With the economy still in the doldrums, the chancellor is under intense pressure to come up with a Plan B. Here are his options
The threat of an unprecedented triple-dip recession hangs heavily over the preparations for George Osborne's fourth budget. The economy has been going nowhere for two years and the chancellor has suffered the humiliation of a credit downgrade. When he became chancellor in 2010, Osborne promised four things: a robust recovery, a rebalancing towards investment and exports, a deep cut in the UK's record peacetime budget deficit, and the safeguarding of the UK's AAA status. He has delivered on none of these pledges and the rumblings of discontent on the backbenches reflect poor opinion polls.
Like most of those who have come before him, the chancellor is finding that running the Treasury is a tough task. His honeymoon is long over and he can ill afford a repeat of last year's "omnishambles" of post-budget U-turns. As usual, he has not been short of advice for what to include in his hour-long address to MPs on Wednesday. Vince Cable, Liam Fox and Ed Balls have all put in their two penn'orth in the past week. So what is the chancellor likely to do?
1 Go for broke
Osborne may feel liberated now that Britain has lost its coveted AAA rating and thus decide to take a risk or two. For the past three years, the government has tried to cut the budget deficit in the belief that this will win credibility in the financial markets and allow the Bank of England to provide a boost to growth through rock-bottom interest rates and £375bn of money creation through the quantitative easing (QE) programme. The chancellor may decide – in the face of weak growth and borrowing on course to be higher this year than last – that the mix of policy needs to be changed. Cable has suggested that he should increase borrowing by £15bn to fund infrastructure projects. The thinking is that the demand boost from public works will lead to higher growth, an increase in tax receipts and – eventually – lower borrowing.
Likelihood: 0/5.
2 Get tougher
Osborne could decide that the slippage in the deficit reduction programme – the gap between revenue and spending is currently expected to be £99bn in 2014-15 against the £35bn forecast when the coalition came to power in 2010 – warrants even more draconian measures to repair the public finances. Borrowing is on course to be at least £5bn higher in 2012-13 than in 2011-12 once a number of one-off distortions are stripped out, and if the chancellor finds this unacceptable he could raise taxes, announce fresh cuts in public spending or take another hack at the welfare bill. Osborne's preference up until now, however, has been to allow the "automatic stabilisers" to work. This means accepting weaker growth leads to a bigger deficit, and that tightening policy when the economy is struggling would be self-defeating.
Likelihood : 1/5.
3 Shrink the state to cut taxes
The right wing of the Conservative party and influential free-market thinktanks believe that radical measures are needed to lift the economy out of its zombie-like state. Fox gave voice to this strand of thinking last week when he called for a five-year public spending freeze to free up £345bn for tax cuts. This would require David Cameron to abandon the ringfencing of the budgets for the NHS, overseas aid and schools, while the cuts to welfare would be unacceptable to the Liberal Democrat wing of the coalition. Osborne would dearly love to be in a position to cut taxes, but will not be able to deliver a giveaway package this year.
Likelihood: 1/5.
4 Sit tight
Cabinet members have been briefing that the budget will be one of the most boring of recent times. Osborne, they believe, will announce that he his sticking to his deficit reduction plans but will provide the Bank of England – under governor-designate Mark Carney – with greater scope to ease monetary policy. From the moment he arrived at the Treasury, Osborne has dubbed himself a fiscal (tax and spending) conservative but a monetary (borrowing costs, QE, the exchange rate) activist. The smart money is on him making changes to the Bank's mandate to allow Threadneedle Street to pay more heed to growth over the coming years. This could include giving the Bank a dual growth and inflation target, giving the monetary policy committee more time to bring inflation back to its 2% target or switching to a new target altogether.
Likelihood: 4/5
5 Mix and match
The budget is one of the big moments in the political calendar. It is therefore inconceivable that Osborne will stand up, open his budget box, produce one sheet of paper and say that he is leaving the economy entirely in the hands of the Bank of England.
As usual, there will be an array of measures designed to get the economy moving. Annual tax receipts this year will be upwards of £600bn, giving the chancellor plenty of scope to move money around while sticking to his deficit reduction plan. In big-picture terms, this will mean changing the mix between capital spending – investment in the nation's infrastructure – and current spending, the day-to-day costs of government. There will be more money for fixing roads and building houses, less for Whitehall departments and the welfare budget. There will also be one or two headline-grabbing measures, and there has been strong speculation that Osborne will raise the personal allowance for income tax to £10,000, scrap the planned increase in fuel duty and reduce taxes on business. With no obvious candidates for raising money, the chancellor is likely to fall back on the traditional sources of cash when the Treasury is skint – closing tax loopholes and cracking down on avoidance.
Likelihood: 5/5