Case for UK tax cuts is stronger, says IFS
The argument for the chancellor to cut taxes to boost the economy is stronger than it was a year ago, according to the Institute for Fiscal Studies (IFS).
Its Green Budget said the government could safely cut taxes temporarily, without worrying that the Bank of England would raise rates in response.
But the IFS warned a big tax cut would risk undermining investor confidence.
It also warned that the current risks to the economy meant that there was little scope for long-term tax cuts.
It cited the pressure on health and pensions spending caused by the ageing population as putting long-term strain on the public finances.
The IFS predicted that government departments would borrow about £2.9bn less in the current financial year than the latest official forecasts suggested, but warned that risks to the economy from dangers such as a growing crisis in the eurozone could mean that borrowing has to be increased.
The IFS releases its Green Budget every year before the actual Budget. It suggests measures that the think tank considers should be included in the chancellor's plans.
George Osborne is due to deliver his Budget on 21 March.
Room for manoeuvre
"The chancellor faces his third budget with the economy and public finances in considerably weaker shape than he had hoped a year ago," said Paul Johnson, director of the IFS.
"His room for manoeuvre is further curtailed by risks that the economy might do even worse than expected, especially if the eurozone should break up."
The Green Budget also includes forecasts from Oxford Economics, which predicts that the UK economy will grow by 0.3% in 2012, less than the Office for Budget Responsibility's projection of 0.7%.
But it warned that "a eurozone crisis would see the UK back into deep recession", with the economy contracting in both 2012 and 2013.
The IFS criticises the government's plans to withdraw child benefit from households with a higher-rate taxpayer from 2013, on the grounds that it would create a "cliff-edge" that would mean 170,000 families could increase their income by earning less.
The think tank suggests that the government should instead gradually reduce child benefit as household income rises, using the existing means-testing system that is used to pay child tax credit.
It says that the current public sector pay freeze and planned two years of 1% increases will return public sector pay to the same position it was relative to private sector pay before the recession.
But it also suggests that there is a strong argument for moving towards more regional differentiation in public sector pay.
The IFS says that in some regions, public sector workers are paid on average 18% more than their private sector counterparts.