Hunt gambles fiscal tailwind on voter-friendly tax cuts

Unlock the Editor’s Digest for free

Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

Buoyed by improved borrowing forecasts, chancellor Jeremy Hunt on Wednesday chose to use his extra fiscal wriggle-room to court businesses and voters with tax cuts.

The political appeal of the strategy was obvious, given the pressure on the chancellor from his Conservative ranks for headline-grabbing sweeteners in the face of the opposition Labour party’s persistent 20-point polling lead and a likely election next year. 

But the package he delivered in his Autumn Statement was founded on a “fiscal fiction” that will leave a bitter legacy for the next government, according to economists at the Resolution Foundation think-tank.

Hunt banked extra tax revenues generated by higher inflation, but declined to lift departmental spending envelopes in light of the rising prices. It has left the government’s finances in a vulnerable state should the economic weather worsen sharply in the new year. 

“Announcing immediate and certain tax cuts in response to highly uncertain changes in assumptions about the UK’s medium-term economic prospects is not a recipe for good management of the public finances,” warned Paul Johnson of the Institute for Fiscal Studies think-tank. 

“Spending the entirety of such a windfall, but allowing borrowing to rise when bad news comes along, is not the route to fiscal sustainability.”

Ahead of the Autumn Statement Hunt was handed unexpectedly positive news on the public finances, with borrowing during the current fiscal year running £16.9bn below the £115.2bn forecast in March by the Office for Budget Responsibility, the fiscal watchdog. 

The improvement reflected the positive impact of the UK’s persistent, domestically-driven inflation on tax revenues, which is outweighing the burden of higher interest rates on debt payments.

Back in March the OBR raised eyebrows by predicting CPI inflation would be just 0.9 per cent next year — far below the expectations of other forecasters. In its new outlook, the watchdog sharply boosted its inflation forecast for next year to 3.6 per cent, alongside increases in the subsequent three years.

Pacier inflation leaves nominal GDP nearly 5.5 per cent higher by the start of 2028 than the OBR predicted forecast in March and bolsters the outlook for government revenues. The decision to freeze personal tax thresholds, rather than raising them in line with inflation, also allowed the Treasury to raise an extra £44.6bn in annual tax revenues by 2028-29.

This means the chancellor was presented with favourable OBR deficit forecasts as he weighed up his policy choices, with public sector net borrowing predicted to be £27bn lower than previously expected by 2027-28.

This improved position left Hunt with a choice: he could seek to further consolidate the public finances following the damaging debacle of former prime minister Liz Truss’s so-called mini-budget last year, or he could spend the unexpected fiscal harvest on spending increases or tax cuts. 

He opted for the latter, in a package that the Resolution Foundation said was the largest tax-cutting endeavour in decades. The measures were dominated by a large cut in national insurance contributions, costing £10.4bn by 2027-28, alongside a decision to make permanent the Treasury’s temporary tax incentives for business investment at a cost of £9.1bn in 2027-28.

The decision to go for tax cuts was a politically-charged gamble aimed at putting clear ideological water between his party and Labour. “Big government, high spending and high tax” lead to “less growth, not more,” Hunt told Parliament. “Instead we reduce debt, cut taxes and reward work.” 

The combined impact of the chancellor’s policies aimed at bolstering investment and lifting employment is to raise the level of GDP by 0.3 per cent in 2028-29, according to the OBR’s estimates.

This involved Hunt spending almost all of the expected fiscal improvement between 2023-24 and 2027-28. After factoring in those giveaways, borrowing forecasts ended up being largely unchanged from March, the OBR noted.

The key constraint facing the chancellor as he weighed his options was a self-imposed fiscal rule that requires public sector net debt to be falling as a share of GDP between the fourth and fifth year of the OBR forecast. 

The favourable trends in tax receipts had left him with headroom of more than £30bn ahead of the Autumn Statement. The tax cutting measures, alongside other budgetary decisions including on welfare spending, whittled that down to £13bn in the OBR’s final forecast. 

That was well above the £6.5bn of headroom estimated in March, and in theory it could leave Hunt with further space for giveaways in his next budget — potentially the last big fiscal event before the election.

But estimates of the trajectory for public debt remain vulnerable to shifting assumptions on the outlook for growth, inflation and interest rates. 

While underlying public sector net debt is now predicted to drop from 93.2 per cent of GDP in 2027-28 to 92.8 per cent the following year, it remains at historically high levels. A sluggish growth outlook, combined with weighty interest payments in a higher-for-longer interest rate environment, will only make it more difficult to keep the debt ratio on a declining trend — a problem by no means unique to the UK.

The fiscal numbers also add up only because the chancellor decided to reap the benefits of higher than expected government revenues while ignoring the damage high inflation is doing to departmental budgets. The OBR itself reported a £19.1bn “erosion in the real value of departmental spending”.

This leaves the Autumn Statement measures resting on unstable fiscal foundations, with costly and painful decisions on public spending left for after the next election.

“With the government assuming no increase in departmental spending, this implies even greater real terms cuts in spending after the election,” said Andrew Goodwin of consultancy Oxford Economics.

He added: “In our view, the spending assumptions don’t look credible and will cause major problems for whoever forms the next government.”