Tax fears on Brown's £10bn gap

TAXPAYERS were warned today to brace themselves for big increases in National Insurance or VAT in the wake of an alarming deterioration in the public finances.

Only rises in these major taxes would yield the extra £5bn to £10bn the Chancellor is going to need if he is to balance the books and meet his own borrowing rules, tax experts said.

A further increase in NI for higher rate taxpayers was the obvious choice for Gordon Brown after he set his controversial precedent last April, by abolishing the upper earnings limit on NI.

The only serious alternative if he needs to raise substantial extra sums would be to lift the 17.5% rate of VAT, the tax paid by consumers on most goods and services except food and children's clothing.

John Whiting, tax partner with PriceWaterhouseCoopers, said: 'It's looking a bit sticky. He may well be looking for an extra £5bn to £10bn. The only sources for that sort of money are income tax, NI or VAT.' Income tax was ruled out by manifesto commitments, he added.

Every 1% rise in NI on income above the upper-earnings limit would generate an extra £800m for the Exchequer, while the 'nuclear option' of treating all income the same would bring in an extra £8.3bn a year. Raising VAT to 20% - the typical rate in Continental Europe - would raise an extra £8bn to £9bn.

Neither option is politically attractive. NI is regarded as a tax on jobs, while VAT hurts the poor disproportionately.

But the Chancellor may not have any other choice if he is to keep within his self-imposed rules on public borrowing. Official figures yesterday showed an alarming overshoot in public spending.

Government running costs, including salaries, grew by 10% in the first five months of the tax year, while tax receipts rose by a more sluggish 6%. Public borrowing ballooned to a worse-than-expected £17bn.

Robert Chote, director of the Institute for Fiscal Studies, said. 'The current budget deficit is widening rather than shrinking as the Chancellor predicted in the Budget. He may argue that this simply reflects the weakness of the economy, which his fiscal rules allow for. But even if the economy does pick up strongly, we fear that he may be too optimistic about revenues over the longer term. Taxes might then have to rise.'

The CBI forecast public borrowing to rise to £32.5bn by 2004-2005 - some £8bn more than the Chancellor's own forecast in the last Budget.

'In the end there will have to be more tax rises or less public spending than planned, unless there is an unexpected improvement in the US business tax competitiveness,' said CBI economist Doug Godden.

Jonathan Loynes of Capital Economics said Brown was being 'very optimistic' about the economy. 'We estimate that taxes will eventually need to rise by £10bn.'