Gordon's target: low tax, high spending

The Bank of England has done its job by acting pre-emptively to loosen monetary policy and bolster the economy. Now the spotlight moves on to the Treasury. Specifically, will Gordon Brown pull out the rusty, long-forgotten weapon of expansionary fiscal policy to shoot down lingering recessionary demons?

The Chancellor's speeches and briefings have hinted at goodies for business in Tuesday's pre-Budget report. Some of the miasma of tax credits, allowances, and tapers that are under consultation will be served up for companies. On top of that the details of personal tax credits - for employment, pensioners, and babies - are expected.

Most of the changes will not come into effect until next April, but the Chancellor has already announced that, 'The central economic theme of our pre-Budget Report will be our support for enterprise - for building a stronger, more dynamic enterprise economy.'

The word from the Treasury and the Chancellor is that they will do nothing to jeopardise the 'hard-won' stability. No Christmas shopping tax credits to bolster Britain's flagging consumers. Monetary policy, in the form of seven cuts to mortgage costs, has done the job for consumers so far.

Targeted tax cuts for business is the mood music, though as much attention will be placed on the Chancellor's own assessment of the direction of the economy.

His repeated assertions about the global situation's 'inevitable impact on UK growth' and 'uncertain times' have been read as preparing the ground for a downgrade of official growth forecasts. Tuesday's public finance figures will provide crucial clues.

This prospect could alter budgetary arithmetic considerably. The revenue's tax take will go down; spending on 'automatic stabilisers' such as unemployment benefits will go up - as the small increase in the claimant count in October suggests. Perhaps more significantly, the underlying hope that the UK had experienced a structural change in productivity performance, along the lines of the US miracle, seems remote.

So where is the room for business-friendly tax-cuts?

Similarly, the longer-term public services agenda suggests higher taxes, not lower. The Institute for Fiscal Studies calculated that taxes would have to go up by at least £5 billion, nearly 2p on the basic rate of tax for a year, to maintain core spending growth on health, education and transport at current rates.

'My perception is that they want to avoid knocking confidence any more than it already has been by international events,' says Stephen King, HSBC's chief economist. 'Even if, in an ideal world, they want to re-orientate towards a high-tax, high-spending system - this is the last thing you'd want to do right now,' he says.

But the seemingly irreconcilable tax- raising and tax-cutting agendas can both be met for two reasons. First, the Chancellor's fiscal rules involve 'cyclically adjusted' measures. If, as expected, growth projections are revised down, then there is scope to borrow money to fund the costs of slower growth. This is not the case with the European Stability and Growth Pact.

But the bigger picture involves the Treasury swag bag that is represented by a level of national debt of around 30 per cent of national income, compared with the US at 41 per cent, Germany at 51 per cent and Italy up at 102 per cent. Brown hinted at this in Thursday's speech to the Institute of Directors.

He said: 'These sustainable levels of debt allow us to meet our health, education, and transport commitments, deal with emergencies as they arise, and at all times maintain and hold both our fiscal rules, which are essential to credibility.'

Indeed these low levels of debt are the Treasury's secret weapon. They provide considerable leeway for short-term fiscal stimuli, such as targeted tax cuts for business. But they also enable the grand debate about public services provision, and the big decision about whether the country will cough up more taxes to pay for them, to be put off until the economic climate is warmer.

'Faced with a choice of knocking consumer confidence, and sticking to increased spending plans, they'll instead use their room for slippage on the fiscal position in the short term and bank on a recovery,' says King.

It might seem like economic alchemy, but today's low debt is essentially the consequence of a high tax take during Labour's first term. The much-vaunted surpluses used to 'pay down debt' were the result of stealth taxes and fiscal drag combined with the chronic underfunding of public services in 1997 and 1998. Effectively, if taxes are now cut, Brown will be transferring taxes paid, and forgone expenditure on public services during Labour's first term, to bolster businesses and wealth creation in the second.

'Because the surpluses generated have been higher than expected, that's left the fiscal position with more room for manoeuvre,' adds King.

Only a year ago these surpluses were something of a headache for the Chancellor as he fended off the fuel revolt.

At a macroeconomic level, with consumers and corporations - crucial bulwarks to the economy - heavily indebted, a transfer of debt from private to the public sector could make sense economically. The £22.5bn paid for 3G mobile phone licences last year was essentially a massive transfer of debt in the opposite direction, from the public sector to the telecoms companies.

The debate raging in the US over rival congressional stimulus packages also has its parallels here. A fiscal stimulus can be tax cuts, but it can also be increased public spending. The Democrats who control the Senate opt for the latter, whereas, the Republicans in the House of Representatives opt for tax relief.

If the British Treasury seeks a pre-emptive fiscal stimulus, it could spend a little more, rather than tax a little less. But for now the sights are set on giving a bit of encouragement to business.