Why is Jeremy Hunt planning big tax hikes and spending cuts?

Chancellor Jeremy Hunt has been warned that the underlying health of the UK’s public finances has deteriorated by £70bn.

The Office for Budget Responsibility has told the Treasury that the UK Financial Services Authority, after registering a budget deficit of £31.6bn in March

The bleak OBR forecast has prompted Hunt to prepare for big tax hikes and spending cuts in Thursday’s fall statement.

Why does the £70bn figure matter?

The £70bn figure is an OBR estimate of how much public borrowing is set to increase in 2026-27 due to the expected deterioration in the UK economic outlook. Governments borrow to make up the difference between what they spend and what they tax.

The fiscal watchdog’s calculation is staggering: it has calculated that the underlying deficit will increase by more than 200 percent in 2026-27 if ministers don’t take steps to address the situation.

A Hunt ally said the OBR estimates the government will need nearly $100 billion in 2026-27. The OBR declined to comment.

Around half of the £70bn is based on the assumption that the government will have to pay more interest on the outstanding £2bn of debt.

Treasury interest rates have risen sharply since March, from around 1.5 percent to around 4 percent, reflecting the Bank of England’s tightening of monetary policy.

Another big chunk of the £70bn comes from the assumption that the government will increase state pensions and benefits by 10.1 per cent in April.

This sharp rise would match the rate of inflation in September, when inflation hit a 40-year high. In March, the OBR projected that pensions and benefits would increase by 8 percent in 2023-24.

A much weaker UK economy over the medium term will also have affected OBR borrowing as this in turn reduces tax revenues. The BoE this month forecast a recession that would last between one and two years.

It’s relatively easy to break away from the underlying deficit of nearly $100 billion.

After estimating the deficit, the OBR adds the impact of all relevant government policy announcements that have taken place since March.

These include Boris Johnson’s plan in May to help households with soaring energy bills, Liz Truss’ ‘mini’ budget in September which includes £45bn in unfunded tax cuts and Hunt’s reversal of most of her measures.

The main changes include the scrapping of both a proposed increase in Social Security and a proposed cut in income tax, suggesting that around £15bn will need to be added to the underlying deficit of almost £100bn, according to calculations by the Financial Times.

At these levels, public finances are at risk of becoming unsustainable and the government also faces a breach of its planned fiscal rule that would see debt as a percentage of gross domestic product fall by 2027-28.

To be confident of reducing the debt burden, the Treasury believes it needs to reduce borrowing by around £55bn in 2027-28.

This is the fiscal black hole it calculated and Hunt is expected to announce tax increases and spending cuts worth around £55bn a year.

Why is the Treasury so worried?

Government officials are concerned that some lawmakers, think tanks and the public have not fully grasped the dire state of public finances.

Ministers do not want Conservative MPs to say that the nasty tax hikes and spending cuts are not necessary and that the government absolutely must get parliamentary approval for the measures. There is a serious risk that Tory MPs will rebel against some measures.

Hunt told Sky News on Sunday: “We’ve had a very big deterioration in public finances.”

Why do ministers base their policies on uncertain forecasts?

The OBR normally produces two sets of forecasts each year, containing forecasts for the economy and public finances.

The outlook for the economy is rarely very different from the BoE and private sector forecasts.

The added value of the Fiscal Guardian is to transform its economic forecasts into public finance forecasts, looking at all aspects of government spending and tax revenues.

Many economists have pointed out that OBR forecasts looking five years out can prove spectacularly wrong.

The whole point of the OBR is not to get the numbers spot on, but to give the best forecasts for the economy and public finances so ministers can make informed policy decisions.

Truss and her then-Chancellor, Kwasi Kwarteng, caused turmoil in financial markets with their “mini” budget, in part because they chose not to release OBR forecasts alongside it.

https://www.ft.com/content/df59e66a-1659-428e-b96a-b0419ed584b1 Why is Jeremy Hunt planning big tax hikes and spending cuts?

Adam Bradshaw

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