updated 12/7/2009 10:59:15 AM ET 2009-12-07T15:59:15

The British government is likely to slug high earners with more taxes to pay the cost of economic recovery in a major budgetary report this week that will stake out its position ahead of the country's next general election.

With Britain one of the few major economies still in recession and the leadership poll less than six months away, Wednesday's pre-budget report is a critical opportunity for the beleaguered Labour government to claw back some vital ground from the opposition Conservative Party with voters.

But the conflicting economic and political pressures make the task of laying out the government's spending, taxation and borrowing plans a highwire act for Treasury chief Alistair Darling.

While he is likely to shy away from any sweeping tax hikes that would be unpopular with an electorate due to vote by June, Darling must still come up with a credible proposal to fuel Britain's recovery from its worst economic slowdown since World War II and cut spiralling government debts.

IHS Global Insight economist Howard Archer said that under normal circumstances the approaching election "would be cue for some serious sweeteners ... to try and gain votes."

"However, there is really no scope for anything meaningful, and the cost of any new sweeteners will have to be offset by other cost saving measures," Archer added.

With major giveaways out of the question, the government is likely to hit wealthier Britons with a number of permanent or temporary taxes — a strategy that has the added advantage of a perceived public "pay back" by those who benefited most from the economic boom that led to the crash.

Lawmakers consider other options
Measures reportedly being considered include a yearlong windfall tax on bank profits and bankers' bonuses following the government's multibillion pound bailout of the sector at the height of the global credit crisis last year.

Another option is a reversal of a tax cut for the country's richest households.

Darling has so far declined to comment on any proposals in detail, but has made clear that anything that doesn't harm recovery is on the agenda.

"We are not going to be held to ransom by people who believe you can pay extremely large bonuses regardless of what's going on," he told BBC television on Sunday. "You have to be fair. You have to be reasonable."

The spotlight on bankers' bonuses follows a public dispute with the Royal Bank of Scotland, the beneficiary of the biggest state-funded bailout in the world. RBS' executives have argued that the government's insistence, as a major stakeholder, on curbing bonuses will harm its ability to turn a profit in the future.

Heavy hangover
Britain is facing a heavy hangover from the global credit squeeze because of its huge financial sector, where the government was forced to carry out a multibillion pound rescue and higher levels of personal debt among consumers. Like the United States, it also faces a collapsed real estate bubble.

The country's services sector, which accounts for nearly three quarters of the economy, expanded for the second consecutive month in November, suggesting improvement. But the economy remains officially in recession, unlike the United States, Japan, Germany and France.

Economists say it's clear that the economy has performed worse this year than Darling predicted in his full annual budget in April, when he forecast a 3.5 percent contraction in gross domestic product.

Many expect Darling to revise that to a drop of between 4 and 5 percent, although he is likely to retain his forecast of 1.25 percent growth in GDP for next year.

The banking sector bailout and billions of pounds lost on a yearlong reduction in retail sales tax and deferrals on company tax have likewise taken a heavy toll on the government's coffers. Economists expect Darling to revise his forecast for public borrowing upward from the current 175 billion pounds.

The need to raise revenue to repair the finances is countered, however, by Britain's position as a place to do business, said Chris Sanger, Ernst & Young's Head of Tax Policy.

Two paths offered before election
With economic recovery by no means assured, the Labour Party is at odds with the Conservative Party about the path to sustained growth.

The Conservatives want the blowout in the budget deficit to be addressed much quicker and have already announced they will hold an emergency budget within 50 days of coming to power if they win the election.

Prime Minister Gordon Brown acknowledged on Monday that Britons face a "profound choice" at the poll with "two competing visions about managing our economy through and out of recession, two competing visions about a fair society."

The Institute for Public Policy Research urged Darling to use the pre-budget report — introduced by Brown when he became Treasury chief when the Labour government came to power in 1997 to signal major changes in the following spring's full budget — to set out an "honest and bold" package of long-term spending cuts and tax rises.

The pre-budget report has been expanded from its first incarnation to include significant policy announcements on its own and the IPPR said it is the ideal opportunity to start the process of taking tough decisions which will be needed to bring down Britain's potentially damaging deficit once recovery is underway.

"Learning the lessons of the expenses crisis, now is the time for the Government to be honest with the public and engage them in a debate about priorities," said IPPR co-director Carey Oppenheim said. "This will mean proposing measures that are likely to be unpopular, but necessary, if the government is serious about closing the U.K.'s fiscal deficit."

Copyright 2009 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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