IFS warns of severe budget constraints for the next government

Britain’s fragile public finances will cast a shadow over the election campaign, with both Rishi Sunak and Sir Keir Starmer warned of looming budget problems by a leading economic think tank.

The Institute for Fiscal Studies (IFS) warns that the economy faces “the worst of both worlds”: low GDP growth and higher interest expenditure as interest rates hit a 16-year high .

According to the IFS, growth is unlikely to return to healthier trends in the next parliament as government spending on debt servicing is expected to remain high. This situation will limit the budgetary flexibility of any new chancellor after the July 4 general election.

Paul Johnson, director of the IFS, noted that both Starmer and Sunak have promising ideas to boost growth, but are also struggling with the challenging economic and fiscal environment. “When growth is high and interest rates are relatively low, the government can pursue looser fiscal policy – ​​it can borrow more – without pushing debt onto an upward path,” the think tank explained. Unfortunately, the conditions of high growth and low interest payments on debt are not expected to be met in the next parliament.

Britain’s debt-to-GDP ratio has risen from around 65% in 2010 to almost 100%, thanks to borrowing to cover the costs of the Covid pandemic and energy price increases following Russia’s invasion of Ukraine. Taxes as a percentage of GDP are also expected to peak after World War II. Interest rates have risen to 5.25%, and although inflation has fallen from 11.1% to 2.3%, increased interest expenditure on debt diverts resources from other public services.

The IFS warns that both the Labor and Conservative parties will face severe budget constraints on their first day in office as they have broadly committed to existing fiscal rules that aim to reduce the debt ratio within five years and limit annual borrowing to 3% of GDP. GDP. Jeremy Hunt, the current Chancellor, has cut National Insurance contributions by four percentage points over the past two Budget events, but the Office for Budget Responsibility estimates there is only £8.9 billion of ‘headroom’ after the March Budget compared to the budget targets, a significant decrease compared to the March budget targets. the average of £27 billion since 2010.

The cuts to national insurance have been partly funded by significant budget cuts for unprotected government departments, including local councils and courts. However, the details of the departmental budgets that will support these cuts remain unclear, leading to criticism from the IFS for the lack of transparency. “We could decide as a country to charge money for services that are free, or to test resources for things that are universally offered, or to make the state stop doing things it does,” the IFS said. They highlighted the inconsistency in allowing parties to promise cuts without specifying where cuts would take place.

The looming cuts could result in cuts of between 1.9% and 3.5% per year in the real term, equating to cuts of £10 billion to £20 billion. The Resolution Foundation, another economic think tank, has described these planned cuts as a ‘budget fiction’.

A comprehensive spending review is expected to be one of the first major economic actions taken by either Labor or the Conservatives after the election.