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AUTUMN STATEMENT: George Osborne is trapped in a nightmare of his own making

Nov 25, 2015, 13:34 IST

A demonstrator wearing a mask depicting Britain's Chancellor of the Exchequer, George Osborne, holds up fake bank notes outside the Barclays Bank Annual General Meeting at the Royal Festival Hall, in London April 25, 2013.REUTERS/Andrew Winning

Imagine that you're the head of a major European treasury department. You've been there for five years already, and you've promised to balance the books (and even run a surplus) by 2019 or so.

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Right now, you're borrowing money worth about 3.7% to make your budget work.

But you have some constraints - you were recently re-elected, and promised not to raise VAT, national insurance or income tax. You've campaigned against extra taxes on things like high-valued property, and cut corporation tax. Altogether, that's a lot of your revenue that now can't be raised.

You've also got problems in terms of spending. You've agreed not to cut health, education, or foreign aid spending. Your boss insists on reaching NATO's aim for each country to spend an amount worth 2% of GDP on defence.

You also signed up to a "triple lock" for pensions, that means they rise at the pace of wage growth or faster every year, making the system practically designed to become unaffordable.

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What there is left to cut has already been hacked away at. The remaining unprotected budgets were slashed by about 20% in your first five years, and the cuts will be have to be even deeper there this time. You've recently tried to cut tax credits and run into opposition from both the media and the House of Lords.

This isn't one of those horrible interview questions for wannabe investment bankers - it's the reality that UK Chancellor George Osborne has created for himself.

When he gets up to present Wednesday's Autumn Statement at 12:30 p.m. GMT (7:30 a.m ET), he'll have to square this circle, and the problems he has in doing that are mostly of his own making.

The Autumn Statement is one of the biannual updates on the state of the UK's public finances, when major budget changes are made and any outlooks adjusted.

The UK has repeatedly failed to reach deficit targets set between the Treasury and the Office for Budget Responsibility (OBR) over the last five years. And right now, it looks like they're going to do that again in 2015. The public sector financial figures we've seen for the first few months of 2015-16 don't make this year's borrowing target look likely:

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Capital Economics

And that's partly because the OBR has been repeatedly over-optimistic about tax receipts.

The UK hasn't been meeting its deficit targets, but not because the government hasn't found the cuts to make - reductions in spending have gone more or less to plan. It's the persistent failure of tax revenue to increase as planned that's derailed things:

Pantheon Macroeconomics

The Chancellor is in a strange position. He's politically successful, to an extent. Political journalists regularly talk about him as the presumptive next Prime Minister. He's also been given a gift by the Labour party - with Jeremy Corbyn now in charge, it seems like the opposition will spend more time in the coming years attacking each other than they will working against Osborne.

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But the rules that he's bound himself to mean he's likely to be embarrassed over the next five years, forced to break one or more of the rules he's bound himself to.

Here's what Samuel Tombs at Pantheon Macroeconomics says about today's event:

In Wednesday's Autumn Statement, the Chancellor can accommodate a small rise in the borrowing forecast and still adhere to his Charter for Budget Responsibility, which requires him to achieve a surplus by the end of the parliament. But his margin for error virtually will disappear, with the surplus in 2019/20 probably being revised down to about £5B from £10B.

So from now on, any further unanticipated borrowing will require the Chancellor to either implement more austerity or break his fiscal rule.

As Tombs says, Osborne can still just about reach his surplus target (on paper) even with the squeeze he's facing today. But any further deviations, and that's much more difficult to imagine. He'll be faced with breaking one of his own special rules - cutting protected spending, raising taxes, or failing to reach the surplus he'd aimed for.

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