THE EURO

Britain would face a series of tax bombshells if it joins the euro under plans drafted by Gordon Brown to control the direction of the economy. The Chancellor aims to compensate for losing the ability to change UK interest rates to boost or cool down the economy by making greater use of powers over taxes, including VAT and stamp duty. Brown would use regular "mini-budgets" to maintain his control over the economy and smooth the peaks and troughs of economic activity. The Tories seized on the warnings that the cost of living and house prices could rocket under the euro as proof that entering the single currency would "put at risk people’s mortgages and jobs".

If Tony Blair finally succeeds in marching Britain into the single currency, he would automatically cede control of interest rates - one of the most important economic levers under his command - to the European Central Bank (ECB). Using tax policy, particularly VAT and stamp duty, would be the Chancellor’s most likely alternative strategy for maintaining control over the economy. But in the first estimates of the likely impact of using taxes to manage the economy, leading economists have warned that he would need to impose massive increases in VAT and stamp duty to have the same effect as a relatively small change in UK interest rates has today.

Under the euro, an £11bn-a-year tax hike would be needed for fiscal policy to have the same effect as a 1% increase in interest rates by the Bank of England, according to early estimates by HSBC. This would be the equivalent of hiking VAT by 2.8 percentage points - up to 20.3%, from 17.5% today. John Butler, UK economist at HSBC, said, "Very important and frequent swings in tax rates would be required. Budgets would become very important again. You would not be able to change taxes only once a year; rather we would be talking about varying tax rates potentially as frequently as every couple of months."

The Treasury believes that its little-known discretionary "regulator" powers, which already allow the government to vary VAT rates by anywhere between 13.1% and 21.9% - the equivalent of £15.9bn - without asking parliament, would be insufficient to cope with all eventualities. These limits could potentially constrain the ability of the existing regulators to offset large shocks by themselves. A wider degree of permitted variation may therefore be desirable, the Treasury argues in one of the 18 background studies on euro entry released last week, implying that the tax changes could reach well over £20bn if the economy grows too quickly or too slowly.

Michael Saunders, chief European economist at Citigroup, said, "The Treasury is proposing a return to a 1960s or 1970s world of mini-budgets, with tax changes used if capacity use deviates significantly from average. Such frequent tax changes could be economically damaging if they distort price signals. They would be politically difficult, requiring the government to punish rapid growth with tax hikes. It is also unclear how such a framework could comply with the EU stability and growth pact which limits the use of fiscal policy and budget deficits."

Analysts were also questioning the suggestion in Treasury documents that stamp duty could be varied to dampen fluctuations in the housing market and manage overall demand in the economy. Sabina Kalyan, a housing economist at Capital Economics, said, "The kinds of stamp duty rises you would need would be so huge that it would be political suicide and hence not tenable." With house prices still growing by 15% to 20% a year, even a 10% hike in stamp duty would still leave gains of between 4% and 9% for cheaper houses currently paying a 1% levy, analysts said.

Michael Howard, the shadow chancellor, said, "Joining the euro would put at risk people’s mortgages and jobs. These new euro taxes threaten to cost thousands of pounds." Brown said that while he backed euro membership in principle, he did not believe that the UK was ready to enter the single currency. He said the government would report back on progress towards meeting the tests in the budget next year - and then decide whether to assess his five tests for euro membership again. He said a bill would be unveiled this autumn to pave the way for a possible referendum next year.

Income tax would have to rise by 5p in the pound if Britain decided to join the euro, it has emerged. The startling conclusion, the equivalent of a £16bn tax rise, is part of the Treasury's economic model on the conditions necessary to ease the transition into the single currency if and when it happens. The figure was found 'buried' in the technical studies published as part of Gordon Brown's assessment of euro membership. Such a painful rise in income tax would be required to prevent spiralling inflation and an unsustainable economic boom.

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