By Ben Simmons

The Chancellor’s hard-earned fiscal credibility is at risk ahead of Budget 2012, warns the independent think tank Reform in its pre-Budget paper today.

The think tank criticises the Chancellor for “moving the goalposts” on his deficit reduction plan instead of implementing further spending cuts and tax changes. It argues that extra spending to help the “squeezed middle” would only repeat the waste of previous years and increase the size of the fiscal hole which remains the Chancellor’s greatest challenge.

The think tank rejects the idea of Budget 2012 giveaways, including the abolition of the 50p rate, given the uncertain economic outlook and the likelihood of further instability in the Eurozone. In new analysis, it shows that looser fiscal policy would gravely undermine the public finances and have little benefit for economic growth. If interest rates on government debt rose to levels currently seen in Spain (around 5 per cent), the Government would have to run a surplus in each year of this Parliament or else face a debt spiral.

The Chancellor’s credibility was called into question in the Autumn Statement when he pushed back the target for the elimination of the deficit from 2014-15 to 2016-17. Moody’s, the ratings agency, has already put the UK on negative outlook. More recently the Prime Minister himself has called for cuts in Child Benefit to be watered down.

Specifically Reform recommends an end to the ring-fencing of the NHS, education and welfare budgets, generating savings of around £18 billion per year by 2014-15. It argues that this package would bolster the Chancellor’s fiscal credibility, promote efficiency in public services and improve the targeting of welfare benefits. It calls on the Chancellor to deliver his public spending target of 39 per cent of GDP by 2016-17 “come hell or high water”, even if economic growth continues to disappoint. The think tank’s analysis gives the Chancellor a new rule of thumb: for every fall of 0.5 per cent in the annual rate of economic growth, he will need to find £20 billion in spending cuts or tax increases.

The study agrees that the Budget should target the “tax gap”. So far, however, the Government has increased the incentives for avoidance for families who own small companies and for high earners. The increase in the personal tax allowance has increased the rewards of tax planning by £600 per year to £2,500. Instead it argues that the best way to raise revenue is to remove reliefs, especially in VAT, rather than increase rates. Zero-rated items and other exemptions from VAT currently cost the Exchequer around £40 billion per year.

According to Reform, the Chancellor risks following a “lite” version of the previous Government’s policy of higher public spending on families funded by greater taxes on high earners. Much of this extra spending was wasted. The think tank shows, for example, that extra funding for childcare saw a sharp increase in childcare costs between 2006 and 2010. At the same time, the Chancellor should recognise that high pay did not cause the recession and that penalties for high pay will not jump start the recovery. However unpopular it may be to say it, high pay can help the economy by boosting tax revenues to support public spending, debt repayment and, eventually, tax reduction.

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