Reversing NICs and corporate tax hikes would leave debt on an unsustainable path
In the “mini-budget” for Friday, September 23, the government is expected to confirm significant tax cuts reflecting commitments made by new Prime Minister Liz Truss during the leadership campaign. Despite this – and despite the fact that the outlook for the economy is now much weaker than forecast by the Office for Budget Responsibility (OBR) in March – this statement will not be accompanied by new official forecasts for the economy and the public finances. It’s disappointing.
Main conclusions
- The OBR last made a forecast of public finances in March. Since then, energy prices and inflation have risen far beyond what was expected, and growth forecasts have collapsed. Here we forecast public finances based on Citi’s latest forecasts for growth, inflation and interest rates. This implies a shorter and shallower recession than the Bank of England predicted in August, due to the substantial support provided to household and corporate finances by the energy price guarantee. In addition, the rise in the inflation outlook since March is mitigating some of the blow to the economy’s cash size – which matters more than its actual size for government revenue. Still, Citi forecasts the cash economy to be 2% lower in 2026-27 than the OBR forecast in March.
- The budgetary cost of guaranteeing energy prices is very uncertain, in particular because the eventual cost will depend on the development of energy prices and, consequently, on whether or not the system is extended in some form or another one. We assume that the energy price guarantee will cost well over £100bn over the next two years, but will then be phased out in accordance with the government’s announced plan. It could be a lot more expensive and end up lasting over two years – or a lot cheaper than we assume.
- The cost of reversing the recent rise in national insurance contribution rates and reversing the large planned rise in the corporation tax rate next April is much more certain. Together, Ms Truss’ tax commitments, if fully met, would result in incomes around £30billion a year lower than they would otherwise have been. Since these are important and permanent measures, they are also more important for the long-term health of public finances than the possible cost of guaranteeing energy prices.
- Rising inflation will also lead to higher spending on debt interest, state pensions and most working-age benefits. In contrast, utility spending is fixed in cash terms and therefore does not automatically adjust in light of increased inflation. Previous IFS research has suggested that an additional £18billion would need to be found in each of the next two years to restore utility spending plans to the generosity in real terms that was forecast in the establishment of plans. In addition, Ms. Truss pledged to increase defense spending to 3% of national income by the end of the decade. Our projections do not include any additions to the public service spending plans that were established a year ago; there is therefore a considerable risk that borrowings end up being higher than our overall estimates suggest.
- The combination of higher spending and substantial tax cuts leaves borrowing much higher than expected in March. Importantly, even after the energy price guarantee is assumed to expire in October 2024, our forecast calls for borrowing of around £100bn a year, or over £60bn per year more than forecast in March. Nearly half of this increase in borrowing would be due to new tax cuts. At around 3.5% of national income, borrowing would be nearly double the 1.9% of national income it averaged over the 60 years before the global financial crisis, when growth prospects were considerably higher. With investment spending amounting to about 2½ percent of national income, this would leave a persistent projected current budget deficit of about 1 percent of national income. Without further tax cuts, the current budget would have been expected to remain in balance.
- According to our forecasts, the debt would increase, not only while the energy price guarantee was in place, but also thereafter. Persistent current budget deficits and rising debt as a share of national income mean that two key fiscal targets legislated only in January would not be met and debt would be left on an ever-increasing trajectory. Allowing the temporary increase in debt to finance one-off support programs, such as the energy price guarantee or the partial unemployment scheme, in exceptional circumstances is justifiable and can be sustainable, but one cannot argue similarly to allow debt to grow indefinitely in order to take advantage of tax cuts now.
- Finding a way to somehow boost the UK’s economic growth rate would undoubtedly help. But the scale of the challenge should not be underestimated: an increase in annual growth of more than 0.7% of national income – the only increase needed to stabilize debt as a percentage of GDP at the very end of our forecast. – would be the difference between the growth the UK experienced between 1983 and 2008 and that of the 2010s. There is no magic bullet, and establishing plans underpinned by the idea that tax cuts policies will provide a lasting boost to growth is, at best, a gamble.
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