Chancellor Philip Hammond is stuck ‘between a rock and a hard place’ in planning his November Budget, and will find it difficult to balance his commitment to fiscal targets with increasing pressures on spending, according to analysis by the Institute for Fiscal Studies (IFS)
The government is committed to getting the public finances into surplus by the mid 2020s. The IFS says its research suggests that if the Chancellor sticks to this plan, then a likely significant deterioration in the public finance forecasts means that he will have little space for Budget giveaways.
The IFS highlights indications from the Office for Budget Responsibility that it is likely to downgrade its forecast for productivity growth, which it says could see the deficit balloon to £36bn, compared with the £17bn forecast in March. In addition, lack of clarity over the nature and impact of Brexit means that the uncertainty around these forecasts is unusually large.
At the same time, the pressures to spend more are becoming increasingly intense while the parliamentary arithmetic makes tax increases look very difficult.
The report finds that borrowing is forecast to be £6bn lower than predicted in the March Budget, and is unlikely to rise substantially.
However, the IFS argues that any substantial downgrade to productivity forecasts would easily dwarf the other factors affecting borrowing. In the March Budget, the OBR assumed productivity would grow by 1.6% a year, still below the over 2% a year achieved over the 40 years leading up to the financial crisis. But over the last seven years productivity has grown at just 0.4% a year.
Were the OBR now to assume productivity growth of 1% a year, borrowing would be forecast to be around £33bn in 2020–21 rather than the £21bn forecast in March. In this case, the Chancellor could still expect to meet his fiscal targets for this parliament, but with only a 60% probability.
However, were the OBR instead to decide that the productivity growth will continue the very low pattern of the last seven years, borrowing could rise to almost £70bn in 2021–22. In this case, the Chancellor could not expect to meet his fiscal targets for the current parliament and the ambition to eliminate the deficit entirely by the mid 2020s would seem almost sure to be abandoned, the IFS claims.
As regards specific policy options, the IFS points out that higher inflation means that manifesto commitments to raise income tax thresholds are now less expensive than expected (just £1.1bn a year to deliver a personal allowance of £12,500 and a higher-rate threshold of £50,000 in 2019–20). This would be on top of the £12bn a year spent on raising the personal allowance since 2010.
Another freeze in fuel duties would cost £750m a year on top of the £5.4bn cost of having frozen them since 2010.
The largest cut to benefits to come over the next couple of years is the continued freeze to the rates of most working-age benefits. Cancelling this entirely would cost £4bn in 2019–20. Fully-funding inflation increases in public sector pay would cost £6bn more in 2019–20 than retaining the 1% cap.
Thomas Pope, a research economist at IFS and an author of the report, said: ‘The first Budget of a new parliament is often the best chance a Chancellor has to set out his stall. Mr Hammond, though, has been dealt a very tricky hand indeed. The political arithmetic makes any significant tax increase look very hard to deliver.
‘It looks like he will face a substantial deterioration in the projected state of the public finances: were the OBR to downgrade productivity growth halfway towards the terrible experience of the last seven years, this could add £20bn to borrowing five years out.
‘And, in the known unknowns surrounding both the shape and impact of Brexit, he faces even greater than usual levels of economic uncertainty.’
Autumn 2017 Budget: options for easing the squeeze is here.
Report by Pat Sweet
