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Surging debt interest payments and sluggish growth have left the UK chancellor Jeremy Hunt with little scope for pre-election tax cuts, the latest analysis suggests.
Hunt warned last week of “difficult decisions” for the public finances in his Autumn Statement on November 22, as the government faces up to a difficult economic backdrop.
The analysis by the Institute for Fiscal Studies think-tank, released on Tuesday, underscored the pressure facing Hunt as he grapples with calls from the right of the Conservative party to push through tax giveaways before the next general election.
Public borrowing is forecast to reach £112bn this year, or 4.2 per cent of gross domestic product, said the IFS. The figure is below March predictions but well above its long-run average — and £60bn more than forecast in the 2022 spring Budget.
As a result, national debt will remain stuck at close to 100 per cent of national income, even with tight public spending settlements and further increases in taxes lying ahead.
“We are in a horrible fiscal bind,” said Paul Johnson, director of the IFS. “The price of our high levels of indebtedness, failure to stimulate growth, and high borrowing costs is likely to be a protracted period of high taxes and tight spending.”
The IFS said that, whether or not the chancellor met his self-imposed fiscal rule — requiring debt to fall as a share of national income between years four and five of the forecast period — made little difference. The rule was too easy to game by pencilling in future spending cuts that carried little credibility, the think-tank noted.
Like other governments, the UK is under pressure to show it is gaining control of its outsized public deficits amid flighty bond markets and elevated levels of inflation.
That challenge has been made harder in Britain by the rising share of public spending being consumed by debt interest payments.
Debt interest spending reached 4.4 per cent of national income in the most recent fiscal year — compared with an average of 2 per cent over the first two decades of the century.
It will stay at or above 3 per cent of GDP over the medium term, £26bn a year higher than previous levels, the IFS said.
Based on current market rate forecasts, the government will spend £20bn more on debt interest in 2026-27 than was forecast by the Office for Budget Responsibility in March, pushing the outlay to £108bn, according to the IFS.
Even if the Bank of England cuts interest rates more sharply than expected, as predicted by analysts at Citi, which worked with the IFS on the outlook, public spending on debt interest would remain higher than predictions made as recently as the March 2022 Budget.
Stripping out the soaring debt interest payments, the UK public finances will look better in next month’s updated forecasts than the OBR predicted in March, the IFS acknowledged in its “Green Budget”.
Though the think-tank found that Hunt is on course to register the biggest primary surplus in a generation by 2027-28, it warned that the surplus did not create space for giveaways.
Hunt’s headroom against his own fiscal targets relies on tax and spending plans whose credibility is “questionable”, Johnson said. The plans include a six-year freeze in personal tax allowances and thresholds that amounted to a “colossal” £52bn tax increase, Johnson said, arguing Hunt would come under political pressure to end it early.
The chancellor’s spending plans also implied cuts to most public service spending once commitments on defence, the NHS workforce, and expanding free childcare were factored in. In practice, the cuts would be “tough medicine for them to swallow”, Johnson said.
Last week, the IMF warned governments to do more to curb their public borrowing, saying a failure to do so could undermine central banks’ efforts to bear down on inflation.
Ben Nabarro, chief UK economist at Citigroup, said households would already be squeezed over the coming year, as higher interest rates continued to bite and taxes rose.
An ill-timed fiscal giveaway that stoked inflation could “require repayment many times over, not just in higher taxation but through a protracted monetary policy-induced recession,” he warned.
