Deteriorating outlook for the public finances amid heightened uncertainty casts doubt on plausibility of promises of large permanent tax cuts

High inflation will mean more spending on social security benefits, state pensions and debt interest. Over the next two years we expect this to more than offset the additional tax revenues generated by that high inflation in spite of lower growth. As a result, the forecasts accompanying the forthcoming Autumn Budget are likely to show the near-term public finances in a weaker position than forecast by the Office for Budget Responsibility (OBR) back in March.

And that’s even before any tax cuts, other additional support for households or extra money for public services that are also struggling with rising prices. In the medium run, higher revenues could roughly offset higher spending, leaving the margin by which the government are meeting their fiscal targets broadly unchanged – though a large package of permanent tax cuts that were not matched by spending cuts would obviously change this.

The two candidates for Prime Minister also need to recognise the even greater than usual uncertainty in the public finances. Additional borrowing in the short term is not necessarily problematic – and indeed may be appropriate to fund targeted support. But large permanent tax cuts would exacerbate already substantial pressures on the public finances – as spelled out by the OBR only last month – unless matching spending cuts can be delivered. In reality significant spending increases are likely to be needed in face of high inflation.

That’s the key conclusion of new research from the Institute for Fiscal Studies, which is an early output from the 2022 IFS Green Budget report produced in association with Citi and funded by the Nuffield Foundation. Our central projections for next year use the Bank of England’s new forecasts for inflation and growth.  

In 2023–24 borrowing is forecast to increase by £23 billion, simply through additional spending on social security benefits and state pensions (up £4 billion on current forecasts to £275 billion) and debt interest (up £54 billion to £104 billion), only partially offset by higher revenues (up £34 billion). There will be additional pressures, likely running into tens of billions, to continue to support households and to compensate public services for high inflation.

If inflation falls back to normal levels by 2024–25, then debt interest spending will fall. Higher tax revenues and increased spending on benefits and pensions could largely offset one another by then, leaving borrowing broadly in line with the OBR’s March forecast. But pressures on public services will be more acute, and higher spending than planned seems almost inevitable. And the uncertainty around tax revenues is particularly pronounced, and will crucially depend on the length, depth and pattern of any period of economic weakness.

Carl Emmerson, Deputy Director of the Institute for Fiscal Studies and an author of the report, said:

“The reality is that the UK has got poorer over the last year. That makes tax and spending decisions all the more difficult. It is hard to square the promises that both Ms Truss and Mr Sunak are making to cut taxes over the medium-term with the absence of any specific measures to cut public spending and a presumed desire to manage the nation’s finances responsibly.”