Philip Hammond will have to confront a £25bn hole in the public finances in his Autumn Statement as UK growth and tax revenues fall short of projections, according to a leading economic think-tank.
The Institute for Fiscal Studies says borrowing will be £31bn a year higher than expected by 2019-20, only partially offset by savings from the UK no longer contributing to the EU budget, which could help reduce spending by about £6bn a year.
This is in sharp contrast to figures from the Office for Budget Responsibility, which forecast in March that the public finances would improve from a £76bn deficit last year to a £10bn budget surplus by 2019-20.
Instead, the IFS report suggests Mr Hammond will face a deficit of £15bn in 2019-20 — a shortfall of £25bn compared with the OBR’s projection.
The chancellor will give a first indication of how he will respond to the forecasts in his Autumn Statement on November 23, though he has already made clear he will not try to meet targets set by George Osborne, his predecessor as chancellor.
While he does intend to bring the public finances “back to balance” eventually, in the near term he has suggested he will adopt a new fiscal framework that allows the government “headroom” to react to any Brexit fallout. He is also aware that, after six years of spending cuts, many public services are struggling to cope.
“Given the levels of uncertainty, [Mr Hammond] might be wise to respond cautiously for now,” said Thomas Pope, one of the authors of the IFS report. “Any new fiscal targets should be reasonably flexible. Any decisions to increase spending or cut taxes in the short run should be taken in the knowledge that significant further austerity after 2020 looks to be on the cards.”
The challenge of balancing the government’s finances will become harder beyond 2019-20, the IFS says, as the pressures of an ageing population mount. Though these pressures existed before the Brexit vote, they could become more difficult if leaving the EU results in lower migration or slower economic growth.
When asked about the IFS’s conclusions on Tuesday, Theresa May said “leaving the EU presents us with a world of opportunities and I am determined to seize on them”. Speaking during a trip to India, Mrs May told the BBC: “We are determined to continue to live within our means . . . I want us to be a global leader in free trade and ensuring we are taking those opportunities . . . Because it means jobs and investment in the UK”.
Mr Hammond has told cabinet colleagues to expect only a modest fiscal stimulus in the Autumn Statement, with a small increase in infrastructure spending. He rejected suggestions last month that there would be a “fiscal splurge”.
The Resolution Foundation, another think-tank, has also suggested the OBR will forecast a significant increase in the budget deficit by 2019-20. Matthew Whittaker, chief economist at the foundation, estimated borrowing would be £23bn higher in that year.
“The first fiscal event for any new chancellor of the exchequer is a big deal, setting the tone for what is to follow,” said Mr Whittaker. “The central question he faces is how to respond to a significant expected deterioration on the economic and public finance forecasts.”
The IFS and Resolution Foundation forecasts assume the government is able to deliver all the spending cuts planned for the next three years. But there are growing signs public services are struggling to cope after six years of tight funding settlements.
A riot broke out in Bedford Prison on Sunday evening after guards lost control of one of the wings. This came just three days after Liz Truss, justice secretary, outlined plans for 2,500 additional prison officers to be recruited to help address rising levels of violence in prisons. The number of prison officers was cut sharply between 2010 and 2015.
There has also been growing concern over the ability of health and social care services to meet rising demand. On Tuesday, the UK’s three leading health think-tanks are to call for the government to use the Autumn Statement to announce £1.9bn of additional funding for social care next year. The Health Foundation, the King’s Fund and the Nuffield Trust said public spending on social care in England had been cut by nearly 2 per cent a year between 2009-10 and 2014-15.
The number of people receiving state-funded care has fallen by 400,000, even though the number of older people has risen significantly. As a result there has been a sharp increase in hospital bed-blocking as people are unable to leave hospital because no suitable care is in place.
“Cuts to social care funding are leaving older and disabled people reliant on an increasingly threadbare local authority safety net,” said Richard Humphries of the King’s Fund.
“While the pressures on the health service are very real, the case to prioritise social care funding in the Autumn Statement is compelling,” said Anita Charlesworth of the Health Foundation.
The central question [the chancellor] faces is how to respond to a significant expected deterioration on the economic and public finance forecasts
The Bank of England and most independent forecasters are expecting lower growth and higher inflation during the next few years than was forecast in March. If the OBR follows suit in its forecasts this month, it will predict substantially lower tax revenues than it had previously expected.
Higher inflation will also push up the cost of paying public service pensions, which rise each year in line with inflation. It will also heap further pressure on public services and on working-age families receiving benefits.
Public service budgets have been fixed in cash terms for the next three years, while many benefits will be frozen for the same period. Higher inflation means the money available to public service providers and households receiving benefits will not go as far.
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