Rachel Reeves has set herself a trap with self-imposed fiscal rules that could force her into tax hikes and deeper spending cuts as the economy deteriorates, a top think tank has warned.
The chancellor’s rules around borrowing have left Britain’s economic policy “entirely exposed” to global changes and could force her into major tax and spending decisions at this month’s Spring statement, previously billed as a non-event, the Institute for Fiscal Studies (IFS) said.
The Treasury has committed to delivering only one major fiscal event a year but the prospect of missing her own targets at the first hurdle could see Ms Reeves intervene earlier, it added.
The chancellor’s fiscal rules mean she cannot borrow to fund day to day spending and that debt must be falling as a share of national income by 2028/29.
In October, the Office for Budget Responsibility (OBR) said she had left herself £9.9bn of headroom against the first rule.
The watchdog’s updated forecast next month is likely to see that wiped out because of higher borrowing costs and weak growth in Britain, as well as global factors such as trade tariffs following Donald Trump’s election.
Meanwhile, IFS analysis of data on tax and spend suggests that expenditure is largely in line with October’s outlook, but borrowing for 2024-25 could be £16bn above it at £143bn.
This would also be £56bn above last spring’s forecast, largely reflecting the £50bn revision to planned spending this year announced last autumn.
The IFS said that if Ms Reeves was put on course to breach her fiscal rules, “it seems more likely than not that she will respond by altering tax or spending plans” than wait until the budget to announce policy changes in response.
Breaking the rules “at first time of asking” could be seen as humiliating, dent her credibility in the markets and lead to months of politically damaging speculation about possible tax rises in the autumn, it said.
Following her last budget, Ms Reeves told the Treasury Select Committee that “we are not going to be coming back with more tax increases” and later repeated a similar message to business leaders.
In a report published on Thursday, the think tank said: “While there is no such thing as an optimal fiscal framework, it is hard to believe that the UK’s could not be improved.
“In an uncertain and volatile world, aiming to meet pass–fail fiscal rules with close to zero headroom leaves fiscal policy entirely exposed to global economic developments (or, more accurately, what the OBR judges the impact of those economic developments might be) and puts the Chancellor’s (sensible) promise to make fiscal policy changes only once a year at risk.
“If there is a material change then policy should of course adjust. But the twice-yearly fine-tuning of policy in response to immaterial forecast revisions is an increasingly costly distraction from the big issues.”
Ms Reeves is expected to slash public spending by billions of pounds in an effort to balance the books when she delivers the statement on 26 March.
The Treasury is putting its proposals to the watchdog on Wednesday as part of the forecast process, the BBC reported.
A leaked early draft of the forecast indicates the watchdog is cutting its forecast for economic growth and the cost of government borrowing will have been affected by the turbulence in the bond markets in January.
Curbing the cost of welfare and a drive for greater efficiency across Whitehall are expected to contribute the bulk of the savings.
Reports suggest that the government is seeking to save around £5bn through changes in work requirements and cuts to the generosity of some payments, which the IFS said “would aid the Chancellor with her fiscal arithmetic”.
The Resolution Foundation said that restricting eligibility for incapacity or disability benefit would be “risky” as it would “concentrate all the income losses on a small group of claimants”.
Reforms should instead seek to close the financial gap between basic and health-related out-of-work support that incentivises health-related claims, the think tank said.
A focus on the three areas that drive higher spending – entrances, entitlements and exits – could stem the increase of the benefits bill, on track to rise by £32bn over the 2020s, and help more people into work, it argued.
Senior economist at the think tank Louise Murphy said: “While the government is keen to score short-term welfare savings ahead of the 26th March, truly effective reforms will take time to deliver.”
Meanwhile, the Liberal Democrats called on the chancellor to use the statement to exempt the health and social care sector from the planned increase in employer national insurance before it comes into force on April 6.
The government has committed to covering the cost of the rise for the NHS but not other health and care providers such as care homes and dentists.
