British finance minister George Osborne looks set on Tuesday to announce big spending cuts and tax rises in what will be the tightest budget in a generation and the first big test for the new coalition government.
As the sovereign debt crisis spreads through Europe, rating agencies have warned even Britain's triple-A status could be at risk if the 39-year old Chancellor of the Exchequer's plans to cut the record deficit are found wanting.
But many economists are also concerned that tightening policy too fast right now could plunge Britain back into recession. U.S. President Barack Obama called on his fellow G20 leaders last week not to repeat the mistakes of the 1930s.
Osborne's view, however, is there is no time to waste following an election last month in which the Conservatives and smaller Liberal Democrats took power in an unusual coalition.
The finance minister has said he will slap a new tax on banks, raise capital gains tax, freeze public pay, examine the welfare system and take an axe to spending on top of the hefty tightening announced by the previous government.
Speculation is also rampant that VAT sales tax will go up to 20 percent from 17.5 percent but the personal allowance is expected to be raised by some 1,000 pounds taking 880,000 people out of the tax net. There is a possibility the headline rate of corporation tax will fall, although this would be offset by savings elsewhere.
"While an improved fiscal position will improve the economy's long-run prospects, we remain certain that the consolidation itself will act as a major drag on the economy over the next few years," said Jonathan Loynes of Capital Economics.
Treasury sources say the budget will have two main themes. The first is being honest about the size of the problem and a second more optimistic one about it being a starting point for unleashing a wave of private sector enterprise and growth.
The government will also publish a distributional analysis of the budget for the first time in an effort to show it is "progressive" and which should reveal a flattish profile with the rich being slightly harder hit.
FEWER GILTS
The Conservative/Liberal Democrat coalition has already announced 6 billion pounds worth of cuts since taking office last month which combined with revisions to last year's figures suggest that gilt issuance for this year will be lower.
A Reuters poll of market-makers last week predicted the Debt Management Office would revise down its issuance remit to 165 billion pounds in 2010/11 from 185.2 billion pounds.
Both coalition partners are united on the need to cut the deficit but differences have already emerged between the centre-right and centre-left partners on how and where the axe should fall.
The scale of the challenge certainly is enormous. The previous Labour government's plans implied more savage cuts than even the Thatcher Conservative administration enacted in the early 1980s. The coalition has promised to go faster than that.
Osborne has said the tightening should be split 80-20 between expenditure cuts and tax rises. He will announce the overall spending envelope but a departmental breakdown won't be available until probably late October. There will be no new capital spending cuts.
But given that certain departments like health will be spared the scythe, others could see their budgets slashed by as much as 20 percent, raising the risk of a wave of strikes in the public sector later in the year.
VAT'S UP?
The administration has also repeatedly refused to rule out a rise in VAT and many analysts predict a jump to 20 percent from the current 17.5 percent, bringing in some 11 billion extra pounds.
More controversial are plans to raise capital gains tax from 18 percent to something closer to 40 percent. This was a Liberal Democrat policy which has greatly angered many Conservative backbench MPs and large parts of the right-wing press.
A bank levy is also expected. In opposition, Osborne said he expected this would raise around 1 billion pounds but the Liberal Democrats favour a much bigger tax of perhaps 4 to 5 billion pounds.
Drinkers and smokers are also likely to be hit hard with more tax rises and analysts are predicting a rise in so-called "green taxes" to help protect the environment.
There has also been much speculation about whether Osborne will go ahead and cut the headline rate of corporation tax from 28 percent. Reducing it to 25 percent had been a Conservative pledge and paying for it by getting rid of some reliefs had been a Conservative pre-election promise.
But the Lib Dems are unhappy with scrapping the reliefs and the promise has been downgraded to an aspiration. Still, Osborne may find some room to come down, particularly if he wants to ram home the message of unleashing private sector potential.
