Sunak faces difficult public finances at Budget, IFS warns

Rishi Sunak will be boxed in by difficult public finances in his Budget this month, leaving little extra money for the UK’s hard-pressed government services, the Institute for Fiscal Studies said on Tuesday in its regular analysis ahead of the fiscal statement.

Despite having “smuggled in” historically large tax increases under the cover of the pandemic, the chancellor will only just meet his rules in his Budget on October 27, the independent think-tank said.

With gas prices hitting record levels, the tough medium-term outlook has left Sunak sparring with cabinet colleagues over support for industry and funding for education, rail, justice and local government as he finalises his spending review, which will be published alongside the Budget.

The IFS “green budget”, which attempts to imitate a government “green paper” that allows for debate before the fiscal event, was produced in conjunction with Citi, the investment bank.

Although the forecasts were significantly more optimistic for 2021 and 2022 than in the March Budget, good times now would be followed by slower growth later, the report said, because it still expected the economic recovery in output to fall short of the pre-pandemic path by 2 to 3 per cent of national income.

This would leave the public finances meeting the chancellor’s aim of a current budget balance, excluding investment, by the middle of the decade, but with little room to spare. But underlying public sector debt would stabilise at around 90 per cent of national income, 17 percentage points higher than before the coronavirus crisis.

The £42bn a year tax increases announced by the chancellor this year in corporation tax, income tax and national insurance would merely shore up the public finances and fund health and social care spending that would have been needed anyway, the report said.

Paul Johnson, director of the IFS, said: “The tax rises have been smuggled in under the cover of the pandemic,” adding that they were “needed to fund social care and the NHS and had literally nothing to do with the pandemic”.

With health spending having grown from 27 per cent of day-to-day public expenditure in 1999-2000 to a projected 44 per cent by 2024-25, the report said there would be little money left for other departments that had not had a protected budget even though spending was likely to rise by 3 per cent a year in real terms.

“There will be high levels of taxes and spending and yet for unprotected areas, it’s going to feel like there’s not much extra spending at all,” Johnson said

Line chart of UK GDP index: Q4 2019=100 showing Citi believes the pandemic will leave a lasting scar of almost 3 per cent on UK national output

The IFS and Citi said the economic picture was mired in uncertainty and the situation would look a lot brighter if they were wrong to assume there would be long-lasting dislocation and scars from a post-Covid “reconfiguration” of the economy. In such a scenario there would be an opportunity for tax cuts before the next election, they added.

Christian Schulz, lead economist for the UK at Citi, said that after an early and rapid burst of growth in the spring, “the going is getting tougher” for the economy with coronavirus still present and people not returning to past patterns of behaviour quickly.

But if the output returned close to its pre-pandemic level, there would be significantly more tax receipts and faster growth ahead. Schulz thought it was more likely that other European countries would recover stronger than the UK because Britain had the additional burden of “lingering” effects of leaving the EU.

“An uneven rebound to date points to more profound Brexit and Covid related reconfiguration in the years ahead,” he said.

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