Slowdown to slash tax revenues, City warns

It is feared that slower economic growth next year will deprive the Treasury of much-needed tax revenues for spending on health and education and leave a gaping hole in the budget.

The warning came as Darling - in his first Pre-Budget Report as Chancellor - was expected to tear up forecasts made by his predecessor Gordon Brown just seven months ago.

It will be a blow to Brown, who for years has staked his political reputation on the state of the economy.

Howard Archer of Global Insight said: "The extent to which Alistair Darling downgrades the growth forecast has significant repercussions for the public finances. If growth comes in well below the Government's previous estimates, Darling faces either having to raise the public finance targets, or having to take some corrective measures to meet them - lifting revenues through tax and/or trimming public expenditure."

In his final Budget in March, before taking over as Prime Minister, Brown forecast economic growth of between 2.5% and 3% next year.

He also pledged to turn a £4 billion shortfall in the current budget this year into a £3 billion surplus next year. And he said borrowing will fall from £34 billion this year to £30 billion next year and then to £28 billion, £26 billion and £24 billion in the following three years.

City economists, however, said today that this was unrealistic and expect Darling to make a string of revisions in the House of Commons. The consensus view in the City is that the economy will grow by around 2% next year, with George Buckley of Deutsche Bank looking for 1.8% - the lowest rate since 1992.

Economists said the lower rate of economic growth will hit tax receipts, putting pressure on Brown's rosy outlook for the public finances.

Receipts from stamp duty, VAT and income tax could all drop as a result of a slowdown in the housing market, falling sales on the High Street and job losses and bonus cuts in the City.

Simon Hayes of Barclays Capital said: "We think the Treasury is being excessively optimistic in expecting the current budget to move strongly into surplus over the next few years. The pronounced downturn in domestic demand we expect to see next year reinforces our view that the current budget is unlikely to move into a significant surplus."

He forecast a deficit of £6 billion next year and £3 billion in 2009 against Brown's hopes of a surplus of £3 billion and £6 billion. Hayes also expects borrowing to rise to £38 billion next year rather than fall to £30 billion as the Treasury makes up for the shortfall in tax receipts.

Trouble in the world money markets has put further pressure on the economy and the Chancellor last week said it would be "prudent" to expect the credit crunch to take its toll in Britain.