What can the IFS warning tell us about the upcoming spring Budget?

As the cost of living crisis continues to drag on, many are hoping for some sort of relief from chancellor Jeremy Hunt in his upcoming Budget. Sean O’Grady looks into the Institute for Fiscal Studies latest analysis and tells us what we can expect

The chancellor has been given little room to manoeuvre by the report’s grim warnings (PA)

Long before the estimable and independent Office for Budget Responsibility (OBR) was set up by George Osborne, then chancellor, in 2010, the Institute for Fiscal Studies (IFS) acted as a kind of fiscal watchdog. Unlike the Office for National Statistics (ONS), the IFS can set its own remit and rules about what it concerns itself with. In the current climate of a post-war near-record high national debt and tax burden, and increasing demographic pressures on the public finances, the IFS is needed as much now as at any time in its near 55-year existence.

Its latest report sets out the options for the chancellor’s Budget on 6 March and contains a number of grim warnings. It seems clear that Jeremy Hunt’s political and economic options remain constrained...

What’s the problem?

Low growth is at the root of the UK’s problems, and why living standards have been fairly stagnant since the global financial crisis (GFC) in 2008. Brexit, the energy crisis and the overhang of public debt from the GFC, not to mention the Covid pandemic, have all badly destabilised the public finances. The collapse in investment after the Brexit referendum, which has eroded the ability of the economy to grow productivity, was a uniquely damaging blow for the UK.

Should the chancellor cut taxes in the Budget?

The IFS thinks the case has not yet been made by the chancellor. The problem is that the chancellor can only get on target to eventually cut the burden of national debt in the medium term and simultaneously cut taxes by making what might politely be termed “heroic” cuts in public expenditure. Such plans are not realistic, says the IFS. Martin Miklos, research economist at the IFS, says that “until the government is willing to provide more detail on its spending plans in a spending review, it should refrain from providing detail on tax cuts.” The International Monetary Fund (IMF) thinks the same. Given that, say, spending on the NHS, schools and defence will probably need to be protected or expanded, then other areas will have to make deep real-terms reductions. These would be on top of more or less continuous austerity for more than a decade.

As the IMF puts it: “The chancellor has a fiscal rule to get debt falling in the fifth year of the forecast period. While aiming to have debt on a falling path in the medium term is commendable, this is a badly designed rule. The chancellor appears to be gaming his own fiscal rule. By pencilling in unspecified spending cuts towards the end of the period, he appears to meet the rule, but he is doing so in a way that will lack credibility and transparency until he tells us where he intends to find those cuts.”

What does the chancellor say?

He thinks he can save money through waste and reform, especially in social security, pushing the long-term sick back into work and boosting productivity via AI and the like.

What do the OBR and the Bank of England say?

Nothing much. Decisions on public spending levels and priorities are taken as given and regarded as political matters outside their terms of reference. But such strictures don’t all apply to the OBR or, indeed, the IMF, which has also expressed scepticism about the practicality of deep real-terms cuts in budgets. Although inflation has come down, it remains above target and in many areas above the increase in resources planned by the Treasury.

What are the risks?

One is the global trend in growth, trade, investment, energy prices and interest rates – even a slight deterioration for an open economy such as the UK can wreck fiscal plans – and Hunt has little room for manoeuvre. Such is the size of the national debt that it will cost about £55bn a year to service in coming years – in excess of the defence budget.

Oddly enough, immigration is also a factor (and a politically sensitive one). High inward migration will generate more tax revenues, which Hunt will jump on – but he seems less willing to account for some higher costs in, say, education.

What will the impact be on interest rates?

As with Kwasi Kwarteng’s mini-Budget in 2023, fiscal policy works best in harmony with monetary policy, and Hunt understands this well. He will not want to slash taxes so much that the Bank has to raise rates (unlikely) or postpone planned cuts in the cost of borrowing over 2024 (more likely). Inflation is still double the 2 per cent official target; it may dip but the experts say it will drift up again.

So will we see tax cuts?

Yes. It is politically unthinkable not to cut taxes in an election year. Because of the array of snarling fiscal watchdogs confronting Hunt the tax cuts cannot be as reckless as to cause a financial panic; but they could nonetheless push things to the very limit. Attractive options to spend the £15bn to £20bn of “headroom” (which would probably be better spent on reducing debt), include further cuts in National Insurance (targeting work incentives) and cuts in business taxation – corporation tax allowances and raising the VAT threshold for small businesses. Abolishing or reducing inheritance tax would be economically useless and would only help the very rich, but would be an irrationally popular move.

What will this mean for a Labour government, if elected?

To mix metaphors, Hunt’s prospective tax cuts are a poison pill and his overall fiscal plan a time bomb for Rachel Reeves, should she take over from him. To make the fiscal plans work, Reeves would either have to implement Hunt’s phantasmagoric spending cuts; or reverse the cuts/raise other taxes; or attempt to borrow more (with adverse consequences for interest rates). Even if she takes the “easy” option of slashing public investment in infrastructure – which doesn’t show up immediately in front-line provision – it will hit growth and climate change targets (and cause the green prosperity plan and interim 2030 net zero target to be ditched).

Thus, even if this budget fails to win the 2024 election for the Tories, it will help them win the one after, by setting Labour for failure in running the public finances.

In its way, it is cunning. Reeves would be well advised to denounce the Budget plans as fantasy economics, unrealistic and bogus, refuse to accept them, and promise a fresh start, if and when she gets her hands on the books.

Will the Budget win the election for the Tories?

No. The Labour lead and the further erosion of the Tory vote by Reform UK make it impossible. The best that they can hope for is that the impact in pay packets, lower mortgage bills and a general feel-good factor may take the edge off the Tory collapse.

However, the last few fiscal events and the 2 per cent cut in national insurance delivered in January had no discernible effect in the opinion polls. The voters seem more conscious that the long-term freeze in the tax thresholds, hikes to council tax and reductions in public services are eroding their standard of living. In that context, modest tax cuts represent only a small discount to sharply rising tax bills. Besides, some polling suggests people want reliable public services more than tokenistic tax cuts.