Britain has spent recent weeks being softened up for the new Chancellor to plug a supposed ‘fiscal black hole’, estimated at about £55billion.
This fiscal hole has resulted in a double threat: a round of spending cuts to public services and a wave of tax hikes, to be delivered by Jeremy Hunt today.
Pretty much every tax you can think of has been rumoured to rise in the run up to the Autumn Statement and while it is unlikely they all will, you can be certain some do.
But what is this fiscal black hole, why is it bad enough to warrant this, and is it true that if you tinker with the numbers a bit in the forecasts it goes away?
How have we gone from Rishi Sunak as Chancellor with a £30billion margin on hitting his targets, to Rishi Sunak as Prime Minister with a supposed black hole twice as big?
AUTUMN STATEMENT IN BRIEF: What it means for you and how much will you save or pay in extra tax?
AUTUMN STATEMENT LIVE BLOG: The latest mini-Budget and reaction
Mr Popular: Jeremy Hunt plans to hike taxes and cut spending to balance the books
Rishi Sunak’s fiscal rule
The first thing to note is that it is Rishi’s targets underlying this so-called black hole.
A year ago, as Chancellor he introduced the UK’s latest fiscal rules, designed to show we were prudent and not going to just keep borrowing money and spending it on stuff.
To put this in the context of how good Britain is at sticking by such rules, ahead of the announcement the Institute for Fiscal Studies noted the UK had eleven fiscal targets in the last seven years.
Nonetheless, the sentiment that we should try to live within our means and not borrow money for day-to-day spending is one that many would appreciate.
Sunak stated to parliament his fiscal rules would apply over a three-year time horizon and were:
‘Underlying public sector net debt excluding the impact of the Bank of England must, as a percentage of GDP, be falling.’
And
‘Second, in normal times the state should only borrow to invest in our future growth and prosperity.’
Earlier this week, I spoke to Carl Emmerson, of the IFS, about this and asked him to explain what was going on with the fiscal rule and the black hole.
He said that as fiscal targets go this wasn’t bad: the three-year period was arbitrary, but it allowed that in bad years there was a case for debt going up, while recognising it can’t rise as a share of national income forever.
Instead, the rules aim to use the good years to get debt going down as a percentage of GDP and state borrowing is fine for investing in our future but not to fill gaps where we can’t balance the books.
Where the fiscal black hole came from
In March, when Sunak delivered his Spring Statement, the accompanying Office for Budget Responsibility report said that there was about a £30billion margin for meeting the fiscal target. But Emmerson says, ‘since then the outlook has clearly got much worse’, with higher spending combined with lower growth that means less tax coming in.
The OBR forecasts came from before Russia’s invasion of Ukraine sent energy and food prices spiralling and drove inflation much higher.
This has sent interest rates up by more than expected and driven up the cost of government borrowing and servicing our debt, with investors demanding higher rates to hold gilts, as UK bonds are known.
To meet the fiscal target the growth in the UK’s debt needs to be slower than the growth in GDP, but there has been abrupt about turn in forecasts for this.
A report in the FT this week suggested the OBR has told the Treasury that a previous forecast budget deficit of £31.6billion in 2026 to 2027 could now be almost £100billion – with about half the rise accounted for by higher interest on the UK’s £2trillion debt pile.
Gilt yields had already risen over summer but spiked after Kwasi Kwarteng’s badly delivered giveaway mini-Budget, which slashed taxes in the hope of growth with no OBR report alongside it.
In the aftermath of that, a few days before Kwarteng was sacked as Chancellor, the IFS assessed the state of Britain’s finances and said the margin had evaporated and instead at that point we were about £60billion out.
Other forecasters made similar estimates and this is the point in time where the £55billion black hole numbers come from.
However, Emmerson added that since then we’ve seen the reversal of almost all those tax cuts – except for National Insurance and stamp duty – and we might now only be £30billion out.
It is true that if you change the numbers on projected growth, inflation and interest rates this can be made to go away, but that is true of any longer-term forecast and the OBR will posit a range of outcomes – but the government usually tends to use the central one.
Meanwhile, although this may mean things aren’t as bad as reported, the Treasury will want some headroom to hit its targets.
It seems that Hunt wants to go further than he has to to try to calm markets that have already calmed down and give the government future wriggle room. But doing that into a recession already forecast to be deep is a risky move.
Is raising taxes into a recession wise?
In a piece of kitchen sinking, Hunt is likely to prefer to get all the bad news out in one go rather than having to come back with more tax hikes in the future.
Politically, Sunak and Hunt would also rather get those unpopular tax rises in now rather than closer to a General Election – and they have only got two years to play with.
Hunt risks going too far. With markets now calmed by Sunak and Hunt’s stern schoolteacher approach rather than Truss and Kwarteng’s kids on a school trip one, a sense of credibility and prudence has already been restored
Assessing the situation, Emmerson said Hunt has to weigh up to what extent does he have to deliver tax hikes now to seem credible, compared to could he take a more nimble approach and pencil some in for years to come.
The advantage of the latter is that they won’t hurt the economy now and can be cancelled later if things turn out a bit better than planned.
‘There are risks of overtightening as well as undertightening’, said Emmerson.
Hunt risks going too far is a message that has been echoed elsewhere, as with markets now calmed by Sunak and Hunt’s stern schoolteacher approach rather than Truss and Kwarteng’s kids on a school trip one, a much greater sense of credibility and prudence has been restored.
Government borrowing costs have fallen, with ten-year gilt yields down to 3.29 per cent compared to 4.5 per cent in late September.
Meanwhile, the pound has risen to a three-month high – trading at $1.19, the same level as in mid-July.
Among many in the financial world there is a concern that the Chancellor risks delivering Austerity Mark Two unnecessarily and that problems in the bond market were to do with Truss and Kwarteng and their delivery of the mini-Budget, rather than a desire for Britain to put on its hair shirt.
Speaking to people outside the financial world, I keep hearing a similar question on whether hiking taxes and killing off any remaining trace of upbeat consumer sentiment in the face of a recession is really a wise move?
Hunt’s version of the mini-Budget is expected to bring a commitment to stick with the triple lock and a rise in benefits in line with inflation to protect the poorest, but little cheer for anyone else.
Households are already struggling with much higher mortgage costs, rapidly rising rents, food inflation at 15 per cent and energy bills that have rocketed.
That will do enough to damage growth.
Let’s hope a harsh round of tax rises don’t arrive to make the recession much worse, because that’s what I fear Jeremy Hunt is about to do.
Some links in this article may be affiliate links. If you click on them we may earn a small commission. That helps us fund This Is Money, and keep it free to use. We do not write articles to promote products. We do not allow any commercial relationship to affect our editorial independence.
