Pay squeeze and tax rises needed in UK to fill £40bn hole in public finances

Tax increases and spending cuts totalling £40bn will be needed to balance the books as a combination of weak growth and pressure on the NHS and welfare budgets leads to worse than expected public finances in the coming years, a leading thinktank has said.

The Institute for Fiscal Studies (IFS), which specialises in tax and spending, said it was unlikely that the economy would perform as well as the independent Office for Budget Responsibility has predicted in its latest forecasts.

The thinktank added that the chancellor was also likely to bow to demands to extend the one-year £20 a week increase in universal credit and also be forced to continue allocating money to fight the Covid-19 pandemic after the 2021-2 financial year.

Paul Johnson, the IFS’s director, said that on the OBR’s central projection there was “only” a 3% long-term hit to the size of the economy caused by the virus, and while painful this would be smaller than the impact of the financial crisis of the late 2000s. The OBR said it would require £27bn of tax increases and spending cuts for tax revenues to cover day-to-day government spending.

“Those central scenarios are not great,” Johnson said. “But they are not terrifying. We have had much bigger economic shocks and fiscal tightenings before. See the last decade.”

However, he added: “I’m not so sure this is really a central scenario though. There are clearly downside risks to the economy from Covid and our ability to respond to it and, as the OBR make clear, from a no-deal Brexit. Of course, history need not repeat itself but remember that the long-term economic, and hence fiscal, hit from the financial crisis was far greater than predicted at the time.”

Johnson said that despite allocating £55bn to fight the pandemic next year, Sunak had actually delivered a “pretty austere” spending review.

“It cut non-Covid-related public service spending by more than £10bn next year, and in subsequent years, relative to plans. It is not obvious that either the need or the appetite for public spending has diminished since March. There has been no top-up to NHS spending plans after next year. Frankly, I would be most surprised if these plans were adhered to.”

The government has insisted that there will be no return to austerity, but Johnson said it would feel very much like it for non-protected Whitehall departments

Johnson added that despite allocating a “whopping” £55bn for Covid next year, he had allocated “precisely zero” for subsequent years. “I hope he is right that we will no longer need to spend anything at all on test and trace, PPE and the rest, but I wouldn’t bet on it.”

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The Treasury’s current plans involve ending the temporary increase in universal credit from April next year. “It was intended as a temporary policy and it is government policy to end it. Experience suggests, though, that pressure will build for it to be kept and the government may change course in response,” Johnson said.

He added that once all the pressures were added together his central scenario was that borrowing will be at least 1% of national income higher in 2024-25 and thereafter.

“In that case, if the chancellor did want to aim for current budget balance he’d eventually need a 2% of national income fiscal tightening – about £40bn in today’s terms.”

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