If the Chancellor wants to cut taxes, he should tell us where the spending cuts will fall

UK taxes are heading to record-high levels as a share of national income. The Chancellor is under pressure to announce cuts. But government debt is high and rising, and barely on course to be falling in five years’ time – that being the fiscal rule the government has set itself. 

Even this unhappy outlook for the public finances is predicated on a fresh round of post-election spending cuts. Unless the Chancellor is willing to spell out where the cuts will fall, the temptation to scale back provisional spending plans further to ‘pay for’ new tax cuts should be avoided. 

This is the main finding of a new report, by researchers at the Institute for Fiscal Studies and funded by the Economic and Social Research Council. In particular, it finds:

• Faster population growth, as projected by the Office for National Statistics (ONS) last month, could boost revenues but it will also make keeping to existing spending plans harder. Under the Chancellor’s November forecast, real-terms day-to-day spending on public services is set to grow by 0.9% a year on average from 2025–26 onwards. At the time, this was expected to translate into growth in per-person spending of 0.5% a year. Under the new ONS population projections, this falls to just 0.2% a year. Plausible settlements for the NHS, childcare, defence, schools and overseas aid would mean real-terms cuts for other areas of government spending. Maintaining real-terms spending on unprotected services would require a cash top-up of £20 billion in 2028–29; maintaining it in per-person terms would require a cash top-up of £25 billion. Reducing the planned growth rate in overall public service spending from 0.9% to 0.75% – as the Chancellor is reportedly considering – would add around £3 billion to the cuts facing unprotected areas.
• Current plans already imply investment spending being cut as a share of national income by £20 billion a year in today’s terms by 2028–29. This would reverse the big increase in investment spending that has been delivered since 2019. It will not help growth. If it happens, it would be a repeat of the sharp fluctuations which have characterised UK investment spending for many decades, fluctuations that hamper growth and create uncertainty, inefficiency and poor value for money.
• Much is being made of the fact that debt interest spending is likely to be forecast to be £10 billion less in 2028–29 than was expected in the Autumn Statement. This could provide the Chancellor with additional ‘headroom’ against his fiscal target. But high debt interest spending remains a big constraint. It is now expected to settle at 2% of national income – £55 billion a year in today’s terms – above what was forecast prior to the pandemic. Market interest rate expectations remain very volatile and high gilt issuance, exacerbated by the Bank of England’s programme of active gilt sales, is forecast to result in private sector gilt holdings having to rise by 7.9% of national income in 2024–25 – the biggest increase on record. Over the next five years, this is forecast to average 6.2% a year which is more than twice the 2.8% a year seen over the last 25 years. The outlook for debt interest spending therefore remains extremely uncertain.

Martin Mikloš, a Research Economist at IFS and an author of the report, said:

‘In November’s Autumn Statement, the Chancellor ignored the impacts of higher inflation on public service budgets and instead used additional tax revenues to fund eye-catching tax cuts. At next week’s Budget, he might be tempted to try a similar trick, this time banking the higher revenues that come from a larger population while ignoring the additional pressures that a larger population will place on the NHS, local government and other services. He might even be tempted to cut back provisional spending plans for the next parliament further to create additional space for tax cuts. 

‘The Chancellor should resist this temptation. Until the government is willing to provide more detail on its spending plans in a Spending Review, it should refrain from providing detail on tax cuts.’

Other key findings of the report include:

• Borrowing this year is now on course to be £113 billion. While this would be £11 billion below the £124 billion forecast in November, it would be £63 billion more than forecast in March 2022 and more than twice what was borrowed in 2018–19 prior to the pandemic. In any case, what really matters for the Chancellor’s Budget options is the extent to which this short-term improvement translates into a lasting improvement in the OBR’s forecasts.
• The Chancellor has a fiscal rule to get debt falling in the fifth year of the forecast period. While aiming to have debt on a falling path in the medium term is commendable, this is a badly designed rule. The Chancellor appears to be gaming his own fiscal rule. By pencilling in unspecified spending cuts towards the end of the period, he appears to meet the rule, but he is doing so in a way that will lack credibility and transparency until he tells us where he intends to find those cuts.
• Tax cuts without tax reform would represent another missed opportunity. If the Chancellor is determined to cut taxes and wants to boost growth then better options exist than simply cutting the rates of income tax, National Insurance contributions or inheritance tax. Stamp duties on purchases of properties and shares are particularly damaging taxes and should be towards the front of the queue for growth-friendly tax cuts.
• Taxes in 2023–24 will be around £66 billion higher than they would have been had their share of national income remained at its 2018–19 level. Whatever cuts may be announced in the Budget, we are still likely to see taxes rise by a record-breaking amount over this parliament.