The government’s mini-budget has left it facing such a large black hole in the public finances that the most credible way of filling it is severe spending cuts similar to the kinds imposed during the austerity years a decade ago, according to an authoritative new report.
The “Green Budget”, from the Institute for Fiscal Studies (IFS), together with investment bank Citi, warns that the chancellor would have to cut spending or raise taxes by £62bn if he is to stabilise or reduce the national debt, as he has repeatedly promised in recent weeks.
That shortfall is a direct consequence of measures announced since the Truss government took office, including its reversal of various tax increases such as corporation tax and National Insurance, and its Energy Price Guarantee.
There is a chance that hole is filled by economic growth, but the IFS said such an outcome would depend on luck more than judgement.
It said the Office for Budget Responsibility (OBR), the government’s in-house forecaster, was unlikely to assume at the end of the month that the measures in Kwasi Kwarteng’s mini-budget would boost the country’s long-term growth prospects.
The IFS said that even raising working age benefits in line with earnings rather than inflation – one of the big and controversial money-saving measures it is considering – would only save a fraction of the money necessary – about £13bn a year.
It added that Mr Kwarteng would instead have to carry out more dramatic cuts, potentially reducing government investment and slashing public spending on departments already squeezed to the bone during the austerity years.
The IFS Green Budget found that the amount the government is set to pay on debt interest is set to rise in the next couple of years to the highest level, as a percentage of national income, since at least the late 1940s.
This increase in debt interest is one element of a “premium” the government is having to pay at the moment because of fears among investors that it has surrendered some of its credibility.
This “credibility premium” means the cost of borrowing is currently higher in the UK than might have been expected, given the increase in borrowing accounted for by the mini-budget.
Moreover, Citi said that the higher interest rates faced by consumers in their mortgages would also dampen economic growth in the coming years.
The IFS said the “credibility premium” for the public finances was around £10bn; Citi said the premium for economic growth was 0.1 or 0.2 percentage points.
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Labour: ‘Reverse mini-budget’
IFS director, Paul Johnson, said that with so much geopolitical instability there were large uncertainties about the outlook in the coming year, but that Mr Kwarteng was left facing large fiscal challenges.
“The specifics of the UK government’s fiscal strategy are under more scrutiny by financial markets than at any point in the recent past. The chancellor should not rely on over-optimistic growth forecasts or promises of unspecified spending cuts. To do so would risk his plans lacking the credibility which recent events have shown to be so important.
“All that said, we would have sympathy with the chancellor if he decided that the uncertainties of the present moment are too great to be promising specific future action around public spending.
But the same would apply to his recent package of tax cuts. He should not apply that argument asymmetrically.”
Benjamin Nabarro, chief UK economist at Citigroup, added: “With monetary and fiscal policy now working in opposite directions, we think the broader risks around UK monetary-financial stability are growing.
“In the years ahead, ‘supply shocks’ such as those seen in recent months seem likely to grow more frequent. That may require profound changes in the manner macroeconomic policy is conducted if we are to avoid another decade of stagnation.
“The UK can ill afford further policy mistakes,” he concluded.
