor of the Exchequer will have to deliver a sharp squeeze on public spending at a time when the economy itself is also losing steam.

The government expects the economy to grow at a robust three percent clip this year, faster than any other country in the Group of Seven major industrialised countries, before slowing gently to 2.75 per cent in 2008 and 2009.

On Wednesday, Mr Brown confidently asserted that his two fiscal rules - that of borrowing only to invest and keeping public debt below 40 per cent of GDP - would be met in both this economic cycle, which the Treasury expects to end this Spring, and the next.

But since Mr Brown's forecasts already make challenging assumptions on tax revenues and spending, his successor will have little room for manoeuvre should the economy slow faster than expected.

Given Mr Brown's record in underestimating government borrowing needs, unpopular tax rises may be the only option - bad timing with a general election expected in 2009.

"The fiscal position remains concerning and any marked shortfall in economic performance could see the borrowing numbers at uncomfortable levels," said Roger Bootle, economic advisor to Deloitte.

"I believe that a fully prudent fiscal stance would require taxes to be raised, perhaps by as much as £10 billion."