Put 2p on tax to keep public finances in check, urges IFS

· Thinktank says £8bn more is needed
· Political considerations mean action is unlikely

Alistair Darling needs to raise taxes by £8bn, equivalent to 2p on income tax, if he is to prevent the public finances spinning out of control, Britain's leading fiscal thinktank said yesterday.

But the Institute for Fiscal Studies said that while it would be "prudent" for the chancellor to take action to swell Treasury coffers now, it thought significant action unlikely because of Labour's political difficulties. As a result, the institute thinks the government's self-imposed fiscal rules are likely to be broken.

"We judge that the golden rule is more likely to be missed than hit, even ignoring the impact of Northern Rock," said Carl Emmerson, the IFS deputy director. "The government begins this economic cycle with a much weaker outlook for the public finances than it began the last one."

In its annual green budget, prepared with the investment bank Morgan Stanley, the IFS said borrowing would exceed £40bn in the 2007-08 financial year and over the next two years, meaning Darling will break the rule that national debt remains below 40% of national income in 2009-10. Although the government met its "golden rule" of covering current spending with tax revenues over the 10 years to 2006, the IFS said it was highly likely that it would not meet it in the cycle just begun, especially as it was starting it with big deficits.

The IFS warned that the outcome could be even worse if the economy grew more slowly than the Treasury expected. "The government is likely to argue that further bad news on the public finances will only be temporary and that fiscal policy should support monetary policy as the economy slows," it said.

"However, recent experience suggests that temporary problems in the financial sector can have a bigger and more persistent effect on the public finances."

David Miles, a Morgan Stanley economist, said he thought the economy would be weaker than the Treasury is forecasting and that there was a one-in-three chance that the economy would go into recession, with grave consequences for the UK's public finances.

The IFS said that any decision to put Northern Rock on the public sector's books would add £100bn to the national debt or about 7% of GDP. Although this would result in an even bigger breach of the government's 40% ceiling for debt, the IFS said any impact would be temporary, since the state would sell off Northern Rock's mortgage book.

The IFS said that while Labour's years in office had seen both the budget deficit and national debt reduced from the levels inherited from John Major in 1997, other countries had done better.

"Of 21 comparable industrial countries, 16 have reduced their debts and 19 have reduced their structural budget deficits by more than the UK while Labour has been in office," it said.

George Osborne, the shadow chancellor, said: "Today's damning and independent report by the respected IFS is startling evidence of just how completely Gordon Brown failed to prepare the British economy. "While our competitors can use their surpluses to guard against turbulence, we borrowed in a boom and have no room for manoeuvre," he said.

The IFS also criticised as "shambolic" the government's handling of its reforms to capital gains tax and said its latest concession on "entrepreneur's relief" would add complexity back into the tax system.

It was also unhappy with the staging of public-sector pay awards, saying they would only make modest, one-off savings; make little contribution to fighting inflation, and would undermine the credibility of the pay review body process.

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