Labour rejects claims of ?5bn tax black hole

Tax increases of £5bn a year or higher borrowing will be needed by the end of the next parliament if Labour is to continue rebuilding run-down public services at the current rate, the Institute for Fiscal Studies said yesterday.

Triggering the first row over tax and spending in the election campaign, the highly influential thinktank said the war chest built up by Gordon Brown during the past four years would comfortably cover the boost to schools, hospitals and transport until 2003-04.

But it warned that further increases at 3.8% a year in the years after that would require the government either to raise taxes by the equivalent of almost 2p on the basic rate of income tax or push the public finances deeper into the red. Andrew Dilnot, the IFS's director, said: "This is not a deep point, it is a matter of arithmetic."

Tony Blair meanwhile gave the clearest signal yet that Labour would not raise the top rate of income tax. At a question and answer session in St Albans, Hertfordshire, he made clear that he would resist pressure from party activists to put up the top rate of tax to 50p.

He said: "I know many people who support us strongly might like us to change tax rates at the top, but I believe the best thing we can do is offer real opportunity at the bottom."

Labour last night rejected Tory claims of a "black hole" in the public finances, saying that Mr Brown's plans were affordable and that the IFS projections were entirely hypothetical. Labour said tax revenues had turned out better than forecast in recent years as a result of falling unemployment and that there was every reason to expect further improvements. It added that William Hague's plans involved cutting spending to finance tax cuts.

"Labour's commitment is a clearly balanced approach meeting the fiscal rules and the needs of public services and targeted tax cuts we can afford," a Labour spokesman said.

However, Michael Portillo, the shadow chancellor, said Mr Brown had "conspicuously failed" to mention tax cuts as one of his five economic goals for the next Labour government, which the chancellor unveiled yesterday morning. "It's not difficult to see why," Mr Portillo added. "Labour want to go on spending faster than the economy grows. That would leave Gordon Brown with a black hole in the public finances that would have to be filled with higher taxes."

The IFS said Labour could afford to spend heavily on its priority areas of health, education and transport because it had turned round the public finances in its first term, raising the tax burden and keeping a tight control on public spending. Despite the tough discipline, spending on schools and hospitals had increased more rapidly under Labour than in the 18 years of Tory rule.

"It seems, then, that the government is likely to be in a position where it can afford the large increases in spending planned to take effect between now and 2003-04," the IFS said. However, it doubted whether the government would be able to rein in the rate of increase for spending on health and education once the current three-year plan expires in 2003-04.

The IFS added that if Labour wanted to continue increasing public spending at the current rate of 3.8% above the rate of inflation after 2003-04 and the growth rate remained at 2.5% a year, it would have to increase taxes by £5bn a year. However, if it scaled back the increases to the rate of 3.3% originally laid down in the spending plans last summer, the annual increase in taxes would need to be £3bn.

Last night Labour set out its five main commitments for a second term with a new version of its pledge card, which focuses on improving key public services by recruiting more teachers, doctors, nurses and police officers. The party pledged:

• 10,000 extra teachers and higher standards in secondary schools;

• 20,000 extra nurses and 10,000 extra doctors in a reformed NHS;

• 6,000 extra recruits to raise police numbers to their highest level yet;

• Pensioners' winter fuel payment retained and the minimum wage rising to £4.20;

• Mortgages as low as possible, low inflation and sound public finances.

Ministers called the pledges "symbolic of the agenda for the second term". But since most extra staff had already been promised, the latest additions are modest, and were mocked by the Tories as an attempt to repeat a failed 1997 "stunt".

Labour's full manifesto will be published on Wednesday. It is being finalised today.