Austerity measures beckon as Truss seeks to restore Britain’s reputation with investors

Eight words from Liz Truss explained how the Prime Minister hopes to restore Britain’s reputation for sound public finances after sacking Kwasi Kwarteng, the Chancellor she appointed just five weeks ago.

“Spending will grow less rapidly than previously projected,” she said, announcing a second partial reversal of September’s disastrous “mini” budget that wreaked havoc on markets.

The importance of these words is difficult to exaggerate. They imply cuts in departmental budgets, a reduction in investment plans, and lower-than-expected benefits.

Paul Johnson, director of the Institute for Fiscal Studies, said Truss’s comments mean austerity has returned. “[Spending] can’t go up much slower without actually going down.

Although the UK public finances have many line items, the basic math for Truss and her new Chancellor, Jeremy Hunt, is simple and brutal.

To reassure markets, the government must deliver on its promise that public debt as a percentage of gross domestic product will decline in the medium term — no later than 2027-28, the final year of the Bureau of Fiscal Responsibility’s forthcoming forecasts. These will be released to coincide with the release of the government’s debt reduction plan on October 31st.

That commitment is significantly looser than current fiscal rules, but financial markets are likely to let it get away with it.

Calculations by the Financial Times, similar to those by the IFS, suggest that the government would need to cut public borrowing by £50-60 billion annually in 2027-28.

A waterfall chart showing the remaining hole in the UK public finances after the government's about-face

About £18bn of the total will come from raising the main rate of corporation tax from 19% today to 25% next April. Kwarteng had scrapped the planned increase in his tax return, a decision Truss reversed on Friday – the second reversal after her decision not to abolish the top tax rate of 45 per cent on income over £150,000, as her former Chancellor had promised .

The rest of the money – about £40bn a year – would have to come from lower public spending, although the Prime Minister left open the possibility of reversing other tax cuts promised in the “mini” budget after declaring a U-turn on corporate tax “Down payment”.

Torsten Bell, director of the Resolution Foundation, said that without further tracing back, the task would still be difficult on other aspects of the financial report. “The need to fund the remaining tax cuts and the gloomier economic outlook – including higher debt interest costs – means that despite today’s about-face, Jeremy Hunt has just two weeks to decide how to fill a tens of billions of pounds black hole can public finances,” he said.

Reducing overall public spending by £40bn is far from easy, a challenge complicated by promises of no real spending cuts.

The simplest option is to simply increase public spending in line with aggregate inflation after existing plans expire in 2024-25. But according to the FT’s calculations, this is not enough to ensure that the debt-to-GDP ratio falls.

Also, the government may therefore need to consider postponing some investment projects and allowing benefits to grow at a slower rate than inflation.

All three measures taken together would enable the new chancellor to say that the figures are correct, at least on paper, and that debt should fall in the medium term.

However, this plan has problems.

First, public services are already struggling to stay within current spending limits, and further cuts will put pressure on services like health, education and the judiciary. The government gives no guarantees that it can live within plans, especially since high inflation has already reduced its real value.

Second, financial markets may question the credibility of promised public spending cuts after the next election.

Bond market approval will be the ultimate test of the medium-term debt reduction plan, which is due at the end of the month. There is still a long way to go to make the totals coherent and credible. Austerity measures beckon as Truss seeks to restore Britain’s reputation with investors

Adam Bradshaw

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