Need Some Debt Management Advice Gordon?

Gordon Brown will have to raise taxes by 2.5 billion pounds to get the nation's finances back in order, the Institute for Fiscal Studies said on Wednesday, less than it predicted a year ago.

Last year's IFS/Morgan Stanley "Green Budget" forecast Brown would need to raise taxes or cut spending by 11 to 13 billion pounds while this year's report again noted risks of the minister missing his fiscal rules and growth disappointing.

The 2006 Green Budget took note of tax hikes worth some 3 billion pounds in Brown's December pre-budget report PBR, largely on North Sea oil company profits, as well as projections of future spending falling by some 8.5 billion.

"Public finance forecasts in the last four pre-budget reports have been over-optimistic," said the IFS's research, prepared ahead of Brown's first budget since last May's election when Labour won an historic third straight term.

"We see a reasonable case for a further 2.5 billion pound tax increase. More would be needed if the Chancellor decides to cut spending less aggressively," the report said.

Brown, who is widely expected to succeed Tony Blair, would probably break his fiscal golden rule by "an economically insignificant" 700 million pounds and not leave 12.8 billion pounds to spare as the PBR implied, the IFS said.

The findings may be embarrassing for Brown as they come just a day after the European Union said he needs to rein in borrowing, now running above the EU's ceiling of 3 percent of gross domestic product.

Brown's own golden rule states he may borrow only to invest over the economic cycle -- a cycle which the Treasury redefined late last year to stretch over 12 years, from 1997-98 through 2008-09 and which gave the Chancellor more room for manoeuvre.

CALL FOR LONG BONDS

The think-tank reiterated that re-dating the cycle has made it easier for Brown to meet his fiscal golden rule. It also said Brown has a 44 percent chance of breaking his other rule, which is to keep net debt under 40 percent of GDP.

"Given the uncertainty implied by the Treasury's past forecasting record, there is still a significant possibility even on its own figures that, unless the Chancellor takes action, one or both (rules) could be breached by the end of the current forecasting horizon."

The report also said the fiscal rules would gain more credibility if the Treasury used an independent assessment of the dating of the economic cycle.

Latest official data showed that public sector net borrowing rose on the year in December, taking the total for 2005/06 to 38.9 billion pounds, more than the 37 billion Brown predicted in the PBR. Net debt is currently 37.2 percent of GDP.

But that could all change as January is typically a strong month for government tax receipts and for its part, the Treasury remained confident it would meet its forecasts.

"The Government's spending plans are fully affordable on the basis of cautious assumptions and decisions already made," said a Treasury spokesman. "With the public finances continuing to strengthen, and as set out by the Chancellor in last month's pre-budget report, the government is meeting its golden rule with a margin of 16 billion pounds."

An article in the Green Budget co-authored by David Miles of Morgan Stanley also urged the Debt Management Office to take advantage of rock-bottom long-term interest rates and increase issuance as that could also support wider pension provision.

"The UK government may look back in 10 years and regret that it issued anything other than long-dated index-linked bonds at yields under 1 percent," Miles said.

"The chances of real yields going higher from here are greater than their going lower. Locking in at today's low real yields by issuing long-dated indexed debt is therefore sensible."

By Ross Finley
Reuters