Not this autumn: Chancellor Jeremy Hunt’s allies have said he is considering tax rises and spending cuts worth around £55bn a year, with a Treasury official warning that “after borrowing hundreds of billions of pounds through Covid-19 and implementing massive energy bills, we won’t be able to fill the fiscal black hole with spending cuts alone.” Government mercenaries have floated many ways to fill the void in recent media stories. Some but not all of these will be implemented in the chancellor’s autumn statement on 17 November.
What is a fiscal hole?
Paul Johnson, director of the Institute for Fiscal Studies, a leading think tank, said almost everyone “prefers” the definition of fiscal or fiscal hole. It is not this year’s budget deficit, nor the amount of public debt. Gemma Tetlow, chief economist at the Institute for Government, another think tank, said that in its most basic form, the fiscal hole represents “the gap [in the public finances] between where they project us and where we want to be.” This means the hole depends on the chancellor’s own definition of sustainable public finances. Hunt said he wants public debt to fall as a share of gross domestic product and is expected to give himself a five-year deadline to achieve that goal. To meet the target, Mr Hunt’s allies said he was looking at tax rises and spending cuts of around £55bn a year until 2027-28, which would serve to reduce public borrowing and then reduce debt. As part of plugging the budget hole, Tetlow said the chancellor was likely to want to “create some margin for error because public finance forecasts are uncertain”.
What factors contributed to the UK’s budget gap?
Since the Treasury’s spring statement in March, almost everything that could go wrong has. New forecasts from Britain’s fiscal watchdog to be published alongside the autumn statement are expected to curb economic growth because high energy prices make a country like the UK, which imports fossil fuels, poorer. In addition, high inflation and interest rate hikes are raising the cost of government borrowing and welfare payments compared to the Office for Budget Responsibility’s March projections. The third issue is the government’s decision to spend tens of billions of pounds extra to prop up household energy bills, putting further pressure on public finances. Tetlow said the biggest contributors to the fiscal hole were “higher government borrowing rates and a slowdown in the expected growth of the economy,” which would reduce future tax revenues. Many of these have been common in the UK and other European countries, but Bank of England Governor Andrew Bailey last week pointed to “UK factors” that are driving up Britain’s borrowing costs more than other advanced economies. This was a reference to how Liz Truss’ ill-fated ‘mini’ budget, which included £45bn of unfunded tax cuts, sent financial markets into turmoil and temporarily raised government bond yields compared to peer countries. Paul Johnson said: “An ironic consequence of the ‘mini’ budget. . . is that the Treasury will need to do more quickly to cover the hole than the ‘mini’ budget never appeared due to the scale of the concern in the financial markets.”
What influence do government fiscal rules have?
The government’s existing fiscal rules state that debt as a percentage of GDP must fall by the third year of the latest OBR forecast and that the current budget must be balanced in the same timeframe. Hunt is expected to revise them, saying targets should be hit after five years rather than three. The OBR’s job is to “examine and report on the sustainability of public finances”, and it does this mainly by issuing forecasts and comparing them to the fiscal rules. Paul Johnson said this role can be effective for three reasons. First, it sets the government’s targets for future borrowing and debt. Second, it ties the chancellor’s hands to independent forecasts, so it’s harder for the Treasury to disprove the numbers. He added that the third and “most important” reason was the power it gave the chancellor to negotiate within the government and tell cabinet colleagues that their pet projects could not be funded because they would break budget rules. Not everyone is a fan of the rules, however. Jagjit Chadha, director of the National Institute of Economic and Social Research, another think tank, said that “in a world where we have been hit by such big shocks as Covid, energy and Brexit”, it made no sense to try to achieve strict rules in five years. “I don’t disagree with the removal [from fiscal rules]but not to try to do [budgetary consolidation] very quickly,” Chadha added.
How will Hunt fix the public finances?
Hunt will soon receive forecasts from the OBR that will reveal how big the hole will be when he wants to meet his main fiscal rule – likely in 2027-28. This figure is estimated to be between £30 and £40 billion. On top of that figure, Hunt is expected to add a so-called budget margin of £10bn to £15bn. Hunt needs to implement tax rises and spending cuts worth around £55bn a year, or a bit more, because as he seeks to reduce borrowing and reduce the debt burden, economic growth will suffer and therefore tax revenue by extension. This highlights that some of the fiscal measures may ultimately not contribute to closing the fiscal hole. Chadha said the latter point was critical in planning fiscal consolidation. “It is important to reduce the debt [the measures] don’t lead to policies that discourage the economy from doing its thing and growing,” he added.
