What is the UK fiscal hole and what contributed to it?

British government officials usually avoid the phrase “tax hole” like the plague because it suggests that ministers have lost control of public finances and that nasty tax hikes and public spending cuts are imminent.

Not this fall: Chancellor Jeremy Hunt’s allies have said he is considering about $55 billion worth of tax hikes and spending cuts, “we won’t be able to fill the financial black hole with spending cuts alone.”

Government insiders have pointed out several ways to fill the void in recent media reports. Some, but not all, of these will be implemented in the Chancellor’s autumn declaration on November 17.

What is a fiscal hole?

Paul Johnson, director of the Institute for Fiscal Studies, a leading think tank, said almost everyone “tends to overlook” the definition of a fiscal or fiscal hole.

It’s not this year’s budget deficit or the level of public debt. Gemma Tetlow, chief economist at the Institute for Government, another think tank, said the fiscal hole is basically “the gap”. [in the public finances] between where we are projected and where we want to be”.

That said, the hole depends on the chancellor’s own definition of sustainable public finance.

Hunt has said he wants the national debt to fall as a percentage of gross domestic product and is expected to give himself five years to achieve that goal.

To meet the goal, Hunt’s allies have said he is considering about $55 billion worth of tax hikes and spending cuts.

As part of filling the budget hole, Tetlow said the chancellor will likely “want to build in some margin for error because the public finance forecasts are uncertain.”

What factors have contributed to the UK budget gap?

Since the Treasury Department’s spring statement in March, almost everything that could go wrong has gone wrong.

New forecasts from Britain’s Financial Conduct Authority, to be released with the autumn statement, are likely to weigh on economic growth as high energy prices impoverish a fossil fuel importing country like Britain.

In addition, high inflation and interest rate hikes are pushing up the cost of government borrowing and welfare compared to the Office for Fiscal Responsibility’s March forecast.

The third problem is the government’s decision to spend tens of billions more on supporting household energy bills, putting further pressure on public finances.

Tetlow said the biggest contributors to the fiscal hole are “higher interest rates on government bonds and a slowdown in expected economic growth,” which would depress future tax revenues.

Much of this was common in Britain and other European countries, but Bank of England Governor Andrew Bailey last week pointed to “British factors” that are pushing up Britain’s borrowing costs more than in other advanced economies.

It was an indication of how Liz Truss’ ill-fated ‘mini’ budget, which included £45bn in unfunded tax cuts, unleashed financial market turmoil and temporarily boosted government bond yields relative to peer nations.

Paul Johnson said: “An ironic consequence of the ‘mini’ budget. . . is that the Treasury Department needs to act faster to fill the hole than if the ‘mini’ budget never existed, given the magnitude of the worries in the financial markets.”

What is the impact of government fiscal rules?

The government’s existing fiscal rules say that debt as a percentage of GDP should decline by the third year of the latest OBR forecast and the current budget should be balanced over the same period. Hunt is expected to surpass those by saying the goals should be achieved in five years instead of three.

The role of the OBR is to ‘examine and report on the sustainability of public finances’, primarily by preparing forecasts and comparing them to fiscal rules.

Paul Johnson said this role can be effective for three reasons. First, it sets the government’s goals for future borrowing and indebtedness. Second, it ties the chancellor to independent forecasts, making it harder for Treasury to mess with the numbers.

He added the third and “most important” reason is the chancellor’s power to negotiate within the government and to tell fellow cabinet members that their pet projects cannot be funded because they would break budgetary rules.

But not everyone is a fan of the rules. Jagjit Chadha, director of the National Institute of Economic and Social Research, another think tank, said that “in a world where we’ve been hit by shocks as big as Covid, energy and Brexit,” there was little point in trying to establish strict rules to meet in five years.

“I’m not advocating moving away [from fiscal rules]but for not trying [budgetary consolidation] too fast,” added Chadha.

How will Hunt clean up public finances?

Hunt will soon receive projections from the OBR showing how big the hole will be if he wants to meet his top budget rule – most likely 2027-28.

That number is estimated to be between £30 billion and £40 billion. On top of that number, Hunt is expected to add what it calls fiscal space of between £10bn and £15bn.

Hunt needs to introduce tax hikes and spending cuts worth around £55bn a year or a little more because trying to cut borrowing and reduce debt burdens will hurt economic growth and hence tax revenues. This makes it clear that some of the fiscal measures may ultimately not help to close the fiscal gap.

Chadha said the last point is crucial in shaping fiscal consolidation. “This is important to reduce debt [the measures] not lead to policies that frustrate the economy, which is doing its thing and growing,” he added.

https://www.ft.com/content/1772624e-735f-4de8-8202-65fc2334444f What is the UK fiscal hole and what contributed to it?

Adam Bradshaw

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