Maintaining public services and funding higher defence spending could lead to £35billion worth of tax hikes or benefit cuts, IFS warns
Chancellor John Healey faces having to hike taxes in this month’s Budget to protect front-line public services, economists have warned.
The Institute for Fiscal Studies said higher-than-expected inflation, caused by the Middle East war, risks “blowing departments’ spending plans off course” in the coming years.
Doing nothing and sticking with current plans could lead to “chunky cuts to the quantity or quality of some public services” at the end of this parliament, the IFS said.
The Chancellor, keen to avoid that, will be under pressure to maintain departmental spending in real terms. However, it comes as the government faces calls to bring forward an increase in defence spending.
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With the government expected to shell out more than £100billion this year on debt interest payments, the IFS warned borrowing even more to cover day-to-day spending is not an option.
Instead, it says both protecting public services and funding higher defence spending could require tax rises or benefit cuts of around £35billion by 2030/31.
Helen Miller, director of the IFS, said: “The Chancellor could choose to spread the pain across all departments, including the NHS. In a world where you want to avoid those cuts – and you want to spent a substantial amount more on public services, which is a choice – then you need to go for tax hikes.
“If you are looking at tens of billions of increasing spending you should be thinking of tens of billions of increasing taxes, by the time that is kicking.”
A burning question ahead of the Budget on October 28 is what taxes Mr Healey is most likely to target. He has already ruled out touching the IFS calls “workhorse taxes” – income tax, VAT and employee national insurance – which account for the vast bulk of the Treasury’s income.
Labour is also desperate not to touch any taxes that could worse still the cost of living crisis for millions of working people, with Mr Healey and PM Andy Burnham pledging instead to give households “breathing space”.
It has led to speculation that Mr Healey is considering other more targeted increases. One that emerged again as a possible is capital gains tax – paid on the profit made when second homes, certain shares or business assets are sold – and potentially bringing it into line with rates of income tax.
Another idea floated has been to introduce a 50% rate of income tax to hit higher earners, and a windfall tax on banks’ profits. Reports over the weekend suggest
Mr Healey has rejected the idea of lowering a mansion tax threshold from £2million to £1.5million, and is under pressure from big retailers to also rule out a higher tax on warehouses.
Much focus over recent weeks has been a jump in government borrowing costs, fuelled by a global rout as investors become jittery about inflation and the possibility of interest rate hikes around the world. The IFS says the UK has actually fared better than many other countries, including France and the US.
Worse-than-feared inflation could add around £12billion to government borrowing costs, it estimates, along with £10billion in cost of living linked benefit payments. But it also believes the Treasury could rake in an extra £10billion from the likes of VAT and corporation tax.
Much of what Mr Healey decides could come down to the government’s “headroom” – the buffer between borrowing and maintaining its so-called “fiscal rules”.
Economists have speculated that the borrowing cost spike has wiped out about half of a previous £24billion gap that was forecast in March. However, the IFS estimates is nearer £21billion, limiting to need for savage tax hikes, although it warned “the degree of uncertainty is very high.”
Helen Miller said a “steady-as-she-goes” Budget is not an option available to the Chancellor. Instead, she said bond markets and others are looking for a “credible” plan for the government to get a grips of the national finances.
“Choosing to stay the course with the inherited tax and spending plans would mean allowing inflation to blow departments’ spending plans off course,” she warned.
“It would be a choice to tolerate chunky cuts to the quantity or quality of some public services – cuts that would be larger if defence spending was increased within existing totals.”
She added: “If he chooses the path of squeezing public spending, he should be transparent that there are tough years ahead for some public services. Simply pencilling in implicit cuts that he has no intention of delivering would make the Budget a work of fiction.”