The government is on course to impose steep cuts in public spending from April and increase taxes by the end of the decade to their highest level as a share of national income since 1986–87 to combat the UK’s persistent budget deficit.
But slower economic growth following the Brexit vote will still leave the UK with one of the largest black holes in public spending in the developed world, meaning the next government must find £40bn to eliminate the budget deficit in the next parliament, according to the Institute for Fiscal Studies.
“For all the focus on Brexit the public finances in the next few years look set to be defined by the spending cuts announced by George Osborne,” said IFS director Paul Johnson.
“Cuts to day-to-day public service spending are due to accelerate while the tax burden continues to rise. Even so the new chancellor may not find it all that easy to meet his target of eliminating the budget deficit in the next parliament.
“Even on central forecasts that is going to require extending austerity towards the mid-2020s. If the economy does less well than hoped then we may see yet another set of fiscal rules consigned to the dustbin.”
The leading tax and spending thinktank said downgrades in GDP growth over the next four years will strain the public finances, which are already on course to be £13bn worse off in this financial year than forecast, after weak growth in tax receipts.
Highlighting the pressure on the chancellor, Philip Hammond, the IFS’s annual assessment of the public finances found that Britain’s ageing population and increasing demands on the NHS will blow a large hole in the government budget over the next two parliaments.
It said: “Demographic and non-demographic pressures are projected to put upward pressure of 1% of national income on health, social care and pension spending by 2025.
“Taking into account possible negative effects from lower growth, the government may need to enact further measures worth £40bn (in 2016–17 terms) in order to eliminate the deficit in the next parliament,” the report said.
Deep cuts in welfare benefits are due to take effect from April alongside cost cutting in Whitehall department budgets. Yet the government still plans to pay for large giveaways in the form of a higher income tax personal allowance at the basic and higher rate and was expected to maintain freezes on fuel duty that totalled £4.5bn a year.
The IFS said the promised spending and slower growth would force the government to implement tougher austerity, even though the chancellor has abandoned his predecessor’s pledge for a budget surplus by 2020.
It said: “Real levels of day-to-day public service spending have actually fallen very little overall in the last three years. The rate of reduction is set to speed up after this year, with cuts of nearly 4% due between 2016–17 and 2019– 20.
“In addition, tax is rising as a share of national income and by 2019–20 is due to reach its highest level since 1986–87.”
It said a deficit in 2016-17 of 3.5% of GDP, or £68.2bn, was £12.7bn higher than the Office for Budget Responsibility, the Treasury’s independent forecaster, had predicted in March 2016.
“This increase was not a result of a downgrade to the forecast for economic growth, but arose as a result of weak growth in tax receipts – in particular, income tax, National Insurance contributions (NICs) and stamp duty land tax – and faster growth in local authority spending,” it said.
Hammond said in the autumn statement last year that he plans to boost public investment spending beyond pre-crisis levels as a proportion of overall public spending, with much of the extra cash to be spent on transport infrastructure.
However, many departments will need to make further savings on day-to-day spending by the end of the parliament.
The IFS said: “Public spending, especially on health, pensions and overseas aid will be higher as a share of national income than in 2007–08, while spending on schools, defence and (in particular) public order and safety will be lower.”