Eric Williams, Birmingham-based national head of private client for Grant Thornton UK, considers the options for Alistair Darling.

We are approaching what is probably the most important UK Budget this decade.

Against a backdrop of the worst recession in most people’s living memory, serious reductions in equity and property values affecting almost everyone in the UK and a fundamental failure in the worldwide banking system, the Chancellor has some critical decisions to make tomorrow.

Public sector borrowing will reach a post-war high next year. Rising government debt and cuts in public sector investment already announced will reduce the net value of the public sector – essentially its assets minus its liabilities – to less than half the level that Labour inherited from the Conservatives in 1997.

In addition the permanent cost to the Exchequer of the credit crunch for at least the foreseeable future, including the bank bailouts, will be around 3.5 per cent of national income, that is around £50 billion per annum in today’s terms.

Overall government debt is forecast by the Treasury to rise to 57.4 per cent of national income by 2013/14 and some respected commentators are forecasting projected debt of over 60 per cent of national income by 2013/14.

Faced with such huge levels of government debt, the obvious reaction is to take urgent measures to reduce it. That would involve some combination of even more spending cuts and tax increases, probably to raise at least £20 billion over the next year or so.

However, it is questionable whether such levels of tax increase and spending cuts are sensible in a recession, given the inevitable adverse effect such action would have on jobs in both public and private sectors. Falls in equity and house prices have already depleted household wealth and increased taxation at this time could make matters worse by discouraging still further the desire of households to spend.

What, then, should the Chancellor do in this budget?

Should he concentrate on reducing his ballooning level of debt or should he accept these debt levels and focus instead on investment to encourage the acceleration of the end of the recession, with a view to attacking debt levels later on when the economy is more buoyant?

The Treasury already collects twice as much in income tax revenue compared to 1997 when the Labour Party came to power. We are already a high tax country and tax increases for very high earners have been announced in the 2008 Pre Budget Report – a 45 per cent top rate for those earning over £150,000 and the withdrawal of the personal allowance above £100,000 of income.

Further tax increases now would be immensely unpopular and probably counter-productive on the personal front. On the business front, according Grant Thornton’s 2008 International Business Report, 77 per cent of global private companies and 70 per cent of those parented in the US say tax issues are a significant factor in deciding where to establish an operating base overseas.

So, what should this Budget do? Fiscal stimulus or fiscal tightening?

Firstly, I believe that any significant tax increase in 2009/10 could easily stifle the recovery before it gains any strength later this year. Personal tax increases will reduce household spendable income at a time when low interest rates and the VAT cut to 15 per cent appear to have just started to stimulate demand.

The very real difficulties faced by businesses in accessing borrowing or in increased borrowing costs as banks seek to rebuild their balance sheets, plus a downturn in demand for their products and services, suggests that any tax rises for business would also be counter productive. Therefore I do not expect to see any significant immediate tax rises beyond those already announced.

We may expect to see, however, further tax increases being announced to take effect in perhaps 2010/11 or 2011/12 as the expected recovery gathers pace. Be prepared also for a widening of the VAT base, and even an increase in VAT beyond 17.5 per cent when the temporary reduction to 15 per cent comes to an end in 2010.

What about public spending?

Spending cuts have already been announced and whilst further limited measures are likely we should not expect any further significant cuts in 2009/10. Once the recovery takes hold, probably in 2010, and with a likely change of government we can expect further spending cuts and tax increases to come.

If these predictions on tax and spending are right, then we are going to see government borrowing continue to increase. However, interest rates are low at the moment and so the cost of servicing that borrowing, at least in the short term, is relatively cheap. Government forecasts suggest average interest rates on government borrowing of below five per cent all the way through to 2013/14, compared with rates up to eight per cent in the 1990s and early part of this decade. The government is forecasting a peak in debt servicing costs, which is significantly lower than Labour inherited from the Conservatives in 1997, notwithstanding the huge increase in government borrowing. Lower interest rates are making the government fairly comfortable with its ability to service the debt whilst it focuses on fiscal stimulus in the short term, instead of debt reduction.

So, I expect a budget of fiscal stimulus, targeted investment but with tax increases and spending cuts to come in a year or two.

My plea to Alistair Darling, if that is what he decides, is to please target the investment at jobs, especially in manufacturing.

Let’s see measures such as increased capital allowances for manufacturing businesses to encourage investment by them, greater relief for losses, even a reduction in employer’s National Insurance, which is essentially a tax on jobs, as well as additional incentives such as a short National Insurance holiday where new jobs are being created, or an initial contribution to employment costs for new jobs.