Five ways to plug the UK’s £40bn public finance hole

Jeremy Hunt, the new chancellor, warned this week he would have to make “amazingly difficult” decisions to balance the government’s books.

Hunt is trying to plug a budget deficit of about $40 billion on Oct. 31 through tax hikes and spending cuts.

He said Monday he wants the national debt as a percentage of gross domestic product to fall and that tax revenues should exceed daily spending, and will likely give himself five years to achieve those goals. Below are some of his options for tax increases and spending cuts.

Higher taxes for people and businesses

When then-Chancellor George Osborne ushered in the “age of austerity” after the financial crisis, his fiscal consolidation was based on an 80:20 ratio of spending cuts to tax increases.

People close to Hunt said the Chancellor believes higher taxes would need to do far more work this time around, perhaps accounting for up to half of the £40bn tax cut.

A major “secret” tax hike could be achieved by extending the four-year freeze on personal tax allowances and thresholds announced by Rishi Sunak, Chancellor, in 2021.

When inflation is high, the “fiscal drag” effect means that millions of people are drawn into the tax system or higher tax brackets for the first time each year. An extension of the freeze would bring in around £5bn a year through 2027-28.

Hunt is also expected by allies to urge banks and energy companies to pay more taxes on their profits, after declaring that “nothing is off the table” and declaring he is “not opposed to windfall taxes in principle.”

Cut pensions and social benefits

Ministers will wake up on Wednesday to unpleasant news: at 7am the inflation rate for September will be announced – the figure that normally determines the annual increase in pensions and social security benefits in the following April. 10 percent is expected.

This alone will increase public spending by £5bn next year over March’s budget plans, leaving Hunt with a dilemma over whether to save money by cutting both pensioner and non-pensioner benefits.

Hunt on Monday declined to guarantee that benefits would rise in line with inflation next April or after, refusing to say he would honor the government’s “triple lock” on the state pension – which it does increases annually in line with inflation, earnings growth, or 2.5 percent cents, whichever is greater.

Every percentage point by which benefits are cut saves the government around £3 billion a year. Some Tory MPs – including right-wing Business Secretary Jacob Rees-Mogg – have indicated they will not support real-world benefit cuts.

Reduction in Whitehall departments’ expenses

The Treasury has said government agencies must live within budgets set in the latest spending review, which sets annual totals through 2024-25.

These budgets are already putting pressure on public services as high inflation affects wages and other spending. Fully reimbursing departments for these additional bills by 2024-25 would cost £18bn annually.

Hunt’s priority is not to spend extra money before the next election, which is due by January 2025. However, he could indicate lower assumed growth in daily spending on public services in the next parliament, which is currently set at 3.75 percent a year in nominal terms.

This could be reduced by 1 percentage point as spending continues to rise in real terms. Such a cut would save £13bn a year by 2027-28 if implemented for three years.

But Cabinet ministers in charge of spending departments are likely to resist any pressure. For example, Secretary of Defense Ben Wallace has indicated that he could resign if Liz Truss backs out on her promises to increase military spending.

squeezing capital expenditures

The traditional first port of call for public spending cuts is to reduce investment, often by delaying rather than canceling projects.

In 2009, for example, Labor Chancellor Alistair Darling drew a knife on investment spending. Recent Conservative chancellors have protected the government’s capital budget.

Public sector net investment is expected to be around £70bn a year over the next few years, but it could fall by £5bn to £10bn, while still remaining higher in real terms than in the pre-Covid era.

The only problem with the investment cut is that Hunt almost ruled it out on Monday. “I don’t think it’s possible to have a long-term, credible economic growth strategy that doesn’t recognize the vital importance of investment,” he said.

Cut foreign aid budget

Perhaps the biggest single spending cut available to Hunt, and probably the least politically controversial with Tory MPs, is the £5bn-a-year cut from Britain’s foreign aid budget.

Hunt’s allies do not expect him to raise Britain’s foreign aid spending back to 0.7 percent of GDP in 2024, as Sunak envisioned.

Sunak cut the aid budget to 0.5 per cent of GDP in 2020 – breaking a promise made by the Tory electoral program – but said spending would fall to 0.7 per cent if underlying debt fell. He expected it to be in 2024.

With that debt target now unlikely to be met well into next Parliament, keeping the 0.5% limit would save £5bn a year. Andrew Mitchell, former Secretary of State for International Development, said there were “moral and national interests” in returning to the 0.7 percent target. Five ways to plug the UK’s £40bn public finance hole

Adam Bradshaw

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