Graphic: drowning in red ink

Poor Alistair Darling. Less than three months ago the Chancellor was lambasted for saying that Britain was heading for its worst economic down-turn in 60 years. Now, as the Chancellor finalises next week’s PreBudget Report, he may have the satisfaction of being vindicated – but it is his fate to have to try to clear up the mess.

It is a grim prospect. With Britain now entering a recession that may be worse than that of the early Nineties, he faces the bleakest of outlooks. The Treasury’s books are already awash with red ink from the huge borrowing bills racked up during Gordon Brown’s ten-year stretch in No 11.

Yet with the threat of a deep and prolonged recession hanging over them, both Mr Brown and his Chancellor are intent on staving off a painful slump. So Mr Darling is expected to announce a substantial “fiscal stimulus” of tax cuts and higher spending to try to jump-start the economy.

Even before he starts factoring in an extra boost to the economy, though, Mr Darling has to find £11 billion just to stand still. He must reapply the political sticking plaster he used in his emergency Budget earlier this year to compensate the five million people who lost out when his predecessor scrapped the 10p income tax band. He also needs to extend a temporary freeze on fuel duty and temporary stamp duty concessions. All three measures will cost £3.9 billion.

On top of that he needs to reverse existing plans for higher taxes and curbs on public spending worth £7.5 billion.

If he therefore wants to deliver a substantial boost to the flailing economy on Monday, an effective “stimulus” could cost between £15-30 billion.

But the big headache for Mr Darling is that he is already stuck deep in the red, with borrowing in 2008-09 set to top £60 billion. Even before any extra moves, borrowing is set to spiral as the economy’s woes cut into tax revenues, while spending is driven up by the bills for rapidly rising unemployment.

This confronts the Chancellor with two big challenges: establishing both the affordability of next week’s proposals, and confidence in the Government’s running of the nation’s finances.

The challenge of maintaining vital trust in the markets has been rammed home in recent days as the pound has plummeted in a vote of no confidence in Britain’s prospects. At the Treasury, the fear is that if markets’ confidence in Britain’s ability to pay its way fades, then it will find it harder to borrow through selling its government bonds, or “gilts”. If that happened, it could have to pay much more in interest to lure investors to lend the money required.

Confidence in the Treasury is not helped by its past, dismal record on borrowing plans. In the past decade Mr Brown repeatedly borrowed more than originally planned as even booming tax receipts did not rise as rapidly as he hoped.

Now, anxious consumers choosing not to spend means falling VAT payments; tumbling house prices and shares mean a drop in stamp duty; more unemployment means less income tax; wilting profits hit corporation tax. In the first half of the financial year, the amount of tax paid is up by only 1.9 per cent from a year earlier, compared with Mr Darling’s hopes for a 5 per cent rise over the full year. The figures are expected to grow still worse as the recession deepens.

In 2008-09 the £43 billion in borrowing that Mr Darling pencilled into his March plans was already £13 billion more than Mr Brown had forecast a year before. The ultimate outcome is now set to be between £60 and £70 billion. Economists expect that borrowing is set to surge still higher in 2009 and 2010, to as much as £150 billion a year.

All of this is despite existing plans to squeeze growth of public spending to only about 2 per cent a year, after inflation, compared with more than 4 per cent in the first half of this decade.

Confidence will now turn on just how deep the red ink gets, and whether the Chancellor can convince the markets that his plans are affordable.

Mr Darling will try to pull this off by coupling some combination of tax cuts, higher spending, and bigger borrowing in the short term with a commitment to put the books back in order in the longer term. He has already signalled that he will junk the Treasury’s battered fiscal rule book, drawn up by Mr Brown, in its existing form. Much will depend on whether markets find the recast rules plausible.

The need to make the figures add up convincingly will also limit the scale of any giveaway on Monday.

Yet whatever he chooses to do, the scale of the Government’s existing and future borrowing means that paying for this will almost inevitably require eventual tax rises, probably large ones, once a recovery is secured.

It is this prospect that leaves economists sharply divided over whether Mr Darling can afford to dive still deeper into the red. By choosing to do so, he will be gambling that staving off a deep recession now will count more with voters than the threat of sharp tax increases to come in the future.

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