Why is Jeremy Hunt planning big tax rises and spending cuts?

Chancellor Jeremy Hunt has been warned the underlying health of the UK’s public finances has deteriorated by £70bn.

The Office for Budget Responsibility has told the Treasury that, having in March forecast a budget deficit of £31.6bn in 2026-27, the UK fiscal watchdog now thinks that figure has mushroomed to close to £100bn.

The bleak OBR forecast has prompted Hunt to prepare big tax rises and spending cuts in Thursday’s Autumn Statement.

Why does the £70bn figure matter?

The £70bn figure is an estimate by the OBR of how much public borrowing will increase by in 2026-27 because of the anticipated deterioration in the UK’s economic outlook. Governments borrow to make up the difference between what they spend and what they raise in taxes.

The fiscal watchdog’s calculation is breathtaking: it has calculated the underlying deficit will balloon by more than 200 per cent in 2026-27 if ministers take no steps to address the situation.

An ally of Hunt said the OBR estimates the government will need to borrow close to £100bn in 2026-27, having in March, at the time of the Treasury’s Spring Statement, calculated the figure would be £31.6bn. The OBR declined to comment.

About half of the £70bn is based on the assumption the government has to pay more interest on the £2tn of debt it has outstanding.

Interest rates on government debt have risen sharply since March, from about 1.5 per cent to about 4 per cent, reflecting how the Bank of England is tightening monetary policy.

Another large portion of the £70bn comes from the assumption the government will increase state pensions and welfare benefits by 10.1 per cent in April.

This hefty increase would be in line with the rate of inflation in September, when price rises were at a 40-year high. In March, the OBR assumed pensions and benefits would increase 8 per cent in 2023-24.

A much weaker UK economy in the medium term will also have influenced the OBR borrowing estimate, because it in turn reduces tax revenues. The BoE this month predicted a recession lasting somewhere between one and two years.

How is the borrowing figure related to the £55bn fiscal hole?

There is a relatively simple read across from the underlying deficit of close to £100bn in 2026-27 to the size of the UK fiscal hole, thought to be about £55bn a year.

After estimating the deficit, the OBR adds in the effects of all relevant government policy announcements that have taken place since March.

These include Boris Johnson’s plan in May to help households with soaring energy bills, Liz Truss’s “mini” Budget in September involving £45bn of unfunded tax cuts, and Hunt’s reversal of most of her measures.

The main changes involve scrapping both a planned rise in national insurance and a proposed reduction in income tax, suggesting about £15bn needs to be added to the underlying deficit of close to £100bn, according to calculations by the Financial Times.

At this level, the public finances risk becoming unsustainable, and the government also faces breaching its planned fiscal rule for debt to be falling as a share of gross domestic product by 2027-28.

To be confident of cutting the debt burden, the Treasury thinks it needs to reduce borrowing in 2027-28 by about £55bn.

This is the fiscal black hole it has calculated, and Hunt is expected therefore to unveil tax rises and spending cuts worth about £55bn a year.

Why is the Treasury so worried?

Government officials are concerned that some MPs, think-tanks and the public have not fully grasped the dire position of the public finances.

Ministers do not want Conservative MPs to say there is no need for the unpleasant tax increases and spending cuts and the government crucially needs to obtain parliamentary approval for the measures. There is serious risk of Tory MPs rebelling against some measures.

Hunt told Sky News on Sunday: “We have had a very big deterioration in the public finances.”

Why are ministers basing policy on uncertain forecasts?

The OBR normally produces two sets of forecasts each year involving predictions for the economy and the public finances.

The forecast for the economy is rarely very different from predictions produced by the BoE and the private sector.

Where the fiscal watchdog adds value is in translating its economic forecast into predictions for the public finances, looking at all aspects of government spending and tax revenues.

Many economists have pointed out that OBR forecasts, looking out five years ahead, can prove to be spectacularly wrong.

The whole point of the OBR is not to get the figures exactly right, but to give its best forecasts for the economy and the public finances so that ministers can make informed policy decisions.

Truss and her then-chancellor Kwasi Kwarteng unleashed turmoil in financial markets with their “mini” Budget partly because they chose not to publish OBR forecasts alongside it.

Letter in response to this article:

A plea to the chancellor to rethink energy windfall tax / From Linda Z Cook, Chief Executive Officer, Harbour Energy, London SW1, UK