Almost two million Britons have accepted pay cuts or reduced hours to stave off unemployment, causing government income tax receipts to collapse by almost one fifth.
The Government is now facing the biggest peacetime deficit in history, and ministers will next week confirm they are likely to borrow close to £180 billion this year – the equivalent of the entire NHS and education budgets combined.
Alistair Darling, the Chancellor, will say in his pre-Budget report that the deficit is higher than expected because income tax receipts have been directly hit by the fall in wages.
Between April and October, the amount the Treasury received in income tax fell by 16 per cent – more than £17 billion – compared with the same period in 2008.
The Treasury calculates that 1.7 million people who might have been made redundant in the recession have been saved from the dole queue by taking a pay cut or shorter hours.
"This wage restraint is the reason why, in bald terms, there has been lower unemployment," one Treasury official said. "But the price we have paid is we have had less money coming in and therefore higher borrowing."
Officials have calculated that in the past year a third of all pay settlements between workers and their companies, affecting up to 10 million employees, were for pay freezes or below-inflation increases of a mere 1 per cent.
This proportion has never been so high: in the years preceding the recession, only one in 50 pay settlements was in that range.
Independent research has shown that, on top of this, around seven per cent of businesses were this year preparing to cut their workers' pay.
In addition to reduced full-time salary agreements, a number of major companies such as BT and KPMG have offered their workers sabbaticals in return for pay cuts.
Mr Darling will cite the shift to "more flexible working" next week as he declares that the Government's policies have helped prevent unemployment – currently 2.5 million or 7.8 per cent of the workforce – from reaching the peaks it did in previous recessions. However, the Treasury still expects unemployment to continue to increase next year.
Yesterday the steelmaker Corus announced that it was to axe 1,700 jobs as it cuts production at its Teesside plant.
John Philpott, of the Chartered Institute of Personnel and Development, one of Britain's leading employment economists, said: "This is a shared pain recession, with the impact of the downturn spread throughout the workforce rather than falling solely on the jobless.
“Although the number of pay freezes will be moderate, it will be a continuing phenomenon right into next year, and perhaps beyond.”
The Chancellor will use Wednesday’s pre-Budget report to give warning that although the economy is expected to start growing again before the end of the year, Britain will this year record its biggest slide in economic output since comparable records began. He will forecast a fall in gross domestic product of 4.75 per cent, and only weak growth of 1.25 per cent next year.
He will risk causing instability in the markets by announcing that, far from drawing up more ambitious plans to cut the deficit as the Treasury had suggested in previous months, he will borrow more this year than originally expected.
But he will take just as long to start paying it back as was laid out earlier this year in the Budget. In a set-piece which is likely to kick off six months of campaigning ahead of next year’s general election, the Chancellor will focus on the extent to which the Government’s policies have prevented a Great Depression in Britain.
He will emphasise that Conservative plans to cut the deficit more dramatically would risk sending the country into a longer-lasting recession.
A spokesman for the Conservatives said the Government’s lack of a credible plan to deal with the deficit “will mean higher taxes and higher interest rates, undermining the recovery”.
The PBR is likely to opt for political positioning over good government,” the spokesman added.
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