Jeremy Hunt’s fiscal juggling act

Since Liz Truss spooked financial markets with a spate of unfunded tax cuts seven weeks ago, the UK has become a global case study in failing to manage public finances in an era of rising inflation and rising interest rates. Jeremy Hunt, Britain’s fourth chancellor since July, must fix that in Thursday’s autumn statement by putting the country’s debt on a sustainable path. If the government sets a five-year target, it could cost over £50bn in tax hikes and spending cuts – about 2% of gross domestic product. It will be a necessary prize to help Britain regain its credibility, but it will involve a tricky act of juggling.

Hunt’s plan must please the markets, his party and voters while limiting the damage to the economy. That will not be easy. Forecasts from the Bank of England last week showed Britain slipping into a protracted recession. Rapid worsening would compound economic pain on top of a decade of lackluster growth. With the cost of living rising and public services overwhelmed, tax hikes and spending cuts will be particularly undesirable. But to reassure investors, the chancellor must come up with credible measures to curb the government’s borrowing needs. Too long a delay risks disrupting financial markets, rising gilt yields and deepening the fiscal hole.

Hunt has to show investors that the tax bill actually works. The target of a falling debt ratio in five years is already less stringent than previous fiscal rules. However, since Truss resigned, markets have calmed: Gilt yields and expectations for the bank’s interest rate path have fallen, and Hunt is seen as safer than his reckless predecessor, Kwasi Kwarteng. But that could change quickly. The war in Ukraine remains an unknown quantity and inflation may prove more stubborn. It is therefore unwise to miss the absolute consolidation needed to bring the debt ratio down by 2027-28.

The challenge is to choose from a stringent set of measures that would cause the least damage to an already ailing economy while raising enough funds. Spending cuts tend to dampen economic activity more than tax hikes, but there are few easy ways to generate large revenues quickly. A significant increase in income tax and social security is politically sensitive, while higher sales tax would increase inflation in the short term. Hunt will likely rely on stealth tax hikes: freezing various thresholds and tax exemptions. Expenditures will not escape the knife. That means splitting the cuts between already stretched departmental budgets and public investment critical to growth.

While the focus will be on the government’s bottom line, Hunt must not brush aside the growth agenda entirely: any increase in potential growth will improve the fiscal arithmetic. Given the fiscal quagmire Britain finds itself in, many things may not be possible, but there are sensible steps to take. More generous tax breaks could encourage low-cost business investment. Initiatives to help the inactive return to the labor market – which is still below pre-pandemic levels – are also crucial. This also applies to avoiding cuts in the skills and education agenda. In fact, improved growth prospects could give the government room to reverse its tightening later.

Prime Minister Rishi Sunak and Hunt face a huge economic and political conundrum. The level of fiscal consolidation required is on par with Britain’s 2010 “austerity” budget. But this time the Chancellor must introduce it when inflation is near a 40-year high and interest rates are rising. The financial plan must reassure many. But if it fails to please the markets, it will leave Britain’s international credibility in even more shambles. Jeremy Hunt’s fiscal juggling act

Adam Bradshaw

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