£125bn blackhole as tax receipts plunge

Tax revenues are set to slump dramatically because of the impact of the credit crunch.

Official figures will tomorrow confirm that Britain's economy shrank between July and last month the first time since 1992 that it has failed to grow.

The double whammy of a downturn in revenue from tax, plus an increase in benefits paid out as unemployment soars, presents Chancellor Alistair Darling and Gordon Brown with a political "perfect storm".

The Evening Standard analysis shows that if the economy shrinks by one per cent next year and 0.5 per cent in 2010, the Government will lose £125billion in tax revenue. To recoup such a shortfall over 10 years would require income tax to rise by 2.5p in the pound. Mr Darling has also pledged to bring forward planned investment to help the economy. But the analysis suggests the Treasury may need to borrow the equivalent of £11,000 for every household £275 billion over three years.

A £125 billion drop in tax receipts for the three years to 2010-11 would be seven per cent down on the £1,830 billion forecast by Mr Darling in the Budget.

Critics blamed Gordon Brown for the predicament, accusing him of spending lavishly during the boom rather than saving for the bust.

Peter Spencer, chief economic adviser to the Ernst & Young Item Club, said: "Our defences required some attention during the boom years, which they did not get. The bills will have to be repaid by higher taxes or cuts in public spending."

Gemma Tatlow, of the Institute of Fiscal Studies, said: "If the Government had acted earlier we would not now be embarking on a recession with public sector borrowing and debt so high."

In the March Budget, Mr Darling forecast economic growth of 1.75 per cent this year, 2.5 next year, and 2.5 in 2010-11; tax receipts of £575billion, £608billion and £647billion over the three years; and borrowing of £43billion this year, £38billion next year and £32billion the year after a total of £113billion.

He now looks set to revise them in the forthcoming pre-Budget report, raising borrowing to fund £1,780billion of planned spending in the three years.

Both Mr Brown and Bank of England Governor Mervyn King this week warned Britain is heading for recession. The Standard's research shows that in a severe recession, where growth of one per cent this year is followed by contraction of one per cent in 2009-10 and 0.5 per cent in 2010-11, tax receipts will fall £125billion short of forecasts.

It also indicates borrowing will rocket to £65billion this year, £90billion next year and £120billion in 2010-11 a total of £275billion.

Borrowing of £120billion represents eight per cent of national output and ranks alongside the £51billion racked up by the Conservatives in 1993-94.

A milder recession involving growth of one per cent this year followed by contraction of 0.2 per cent in 2009-10 before growth of 1.6 per cent in 2010-11 will see tax receipts come in £80billion below Treasury forecasts. Government borrowing would rise from £60billion this year to £80billion and then £95billion to total £235 billion more than double the forecasts.

In London alone, stamp duty from housing sales has soared from £220million to £1.9billion in the past 10 years, but with prices down 20 per cent and transactions halved, this year's take is set to be no more than £1billion.

Job losses and lower City bonuses will also hit income tax, while corporate profits were eight per cent lower last month than a year ago. Tax receipts between April and September rose by only two per cent on last year to £243.7 billion against predictions of 4.9 per cent.

Mike Warburton, senior tax partner at Grant Thornton, said tax rises were needed once the economy recovers: "The economy would be hurt if we tried to solve it by raising taxes or cutting spending too soon."

Shadow Treasury secretary Philip Hammond said: "Gordon staked his reputation on the claim to have abolished boom and bust. It is clear the boom was a debt-fuelled illusion. The bust, however, is becoming a painful reality."