Tax rises needed to plug ?7bn gap in state finances

Gordon Brown will have to plug a £7bn hole in the public finances with tax rises in this year's Budget, independent fiscal experts said yesterday.

The Institute for Fiscal Studies said the extra cash would be needed if the government is to fulfil its pledge to deliver "world class public services" while meeting Mr Brown's fiscal rules with a comfortable margin for error.

Labour has promised not to raise the basic or upper rates of income tax, but the IFS said the extra money could be found by tweaking the national insurance system or raising the rate of VAT.

The Treasury's projections of spending show that by 2003-2004 the chancellor will come his closest yet to breaking the golden rule which states that the government must borrow only to invest.

Carl Emmerson, of the IFS, said the size of the budget shortfall depended on whether Mr Brown wanted to restore the safety margin in his current plans. "If he does, and if spending is to rise significantly in real terms, then taxes will have to rise."

A Treasury spokesman gave little indication that the chancellor was ready to sail closer to the wind, however. "With the slowdown in the world economy, this is the time for more discipline not less," he said.

Despite forecasting tricky decisions for the chancellor, the IFS believes higher than expected revenues will help the government post a £14bn surplus for the financial year 2001-2002, higher than the £11.1bn forecast by the Treasury in November.

Tax revenues have held up well as Britain's economy has been buoyed by strong consumer spending, and official figures published yesterday showed households kept up the habit in December, funding their Christmas shopping with a record £2.2bn borrowing spree.

Low interest rates tempted consumers into stacking up fresh credit at an annual rate of 14%, up from 13.1% in November, the Bank of England said.

Analysts said the news made a further cut in interest rates by the Bank's monetary policy committee unlikely, particularly because its members have already expressed concern about the burden of debt being taken on by households.

"Today's readings fit in with other measures (consumer confidence, house prices, survey of housing activity) which suggest that consumer spending remains robust, fuelled by rapid growth in real household disposable income, plus the lowest level of base rates for 40 years," said Michael Saunders, of Schroder Salomon Smith Barney.

"As a result, with signs that external growth is beginning to pick up, we doubt that the MPC will cut rates again, and expect them to hike rates quite aggressively over the course of the year."

Despite the expansion of consumer credit, the Bank of England said mortgage lending eased in December.