The black hole in the public finances is set to require as much as £40bn in tax rises or spending cuts from Rachel Reeves, economists fear as the Treasury braces for another brutal Budget.
Heading in to this week’s Labour party conference in Liverpool, the Chancellor admitted that the economic outlook is “very uncertain” ahead of the Budget in November.
Her allies are set to blame much of the shortfall in the Exchequer on Conservative policies such as austerity and leaving the European Union, The i Paper understands.
On Friday the official watchdog, the Office for Budget Responsibility (OBR), will submit its first estimates of the trajectory for the UK economy and public finances over the next five years.
This document will make clear the gap between projected Government borrowing and the maximum allowed under Reeves’s self-imposed “fiscal rules”, assuming she makes no changes to tax or spending.
At the Spring Statement in March, the Chancellor had £9.9bn of “headroom” against these rules – low by historical standards – and is likely to seek to retain a cushion at least that large in this Budget.
“It seems quite likely that the [OBR] pre-measures forecast will have a current budget forecast that is in deficit,” Isabel Stockton of the Institute for Fiscal Studies (IFS) said – pointing to a number of economic indicators which had significantly changed since the OBR’s last forecast. “It is difficult to guess how these things will shake out, but it is very difficult to imagine that it will shake out in a way that is positive.”
Ruth Gregory of Capital Economics estimated that the public finances had deteriorated by up to £38bn in total – which would force Reeves into a tax-raising Budget as big as last year’s if she wanted to keep the same headroom.
The Chancellor admitted to The Times over the weekend that the Budget would be “tough”, saying: “I think anyone who opens a newspaper, watches the telly in the evening, goes on social media, can see that the world is a very uncertain place and that the world has changed in the last 12 months.”
Rachel Reeves with Sir Keir Starmer in May (Photo: Justin Tallis/Reuters/Getty)The OBR has been working on a review of how it forecasts future growth in productivity – the amount of economic output from each worker – after several years in which its estimates proved repeatedly too optimistic.
It is widely expected to conclude that its projections for the next few years should be downgraded by 0.2 percentage points each year – which would cut the amount the Treasury can expect to receive by nearly £20bn annually.
“The biggest one is what is going to happen to GDP growth over the next few years,” Gregory Thwaites of the Resolution Foundation said. “The OBR is pencilling in a much stronger recovery over the next few years, and you don’t need a big change to that to see a big downgrade in the public finances.”
A source close to Reeves insisted that any downgrade in productivity would be due to the effects of the previous Government’s actions – telling The i Paper: “It is nothing to do with us, this is about the OBR deciding that Brexit and austerity were not good policy ideas.”
Cuts to immigration could also drag down growth projections – Capital Economics estimated that if the UK receives fewer migrants as Sir Keir Starmer has promised, the public finances will suffer to the tune of £6bn.
Efforts to curb migration to the UK could drag down growth projections (Photo: Sameer Al-DOUMY/Getty)More expensive borrowing
International debt markets have been volatile this year, as investors worry about the scale of borrowing by governments across the rich world, against a backdrop of persistently high interest rates.
The precise dent in the public finances created by more expensive borrowing costs is uncertain, as there are likely to be several more weeks before the OBR takes its final reading of the markets to determine the assumptions it will use in its forecasts.
But it is almost certain that the effect will end up being negative, with economists estimating a shortfall of £4-5bn based on the current status of UK bonds.
Ben Caswell of the National Institute of Economic and Social Research (Niesr) said: “Markets think that the UK’s economic and fiscal outlook is a little bit less certain than it was in the past, so they are charging a bit more to lend.”
Since the Spring Statement, the Government has reversed two policy decisions that were intended to show that Reeves was serious about making difficult calls to balance the books.
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The combined cost of restoring winter fuel payments to most pensioners and scrapping planned cuts to disability benefits is around £6bn a year.
Welfare reform remains on the agenda, but there is no prospect of new proposals being brought forward in time to be taken account of in the Budget on 26 November.
Caswell pointed out that ramping up GDP growth would be the least painful way of resolving issues such as these, saying: “If you had really, really strong growth of 2 per cent, then a lot of these conversations about borrowing costs or welfare would go away.”
Extra spending plans – fuel duty to two-child cap
With Labour struggling in opinion polls, ministers are under pressure to enact new policies which would show they are serious about helping voters with the cost of living.
One of these is ending the two-child benefits cap, which would cost around £3bn a year – although a compromise, which could see the cap ended only for families with a parent in work, would be cheaper.
Another would be to extend the freeze in fuel duty, which has been in place since 2011 but is in principle due to end in April next year.
Allowing the levy to rise by 7p per litre of petrol or diesel would be highly politically controversial but would avoid the need for Reeves to find savings adding up to nearly £5bn over the next five years.
The Government has also committed to raising defence and security spending to 5 per cent of GDP by the middle of the next decade, but has not explained how this will happen. Adding this spending to the upcoming Budget would cost £36bn a year, according to the IFS.
How to limit the tax hit
An initial shortfall of £30bn-plus in the OBR estimates would not necessarily lead to tax rises of the same scale, even if some increase in taxation appears inevitable.
One factor is that the Chancellor may be able to promise lower growth in Government spending from 2029 onwards, which would help the public finances but would not require her to explain how it would be achieved until a spending review takes place at a later date.
Treasury insiders also insist they are optimistic the watchdog will rule that some of Labour’s policies – including reforms to infrastructure planning, cuts to business regulation and new trade deals – will have a positive effect on growth and therefore boost tax receipts.
Reeves told The Times that a “reset” of relations with the EU should help the economy. She said: “We also want the OBR to score that because when we left the European Union, the OBR said that our economy would be 4 per cent smaller as a result. As a result of that reset in May, we think the economy will be stronger.”
Economists expressed scepticism at the idea that any current policies could have a transformative effect on the forecasts. Caswell said trade deals with the US and India were “basically peanuts”, while Thwaites added: “I don’t know what they could come up with that would raise growth by 1 per cent a year, unless they are going to rejoin the single market and customs union.”
A Treasury spokesman said: “We do not comment on speculation on the budget or around the OBR forecasts. The OBR will publish its independent assessment alongside the Chancellor’s statement in November.”
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