Cliff Notes
- Rachel Reeves must go beyond merely addressing the estimated £22bn public finance black hole or face repeated fiscal challenges, according to the Institute for Fiscal Studies (IFS).
- UK economic growth was recorded at a modest 0.3% for the three months ending in August, despite claims of being the fastest-growing Economy in the G7.
- Tax increases are deemed unavoidable by economists, with income tax hikes suggested as the most effective means to raise necessary funds without complicating the system.
Tax hikes or risk ‘groundhog day’, Chancellor told as limited growth recorded
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Rachel Reeves faces the prospect of another “groundhog day” unless next month’s budget goes further than plugging an estimated £22bn black hole in the public finances, according to a respected thinktank.
It comes as latest official figures showed the UK economy grew 0.3% in the three months to August, limited growth, despite the Treasury saying it is the fastest growth in the G7.
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The Institute for Fiscal Studies (IFS) said there was a “strong case” for the chancellor to substantially increase the £10bn headroom she has previously given herself against her own debt rules, or risk further repeats of needing to restore the buffer in the years ahead.
It said Ms Reeves could bring the cost of servicing government debt down through ending constant chatter over the limited breathing space she has previously given herself, in uncertain times for the global economy.
The chancellor herself used an interview with Sky News this week to admit tax rises were being considered, and appeared to concede she was trapped in a “doom loom” of annual increases.
What is the chancellor facing?
Speculation over the likely contents of the budget has been rife for months and intensified after U-turns by the government on planned welfare reforms and on winter fuel payments.
The Office for Budget Responsibility’s determination on the size of the black hole facing Ms Reeves could come in well above or below the IFS estimate of £22bn, which includes the restoration of the £10bn headroom but not the cost of any possible policy announcements such as the scrapping of the two-child benefit cap.
Economists broadly agree tax rises are inevitable, as borrowing more would be prohibitive given the bond market’s concerns about the UK’s fiscal position.
Long-term borrowing costs have recently stood at levels not seen since the last century.
What are her tax options?
While there has been talk of new levies on bank profits and the wealthy, to name but a few rumours, the IFS analysis suggests the best way to raise the bulk of sufficient funds is by hiking income tax, rather than making the tax system even more complicated.
Earlier this week, it suggested reforms, such as to property taxes, could raise tens of billions of pounds.
But any move on income tax would mean breaking Labour’s manifesto pledge not to target the three main sources of revenue from income, employee national insurance contributions and VAT.
She is particularly unlikely to raise VAT, as it would risk fanning the flames of inflation, already expected by the International Monetary Fund to run at the highest rate across the G7 this year and next.
Business argues it should be spared.
The chancellor’s first budget, which raised taxes by £40bn, has been blamed by the sector for raising costs in the economy since April via higher minimum pay and employer national insurance contributions.
They say the measures have dragged on employment, investment, and growth.
‘A situation of her own making’
Analysis by Barclays, revealed within the IFS’s Green Budget, suggested inflation was on course to return to target by the middle of next year but that the UK’s jobless rate could top 5% from its current 4.8% level.
Ms Reeves, who has blamed the challenges she faces on past austerity, Brexit and a continuing drag from the mini-budget of the Liz Truss government in 2022, was urged by the IFS to not harm growth through budget measures.
IFS director Helen Miller said: “Last autumn, the chancellor confidently pronounced she wouldn’t be coming back with more tax rises; she almost certainly will.
“For Rachel Reeves, the budget will feel like groundhog day. This is, to a large extent, a situation of her own making.
“When choosing to operate her fiscal rules with such teeny tiny headroom, Ms Reeves would have known that run-of-the-mill forecast changes could easily blow her off course.”
Ms Miller said there was a “strong case for the chancellor to build more headroom against her fiscal rules”, adding: “Persistent uncertainty is damaging to the economic outlook.”
‘No return to austerity’
A Treasury spokesperson responded: “We won’t comment on speculation. The chancellor’s non-negotiable fiscal rules provide the stability needed to help to keep interest rates low while also prioritising investment to support long-term growth.
“We were the fastest-growing economy in the G7 in the first half of the year, but for too many people our economy feels stuck. They are working day in, day out without getting ahead.
“That needs to change, and that is why the chancellor will continue to relentlessly cut red tape, reform outdated planning rules, and invest in public infrastructure to boost growth – not return to austerity or decline.”
The budget is scheduled for 26 November.
