UK will need £27bn of spending cuts or tax rises, watchdog warns

The government will need to find up to £27bn worth of spending cuts or tax rises by 2024 to put the public finances on a sustainable footing, the Treasury’s spending watchdog has warned.

In a forecast for the public finances that predicted long-lasting damage to the economy following the Covid-19 crisis, the Office for Budget Responsibility (OBR) said the spending gap based on its most likely estimate was unlikely to be filled by stronger economic growth, leaving ministers to make tough decisions in the years ahead.

Richard Hughes, the chairman of the OBR, said in a report published following the spending review that extra measures announced by the chancellor since July totalling £86bn this year and £40bn next year had saved the economy from being “materially weaker”.

Borrowing chart

He said the extension of the furlough scheme to next March had probably saved about 300,000 jobs and preserved significant levels of income tax while extra funds for the NHS and local authorities to cope with the health crisis had saved many lives.

Rishi Sunak had also reduced the gap in public spending from next year following a planned £10bn cut in departmental spending that he expects to be repeated in following years while pencilling in a reduction to almost zero in Covid-19 spending from 2022.

Debt chart

However, Britain’s debt-to-GDP ratio, which measures the gap between annual national income and the deficit is on course to hit 108% in the next financial year and peak at 109.4% in 2022-23.

The annual deficit will increase this year by £394bn or 19% of GDP before falling back to £100bn by 2024, which will leave the UK with an annual deficit of 5%.

Hughes said it would be tough to bring down the deficit later in the decade as pressure on the health system and pensions from an ageing population increased, though debt borrowing costs remained at historically low levels.

Coronavirus costs

Paul Johnson, the director of the Institute for Fiscal Studies, said the plans, coupled with the aim to reverse a Covid-linked rise in universal credit next April, would be difficult to carry through and were “questionable”.

“It seems more likely than not that spending will end up significantly higher than set out today, and so borrowing in 2024-25 will be considerably more than the £100 billion forecast by the OBR,” he said.

“Either that or we are in for a pretty austere few years once again, or for some significant tax rises.”

Unemployment chart

Torsten Bell, the head of the Resolution Foundation, said: “The idea that there will be no permanent increase in spending post-pandemic is what you might politely call optimistic.

“It is certain that tax rises will end up playing a bigger part in any real plan to put the public finances on a sustainable footing once the recovery is secured,” he added.

The OBR said there were several elements to the current crisis that made it difficult to determine whether the government would lose some of its income temporarily or whether the economic damage was such that the hit would make it longer lasting.

Hughes, who set out three scenarios for the next five years from optimistic to pessimistic, said the recovery remained uncertain and depended on the success of the current lockdown, the reaction to the tiered restrictions next month and how effective the vaccines will be and when they will become generally available.

He said a fresh estimate of the impact of a breakdown in trade talks with the EU had shown that a no-deal Brexit would reduce GDP growth by 2% and cost the exchequer £10bn more than if the government struck a deal.

GDP charts

The loss of trade would only be partially offset by a rise in tariffs on imported goods, the OBR said, leaving the economy and the public finances worse off without a deal.

Mel Stride, the chair of the all-party Treasury select committee, said the chancellor could comfortably delay difficult decisions until the economic recovery was in full flow.

He said most Tory backbenchers recognised that extra spending to rescue the economy and get it motoring again was essential before beginning to consider tax rises or spending cuts.

“I don’t think there will be pressure to cut too early because there is general acceptance that these decision will have to wait. That said, if the OBR is right, there will be a considerable gap to close,” he said.

Capital Economics said the OBR was probably being too pessimistic. Ruth Gregory, the consultancy’s UK economist, said: “It is not necessarily the case that there will be a fiscal hole anyway if the economy eventually gets back to its pre-virus level as we think it will.

“The economy would be around 1% smaller in 2024-25 compared to if the pandemic had never happened. That’s closer to the OBR’s upside scenario.

“Moreover, we expect the economy to get back to its pre-virus trend later in the decade. And low borrowing costs means that the government can take time to let economic growth fill the hole,” she added.


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