The Pre-Budget Report announced surprisingly large medium-term fiscal tightening measures but these were necessary to prevent a further upward revision to borrowing projections. The Report takes a big political risk by raising taxes on the middle classes as well as high earners, and an economic risk by delaying a cut in borrowing until 2011-12.

Key points:

The main surprise was the 0.5 percentage point rise in National Insurance Contribution (NIC) rates from April 2011, which will hit middle earners and raise £3.0 billion by 2012-13. A further attack on pensions tax relief brings in £500 million and a freezing of the higher-rate income tax threshold £400 million in the same year. The one-off bankers’ bonus tax was overtly political rather than fiscally meaningful – it is doubtful that the projected £550 million in 2009-10 will be achieved.

The Chancellor also cut longer-term spending forecasts, with "total managed expenditure" now projected at £752 billion in 2013-14 versus £758 billion in the Budget. Savings include £3.4 billion from a one percentage point cap on pay settlements in 2011-12 and 2012-13 and £1 billion from pension reforms. The Report’s overview refers to growth in real current spending of 0.8% a year between 2011-12 and 2014-15 but this greatly underestimates the coming squeeze because it ignores plans to slash investment and a rising burden of debt interest. Detailed figures within the Report imply that total spending excluding interest will contract by a real 0.6% a year between 2010-11 and 2014-15.

Despite tax increases and reduced spending, the projection for public sector net borrowing in 2013-14 is only £1 billion lower than in the Budget, at £96 billion. With little change to underlying economic assumptions, the implication is that the Budget revenue forecasts either were too optimistic or embodied an assumption of further significant tightening.

The debt interest projections continue to be based on hopeful-looking interest rate assumptions. Net interest is forecast to rise from 1.9% of GDP in 2009-10 to 3.3% by 2014-15 but the latter figure implies an average interest rate on outstanding net debt of 4.3%, well below projected money GDP growth of 6.1% in the same year.

The Chancellor revised his projection of the fall in GDP in 2009 to 4.75% from 3.5% but maintained growth forecasts of 1.25% and 3.5% for 2010 and 2011 respectively. Despite this year’s shortfall, the money GDP projection for 2010-11 is higher than in the Budget because of faster-than-expected inflation.

By delaying deficit-cutting until 2011-12, the Chancellor is relying on the kindness of the gilt market as it takes over responsibility from the Bank of England for funding the current gargantuan shortfall. A big rise in gilt yields could yet derail his economic and fiscal strategy.