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It’s Hammond vs May as IFS says they can't both have it their way

Credit: PA

Promises, promises. The prime minister has promised to end austerity, the chancellor has promised to balance the books by the mid 2020s.

The Institute for Fiscal Studies (IFS) doubts that both can be done.

In its Green Budget, the IFS defines an “end to austerity” as ending the real terms cuts to unprotected departmental budgets. It estimates that to do this the chancellor will need to find an extra £19 billion a year by 2022/23.

Credit: IFS

Much of this figure (£13 billion) is the cost of the commitment the government has made to increase funding for the NHS, defence and overseas aid over the next four years.

The balance is the cost of reversing cuts to other departmental budgets which have already been allocated but are yet to be felt.

The IFS argues that, unless the economy suddenly roars into life or taxes rise significantly, the chancellor won’t be able to raise anything like £19 billion without breaking his pledge to the eliminate the deficit.

In short, Number 10 and Number 11 can’t both have it their way. It’s Hammond vs May. Top Gear without the excitement.

Credit: IFS

The IFS points out that its definition of “austerity” is extremely modest, indeed the “minimum” that it considers to be acceptable.

It assumes that the squeeze on public services comes to an end but argues that public service spending (as % of GDP) would still be low and £7 billion of social security cuts, announced by the Cameron/Osborne administration, would continue to roll out untouched. The IFS’s £19 billion figure also excludes the money required to fund the extension of the fuel duty freeze that the Prime Minister announced recently at party conference. The IFS estimates the cost of doing this at £800 million.

For a chancellor who talks a lot these days of maintaining “fiscal firepower” his ammunition belt is looking rather empty.

The IFS thinks the Chancellor will have something to shout about on Monday 29th October. Since the Budget, in March, tax receipts have been higher than forecast, spending has been lower.

The headline rate of borrowing and the deficit are already at pre-crisis levels. The IFS expects the Office for Budget Responsibility (OBR) to lower its forecasts for both yet further. If the IFS is right, then by 2022/23 the chancellor will have an extra £5-6 billion of wiggle room.

Credit: IFS

Brexiteers, take note: The IFS admits that, despite all the glum forecasts, the public finances currently show no sign of deterioration since the referendum. However it argues that stronger tax receipts are the reason, the performance of the British economy has demonstrably weakened since Britain voted to leave the EU.

And while the borrowing picture has improved noticeably, the stock of national debt we’ve run-up in the last decade is big and ugly. Public sector net debt (£1.8 trillion) stands at just over 80% of GDP, before the financial crisis it was 35%.

The chancellor has already hinted that taxes will rise but tax is a tricky issue. The overall tax burden (33% of GDP) is high by historic standards, although low compared with other European advanced economies, like Germany (38%) Italy (43%) and France (45%).

Credit: IFS

The government pledged not to raise the level of VAT in its 2017 election manifesto. It also committed itself to corporation tax cuts (which have already been legislated for) and promised to increase the personal allowance thresholds for income tax to £12,500 and £50,000 for higher earners.

The IFS calculates the government would save itself more than £7 billion a year in five years time, if both income tax thresholds were frozen at current levels.

Would Hammond break a manifesto pledge? It’s unthinkable, surely. He was forced to abandon a plan to increase national insurance contributions for the self-employed in March 2017 for precisely that reason.

And while opinion polls suggest public attitudes to paying more tax to fund better services have softened, attitudes within Mr Hammond’s party have not.

In theory, the chancellor will stand up in two weeks time, set out the public spending “envelope” (budget) for the years beyond 2020 with the departmental detail to be filled in next March. He will loudly confirm an end to austerity and then finance it by either raising taxes or borrowing more.

In practice, he doesn’t have to do any of the above. Now is not the obvious time to be bold.

The chancellor can reasonably argue that it’s sensible to postpone making difficult spending decisions until next year when we’ll know a little more about what Brexit will mean for our future trading relationship with the European Union.

It’s also pragmatic to delay. This government holds power thanks to the support of the Democratic Unionist Party and the DUP is already threatening to vote against the Finance Bill - there’s a powerful incentive not to put anything controversial in it.

In extremis, would it matter if the chancellor were to have to break one of his (self-imposed) fiscal rules? Probably not. Every chancellor before him has done. I’m not sure they resonate with the public and I’ve not met many people in the City or in business who know exactly what they are and who they are for.