Pressure builds for tax cut

Gordon Brown will need to cut the equivalent of a penny off income tax in his budget to reduce Britain's tax burden and fend off the main Conservative attack on his handling of the economy, according to an influential report published yesterday.

The Institute for Fiscal Studies and the investment bank Goldman Sachs said the chancellor would need to give away £2bn in the March budget just to hold the tax burden steady - and £3bn to put it on a downward trend. With the chancellor highly sensitive to charges from the opposition that taxes have gone up under Labour, the IFS and Goldman Sachs said that the government would have to use some of Mr Brown's burgeoning war chest to offset so-called fiscal drag - where rising incomes automatically push people into higher tax brackets and increase state revenues.

The Conservatives have been pressing Mr Brown to admit that the tough action taken in Labour's first two budgets has resulted in a rising tax burden since the Blair government came to power in May 1997. Yesterday's report said that taxes had risen under Labour, with the £3.5bn reduction in last year's budget and November's pre-budget report dwarfed by the £11bn increase in previous budgets.

Income tax is coming down by a penny in the pound this April to soften the blow from the abolition of mortgage tax relief and the scrapping of the married couples allowance. Labour has made no specific commitment on the share of national income accounted for by taxes, but the prime minister is thought to be keen to keep the government's middle-class supporters happy in the run-up to the next general election, expected to be in the summer of next year.

The report, called the "green budget", predicted that the government was in the enviable position of being able both to cut taxes and respond to demands for higher public spending from its core supporters. In addition, Mr Brown will be able to meet his stringent rules for borrowing and help the Bank of England's monetary policy committee to keep the lid on interest rates.

The IFS and Goldman Sachs estimate that even after cutting taxes, the impact of falling unemployment and faster economic growth will give Mr Brown an extra £19bn to distribute in the next three-year spending review due to be unveiled in the summer. That would enable Mr Brown to increase spending by 2.5% a year in real, inflation adjusted, terms, slightly more than in the current programme.

Within that total, he could give 5% more a year to the NHS but there is question mark about whether substantially higher increases are affordable without jeopardising other departmental budgets.

The IFS and Goldman Sachs estimate that the chancellor would have to spend 5.7% to take Britain's spending on health up to the simple European average of the 15 EU member states.

A treasury source said that forecasting the public finances was notoriously difficult, and that the average error per year was £11bn, more than enough to wipe out the surplus cash identified by the green budget. He added that in the light of the policy mistakes in the late 80s, the government would err on the side of caution.