The Institute for Fiscal Studies published its influential “green budget” report on Monday, analysing the public finances ahead of Chancellor John Healey’s first budget on October 28, and the verdict was blunt. Healey will need to find 36 billion pounds ($47.6 billion) in tax hikes or welfare cuts just to offset the inflation hit to public services and meet a defence spending pledge, Reuters reported, citing the think tank. The Guardian and Bloomberg put the figure at 35 billion pounds. The driver is the inflation shock from the Iran war: higher inflation has squeezed the public spending power of the plans Healey inherited from his predecessor Rachel Reeves, forcing a choice between accepting real-terms cuts, finding efficiency savings, or topping up departmental budgets by raising taxes or borrowing more.
IFS director Helen Miller said leaving the spending totals unchanged would implicitly mean allowing the quality or quantity of public services to fall, with deeper cuts if defence spending is increased within existing totals. “Simply pencilling in implicit cuts that he has no intention of delivering would make the budget a work of fiction,” she said, calling on Healey to avoid a “steady as she goes” budget that delays decisions until next year’s spending review. Healey has pledged to raise defence spending to 3 percent of GDP by 2030, and compensating for the inflation shock plus funding that pledge is what generates the roughly 35 billion pound requirement, the IFS said. Reuters notes that raising 36 billion pounds entirely through income tax would be equivalent to adding three percentage points to the main rate.
The arithmetic is brutal because the room for manoeuvre is gone. Healey and Prime Minister Andy Burnham say they will stick to the previous government’s promise not to raise the main rates of taxation, but are expected to find other ways to increase revenues; they are also under pressure to reduce Britain’s rising welfare spending. More than 60 billion pounds of tax hikes were introduced in Reeves’s previous two budgets, Reuters reported, and a sharp rise in government borrowing costs since the start of the Gulf conflict has added to the debt interest bill. Bank of England governor Andrew Bailey said last week that fiscal policy “must be credible and be seen as such by financial markets,” and the Times quoted a government source snapping back: “Andrew Bailey needs to focus on doing his job.” A Treasury spokesperson said the chancellor is fully focused on boosting business, helping with the cost of living and meeting the fiscal rules, and that the Office for Budget Responsibility will publish its updated forecast alongside the budget on October 28.
The IFS allowed one escape hatch: much of the extra debt interest bill and higher inflation-linked welfare costs could be offset if the OBR’s forecasters decide higher inflation will push up earnings growth and income tax revenues. But the report’s message is that a budget that makes no significant adjustments would effectively mean accepting substantial reductions in public services, a position investors may not find credible against what the Guardian described as a “febrile backdrop in the bond market.” Sixteen days out, the question is not whether Healey tightens, but where the 35 billion lands: on taxes, on welfare, or on services.