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Osborne Facing Tax And Spending Questions

The Institute for Fiscal Studies is one of those institutions which is as feared in Downing Street as it is revered throughout the academic world.

This is hardly surprising: its job, after all, is to hold the Chancellor to account, providing an independent assessment of his tax and spending decisions. So the IFS's Green Budget, its annual report on the state of the UK economy, is always a closely-watched event.

This year's publication is no exception. Among the many issues tackled in its pages are the generosity (or not) of the universal credit system, the question of whether it is possible to confront footloose multinational companies like Google and Starbucks (Swiss: SBUX.SW - news) on their tax behaviour and whether we are taxing fuel and alcohol properly.

But the issue garnering most attention from today's report, which you can read in full here , concerns George Osborne's fiscal rules, and whether they might force him to raise taxes or slash spending in the future.

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Veteran economy-watchers may hear a bell ringing at this point. After all, Gordon Brown spent much of his Chancellorship being warned of fiscal black holes by the IFS - much to his chagrin. And, given what ensued, he might have done well to listen to them.

Mr Osborne has three fiscal rules and he is not doing well on any of them. One of them compels him to cut the national debt (as a percentage of GDP) every year.

He is likely just about to meet this challenge this year and the next, though only by selling off a whole load of public assets - hardly a sustainable way of getting the debt down.

There is another rule, the welfare cap, that is supposed to limit his spending on social security. Thanks to his U-turn on tax credit cuts in the Autumn Statement, he will breach this rule this year and will do so for the next three years as things stand.

Finally there is his surplus rule. This stipulates that he must generate a surplus in the public finances (in other words to bring in enough tax revenues to more than cover his spending) by 2019/20, and every year thereafter. This would be no mean feat.

The Government has achieved a surplus only eight of the past 60 years. Mostly we, as a nation, are more inclined to notch up deficits, where we borrow to make good the shortfall. The same goes for many developed economies.

Anyway, on the basis of the last Autumn Statement, Mr Osborne was planning to meet this target with a bit of room to spare by 2019/20. He had pencilled in a £10bn surplus by then.

However, that figure did not take account of about £8bn worth of tax giveaways that he had pledged during the election campaign (remember all that stuff about increasing personal allowances and the higher rate tax threshold?).

And, since the Autumn Statement, the outlook for tax revenues has worsened. Share (Berlin: 5CI.BE - news) prices are down sharply: that could cost him about £2bn in revenues. Average earnings look considerably weaker, which could mean income tax revenues drop by about £5bn.

Subtract the total £15bn in "disappointments" from the Chancellor's leeway and you see the problem: far from getting a surplus in 2019/20, he might find himself staring at a deficit.

This leaves him with three options. The first is to raise taxes or cut spending to meet the rule. There are already whispers that he is considering a major raid on pensions.

The second is to change the date on the rule, giving him more time to meet it. The third is to ditch the rule altogether.

Most economists would recommend the latter. They never much liked the rule, which seemed arbitrary and blunt. But Mr Osborne - a politician first and economist second - realises that doing so would damage his credibility. So higher taxes and lower spending may well be in store. Britain's days of austerity are not over yet.