Jeremy Hunt could offer striking public sector workers a bigger pay rise before his budget next month by cancelling plans for a fuel duty freeze costing £6bn, according to a leading tax and spending watchdog.
With waves of fresh strike action planned across the public sector next month, the director of Institute for Fiscal Studies (IFS), Paul Johnson, said the chancellor faced a “straight choice” between subsidising car driving and helping public sector workers cope with the cost of living crisis.
He said concerns that a pay rise averaging 5.5% – adding £5bn to the bill for this year’s settlement – would spark a fresh round of inflation were exaggerated because the effect would be “extremely small” compared with the size of the overall economy.
“If as we expect we have yet another freeze on fuel duties, that is a £6bn in-year tax cut and indeed an injection of money into the economy. And there is a straight choice there, £6bn goes quite a long way, if you are spending that on public sector pay rather than cutting fuel duty,” he said.
“Supposing the Treasury came up with an extra 2% or 3% for public sector workers, we are talking about a few billions of pounds from a two and a bit trillion pound economy. The likelihood of inflation making a big impact on that is extremely small,” he added.
Hunt has fended off calls for the government to offer public servants a bigger pay rise by arguing it would cost £28bn and push up inflation, forcing the Bank of England to raise interest rates further.
In its look-ahead to the budget, the IFS said it disputed the Treasury’s figures, arguing the cost of an increase from the current 3.5% average offer to 5.5% could be even less than £5bn. It said between 30% and 40% of the pay rise would be clawed back in higher VAT, income tax receipts and national insurance payments, bringing the cost down to nearer £3bn.
The chancellor is under intense pressure to please different wings of his party seeking an improvement to public services, an end to strikes across the public sector and a reversal of recent increases in personal and corporate tax rises.
The defence secretary, Ben Wallace, has bid for extra funds while the health secretary, Steve Barclay, wants a bigger budget to achieve Rishi Sunak’s pledge to cut NHS waiting lists by the end of the year.
Johnson said that before budget day on 15 March it was likely official figures would show the public finances benefited from better-than-expected economic growth over the past four months.
The rosier picture has already prompted the Bank of England to revise gloomy growth forecasts made last year that predicted the UK would suffer its longest recession in 100 years. Fresh predictions showed the recession would last only half as long and a previous forecasts for a 3% slump in gross domestic product (GDP) was revised to 1%.
The IFS said the improved situation meant the public finances were on course to be £31bn in the black over the next five years, but warned the extra funds were vulnerable to downward revisions.
Projections by the Treasury’s independent forecaster, the Office for Budget Responsibility, will accompany the budget and are likely to show the UK economy struggling to grow over the next five years.
Low investment and high interest rates will limit the economy’s capacity to grow, depressing tax receipts in later years.
Johnson said it would be unwise for Hunt to promise tax cuts and higher public spending when the reasons for the fiscal boost – lower debt interest payments, lower energy price guarantee payments and higher tax receipts – were likely to prove temporary.
While taxes have been between 33% and 34% of national income, or gross national product (GDP), for decades, they are about to jump and stay high, Johnson said.
“They are now forecast to go up to 37% of national income over a very short period. That is a big tax rise and one we have been warning about for a very long time. And I don’t think they are going to come down in my lifetime. We have had a move up that is going to stay up,” he said.
“It is easier to cope with a low tax to GDP ratio if the economy is growing strongly, but if growth stays as miserable as it is currently projected to be, then we are going to have to have a very serious discussion about whether that means we are going to have more miserable public services than we would like or higher taxes.”
He said over the longer term the extra costs of health provision, long-term care and defence spending would prevent governments from cutting tax back to previous norms.
