New chancellor Kwasi Kwarteng will need to cut spending on public services, raise other taxes or break the government’s fiscal rules if he implements Liz Truss’s promised tax cuts.
While Kwarteng’s immediate challenge will be supporting households and businesses through a winter of sky-high energy prices, this paper warns that the new chancellor should use Truss’s planned ‘fiscal event’ on 21 September to be honest about difficult choices on tax and spending beyond this winter.
The prime minister has said this will be held without a new Office for Budget Responsibility forecast, but the new IfG paper says Kwarteng would be irresponsible to carry out her tax cuts without an updated official forecast. Much of the £30bn of headroom forecast by the OBR in March may well have been wiped out by rising inflation and interest rates and lower growth prospects due to the energy price shock.
Truss’s pledge to reverse the health and social care levy will cost around £12bn per year and her corporation tax cut promise will cost £17bn per year from 2025. Her plan to increase defence spending from 2% to 3% by 2030 will cost an additional £11bn in 2025/26.
At the same time the rising cost of energy and goods – and higher than expected pay increases tied to these – means the government would need to increase departmental spending by £2bn in 2024/25, the last year of the 2021 spending review period, just to maintain the generosity of Boris Johnson’s October plans. Not doing so will mean cutting the quality or scope of public services and performance would almost certainly suffer as a result.
The Truss campaign argued that her tax cuts would boost economic growth and make the fiscal situation easier, but slashing headline tax rates is not a good way to achieve this as it won’t address the flaws and distortions of the UK’s existing tax system. The new chancellor should instead look at ways of improving the tax system and look to other policy levers, such as infrastructure and skills policy, to try to improve economic growth.