'Painful’ cuts ahead amid £60bn hole in public finances, think tank warns

mini budget British Prime Minister Liz Truss and Chancellor of the Exchequer Kwasi Kwarteng walk outside a hotel, as Britain's Conservative Party's annual conference continues, in Birmingham, Britain, October 4, 2022. REUTERS/Toby Melville
IFS: Getting government finances on a sustainable path without cancelling mini budget's tax cuts poses challenge. Photo: Toby Melville/Reuters

Without yet another U-turn on the mini-budget, chancellor Kwasi Kwarteng faces “big and painful spending cuts” of over £60bn, a think tank has warned.

The Institute for Fiscal Studies (IFS) said that if Kwarteng keeps his pledge of getting debt falling in the medium-term and goes ahead with his tax cutting mini-budget, the Treasury will need to find over £60bn somewhere else, with day-to-day public service spending at the top of the list.

“He would need to announce a fiscal tightening of more than £60bn just to stabilise debt as a fraction of national income in 2026–27,” the IFS estimated.

To find this amount of money when the mini-budget will already cost £43bn, finding where to cut “on that scale would pose severe challenges, to put it mildly,” the think tank said.

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One way to tighten by £62bn without announcing tax rises would be to cut day-to-day public service spending in 2026–27 by 14%.

In a scenario where the NHS and defence budgets were exempt from any cuts (and instead frozen in real terms after 2025), the required cuts to everything else would rise to more than a quarter (27%).

“Even indexing working-age benefits to growth in earnings for two years (£13bn cut) and returning investment spending to 2% of national income (£14bn cut) would leave him needing to cut 15% from non-NHS, non-defence day-to-day public service spending to deliver the required tightening through spending cuts alone,” the analysis showed.

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“It is just about possible to see how Kwarteng could get debt on a stable, or ever-so-slightly falling, path in the final year of his forecast. He could, for example, announce some combination of cuts to working-age benefits and capital investment, plus some unspecified cuts to public services pencilled in for the years after 2025. That might work on paper and spare him having to row back on any more of his mini-budget tax cuts,” Paul Johnson, director of IFS, said.

“But 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,” he added.

IFS said that borrowing this year is likely to hit almost £200bn, its third-highest peak since World War II, below only the peaks associated with COVID and with the financial crisis. This would be nearly £100bn higher than the £99bn forecast by the Office for Budget Responsibility (OBR) in March.

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“In 2026–27 we expect borrowing of around £100bn, which would be £70bn higher than forecast in March. Much of this increase is uncertain — it will in particular depend on the path of the economy, inflation and interest rates. Less uncertain is £43bn of the increase in borrowing, which is explained by the direct impact of the permanent tax cuts announced by the new chancellor,” the IFS noted.

Mark Franks, director of welfare at the Nuffield Foundation, warned that the choices in front of the chancellor risk hitting the poorest households the hardest.

“The UK is experiencing very high rates of inflation, rising interest rates, growing national debt and intense pressure on many government services. The IFS Green Budget sets out the huge scale of the challenge and the tough choices and trade-offs involved,” he said.

“It also shows that the least-well-off are most vulnerable to the current crisis. There is an urgent need for a serious strategy for economic growth which also supports vital public services and responds to the immediate pressures on people and families most under strain from rocketing food and energy costs.”

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Citi (C) analysis on the outlook that served as a basis for the think tank’s report puts inflation peaking at just under 12% over the coming months, before falling back but only gradually.

“With monetary and fiscal policy now working in opposite directions, we think the broader risks around UK monetary-financial stability are growing,” Benjamin Nabarro, chief UK economist at Citigroup, said.

Watch: Kwasi Kwarteng bows to pressure and brings forward debt-cutting plan to 31 October