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Rishi Sunak inherits a £40bn fiscal hole and is likely to opt for tax rises, not just spending cuts, to fill it

First fall in GDP

A deteriorating economic outlook and the legacy of Trussonomics has left Rishi Sunak’s Government on course to announce a fiscal tightening of at least £40 billion which is likely to require tax rises, not just spending cuts, according to new analysis published today (Tuesday) by the Resolution Foundation ahead of the Autumn Statement on 17th November.

The new Prime Minister will be handed a grim economic forecast by the Office for Budget Responsibility (OBR), which is likely to include a recession next year as GDP forecasts are slashed by up to 4 per cent by the end of 2024. The OBR is also likely to project an unemployment rise of around half a million, taking it above levels seen during the pandemic. This weaker economic outlook is set to raise borrowing by around £20 billion a year by 2026-27.

And while growth is set to be revised down, interest rates are going in the opposition direction, causing borrowing costs to rise. While the premium the UK is charged to borrow compared to other advanced economies has fallen back to its level before the mini-Budget, the increase over the summer has not. This will add around £10bn to borrowing in 2026-27, while rising global interest rates since the mini-Budget will add a further £10 billion.

Against this backdrop, the Prime Minister has made re-establishing economic credibility – by showing that the public finances are on a sustainable path – the central task for the Autumn Statement. To do that, the Chancellor has already committed to two fiscal rules: reducing the debt-to-GDP ratio in the medium term and delivering a current-budget balance.

However, the weaker economic outlook, higher interest rates and remaining legacy of ‘Trussonomics’ (£17 billion of unfunded tax cuts) mean that the Government is on course to break these rules unless significant further policy action is taken.

At least £30 billion of fiscal tightening will be needed to get debt falling in 2026-27. However, more will be needed to provide ‘headroom’ against future economic shocks, with the smallest amount of headroom a Chancellor has had against a new set of fiscal rules equivalent to around £12 billion. This would bring the scale of fiscal consolidation to at least £40 billion.

The unpalatable menu of options the government has to choose from means it is likely the Autumn Statement will announce further tax rises, not just spending cuts says the Foundation. Possible policy choices include:

  1. The ‘anti-growth’ option. Government’s tend to cut investment spending when belt tightening is needed. But such an approach would damage growth, with investment in the likes of transport, science and regional economic development cut. This option is also limited: the current balance rule (which excludes investment) means that only roughly £10 billion of these cuts can contribute to meeting the Government’s fiscal rules. Even so, £10 billion in cuts would cancel three-quarters of the investment increases planned while Rishi Sunak was Chancellor.
  1. The ‘austerity’ option. With inflation at its highest level for 40 years, Government departments are already seeing their budgets fall in real terms by around £22 billion by 2024-25. It is hard to see how the Treasury could credibly save more than £20 billion by announcing cuts to day-to-day public service spending. Even that would require a real-terms freeze in the total levels of such spending, and cutting unprotected departs by around 9 per cent.
  2. The ‘income cutting’ option. The PM could save £9 billion by reneging on pledges he made as Chancellor this Summer to raise working-age benefits and the State Pension in line with prices next year. But the living standards cost of doing this would be huge – a low-income working family with two children would lose around £750, and a pensioner £342 – against the backdrop of an already huge squeeze on incomes.
  1. The ‘tax raising’ option. The Chancellor could go full circle on mini-budget U-turns by reinstating Rishi Sunak’s Health & Social Care Levy, raising around £15 billion by 2026-27. Other options include raising £2 billion by extending the ‘stealth’ freezes in Income Tax thresholds by a further year to 2026-27.

James Smith, Research Director at the Resolution Foundation, said:

“The Government has a little over two weeks to finalise its plans to repair its economic credibility and the sustainability of the public finances. While the recent focus has been on conditions improving post-Trussonomics, the central picture remains one of a weaker growth, higher borrowing costs and expensive tax cuts that have left a fiscal hole of at least £40 billion to fill.

“History tells us that this will involve cuts to public investment, which are easy to announce but reduce growth in the longer term. Further austerity for public services is also likely, but there are limits to how big these can credibly be, as public services are already facing cuts of £22bn thanks to high inflation.

“This reality means that the Autumn Statement is likely to involve tax rises, not just spending cuts.”

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