Amid sluggish growth and fears over Britain's AAA credit rating, the chancellor has difficult questions to answer – over his own pledges on the deficit
When Gordon Brown was in No 11 Downing Street, last-minute tweaks and late-night dashes to the printers were part of the ritual in the runup to a major outing for the chancellor at the dispatch box.
But having tied his own hands by setting up the independent Office for Budget Responsibility (OBR), run by ex-Institute for Fiscal Studies director Robert Chote, Osborne can't get away with the skin-of-the-teeth decision-making favoured by the Treasury's movers and shakers in the Labour years.
Instead, Osborne and his aides now have to present any tax and spending changes they plan to make to the OBR well in advance, so that it can make its own projections of the impact on the public finances.
Just because the numbers are already inked in, though, it won't make the chancellor's mathematics any easier. When he delivers Wednesday's autumn statement, Osborne will have to explain why his austerity drive has failed to kick-start growth, a full two-and-a-half years after the government came to power. He is also likely to be forced to concede that at least one of his cherished fiscal rules will have to be torn up.
Setting up the OBR and drafting two new rules to replace Gordon Brown's discredited fiscal framework in 2010 enshrined the chancellor's deficit-cutting plans at the heart of government policy, after an election campaign in which the Tories had raised the spectre of a Greek-style economic death spiral if the public finances were not brought under control.
More importantly, the new regime tied Osborne's hands, preventing the Treasury from massaging its economic forecasts to make the public finance projections add up – something Brown was repeatedly accused of when he was in Downing Street.
However, the OBR's independence from government is no guarantee that its forecasts are any better than those of the Treasury (or the Bank of England). Chote's team has repeatedly overestimated the strength of the economy – and, some experts argue, the likely impact of the deepest cuts in a generation on the UK's growth rate.
Since Osborne delivered his 2010 budget, the economy has plunged back into a double-dip recession, while growth has repeatedly undershot expectations. On Wednesday, when it publishes its latest projections, the OBR is likely to have to cut this year's growth rate from 0.8% to something around zero, and next year's from 2% to something closer to 1%.
"The growth forecasts that the OBR had made in March looked optimistic at the time and are now well above other economists' forecasts," says Simon Wells, UK economist at HSBC.
Such large cuts in growth forecasts mean billions of pounds in lost tax revenues, and more costly welfare bills – putting the public finances way off track. This year alone, most analysts believe the latest official figures, covering the first seven months of the fiscal year, suggest that the deficit will be at least £10bn larger in 2012-13 than the £121bn the OBR was projecting in the spring.
In last year's autumn statement, the chancellor extended his austerity plans for two years beyond the next general election in 2015, so that he could still say that his "fiscal mandate", of eliminating the structural budget deficit over the coming five years, would be met.
The IFS now believes he may need to repeat that trick, promising relentless austerity until 2018. "Austerity is going to be longer and harder than was envisaged even a year ago," says Wells.
The chancellor is also likely to provide more detail on how he will achieve the drastic cuts pencilled in for 2016 and 2017, an extremely fraught subject since his suggestion that he would demand £10bn of cuts to the benefits bill provoked fury among the Liberal Democrats, who would like to see a heavier tax burden on the wealthy in return.
Much will depend on whether Chote and his colleagues have decided the worse-than-expected state of the economy is a temporary blip or a permanent hit. Crucially, the Treasury's target aims at eliminating the "structural" deficit – the underlying gap between taxation and spending once the short-term impact of booms and busts in the economic cycle is taken into account. That means it is deliberately drawn up to be flexible in difficult times.
As Bank of England governor Sir Mervyn King put it earlier this year, "the plan did allow for the fact that if the economy were to grow slowly, then taxes would not rise as quickly and spending would be higher – so the deficit would be bigger … The plans said 'don't attempt to bring that deficit down if it's the result of slow growth in the economy'."
If the OBR thinks that the UK is just suffering a temporary shortage of demand, so that growth – and revenue – will bounce back strongly once it's over, it could still declare that Osborne's target will be met.
But economists are fiercely divided about how much of the shortfall in growth is temporary, and how much reflects a more fundamental shift in how strongly the economy is able to expand over the long term.
Even if Osborne scrapes through that tough test, City experts believe there is a much stronger risk that the Treasury will miss its second, "supplementary" target, which requires debt to be falling, as a percentage of GDP, between 2014-15 and 2015-16. This rule, which Osborne said in 2010 would "place our fiscal credibility beyond doubt", is harder to wriggle out of, since it involves a specific year.
Philip Shaw of Investec says: "As things stand, the deterioration in the public finances makes it difficult to see how the debt ratio could turn downwards as early as 2015-16, and on a 'do nothing' scenario the danger is that the OBR will conclude that this rule will be missed."
Osborne granted himself one potential get-out-of-jail card last month, when he insisted that the payments on the bonds bought by the Bank of England under the quantitative easing programme, worth about £35bn, be held on the Treasury's books, instead of being paid to Threadneedle Street.
But the IFS – which was widely considered the best independent check on the public finances before the OBR came into being – has insisted that these revenues will only flatter the finances temporarily and may not offset the losses that the Bank will sustain when it sells the bonds back into the market. For that reason, it says they should just be ignored for the purposes of the public finances.
"He used to accuse Gordon Brown of moving the goalposts on the golden rule, and this would smack of the same thing," says Howard Archer of consultancy IHS Global Insight.
In that case, Osborne will have to admit that the carefully crafted rules meant to be the key test of whether he is bringing the Treasury's finances under control have been breached. Wells at HSBC warns that that may provoke alarm at the ratings agencies, which have so far given their backing to the chancellor's approach.
"There is no doubt that the UK had a plan, which many western economies didn't, and because of that the rating agencies have been giving us the benefit of the doubt so far," Wells says. "But there's only a certain number of times you can accept the pain being pushed down the road."
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