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George Osborne faces £20 billion black hole

Chris Giles, Economics Editor and George Parker, Political Editor

George Osborne faces a black hole of more than £20 bn in the public finances,according to official government economic models.

The news suggests that Britain might have to endure an extra year of austerity before the books are balanced.

(Read more: UK's Osborne promises budget of 'hard truths' to balanceeconomy)

Rosie Hallam | Getty Images

The models by the Office for Budget Responsibility, which the Financial Times has replicated, indicate that the government should no longer rely on an economic recovery to eliminate part of the budget deficit.

While Britain has staged a remarkable recovery, indicators of the economy's capacity for future growth have deteriorated. With unemployment falling quickly, the figures show that companies may have little room to expand production rapidly.

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The estimates come less than two weeks before Budget day and pose a difficult challenge to whichever party wins the election. If the models are correct, the next government would have to announce new spending cuts or tax rises to eliminate the structural deficit and ultimately to run a surplus.

Larry Summers vs George Osborne

The Conservatives have promised to eliminate the deficit by spending cuts alone: another £20bn of cuts would put serious pressure on welfare and "unprotected" budgets such as business support, local government and police. Mr Osborne, the chancellor, is already eyeing £12bn of new welfare savings.

Labour and the Liberal Democrats would both face the prospect of having to make deep spending cuts and put up taxes further than expected: both parties have promised to target the rich and expensive properties.

In the run-up to the Budget the OBR faces a difficult choice in the message it has to give the chancellor. It could tell Mr Osborne he will need to pencil in more austerity: or it could tear up its own models, deeming them too pessimistic.

(Read more: Summers and Osborne slug it out over austerity)

The black hole stems from the difference between the actual deficit –expected to be close to £111 bn in 2013-14 and the cyclically adjusted deficit estimated to be £85bn this financial year. So far politicians have assumed that they only need to look at the lower figure.

Changes in the OBR's cyclically adjusted estimates have already been the primary cause of the government's extension of austerity policies from the five years planned in 2010 to the nine years currently thought needed.

Osborne in denial, living standards falling: Shadow Fin Min

If the OBR delivers the bad news to the chancellor in the Budget, it would not mean immediate tax increases but would paint a picture of even more difficult public finances for political parties to face in the next parliament. Austerity policies would potentially be poised to continue until 2020.

The models, which take account of 24 separate indicators of theeconomy's cyclical position, demonstrate the consequences of Britain's weakproductivity since 2010. Even though total output remains 1.4 per cent belowthe 2008 peak, most indicators of the economic cycle – including unemployment,wages and the recruitment difficulties of companies – are already showing a full recovery from the recession, without room for a further acceleration.

The results of the model are also awkward for the Bank of England, which last month published its own estimate, suggesting that spare capacity existed.

(Read more: Carney warns of UK 'false dawn', overheating housing market)

If the OBR ignored the warning signs in its models and gave thechancellor a rosier picture, it would face the risk that over the next fiveyears economic growth performs worse than forecast, leaving the deficit higherthan expected.

The OBR has seen the FT's replication of its models, but refused tocomment on its plans before the Budget.

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