Jeremy Hunt has said he will scrap most of the unfunded tax cuts in the mini-budget, in the latest government U-turn designed to boost the financial markets’ confidence.
Days after replacing Kwasi Kwarteng as chancellor, Hunt said he would cancel all the remaining measures in the ill-fated tax and spending plan that had not yet been legislated for. Here are the reasons why he is taking action.
How much money will the measures save?
Hunt said his tax changes would raise about £32bn a year, scrubbing out most of the £45bn of unfunded promises announced by Kwarteng last month. Some changes are still in place, including keeping a stamp duty cut – costing £2.1bn a year – and the reversal of the national insurance rise, which will cost about £18.7bn annually.
Cutting the energy price guarantee from two years to six months, then replacing it with more targeted support, could save the exchequer about £40bn, according to the Resolution Foundation thinktank. However, precise calculations on the savings from the energy U-turn are difficult, given that the policy costing depends on price moves in international gas markets.
Why is Hunt taking action now?
The aim is to restore confidence among financial markets after the mini-budget led to a meltdown in UK government bond markets and a soaring in borrowing costs for households and businesses.
Economists said the changes could help reduce the interest rate on UK government debt ahead of the 31 October debt-cutting plan. This could allow the Office for Budget Responsibility to use the lower rates to inform its debt interest forecasts – due to be published on the same day – limiting some of the damage to the public finances.
A healthier outlook for debt interest could help reduce the need for much bigger tax rises or spending cuts to balance the books. Investors will also be closely monitoring the OBR assessment.
The Resolution Foundation said that if the announcement on 31 October calmed markets, and cut interest rates on UK government debt by about 0.5 percentage points, that this would reduce borrowing costs by a further £8.1bn on top of the £32bn savings announced by Hunt.
The U-turns could also ease pressure on the Bank of England to launch an even more aggressive interest rate rise next month. Some City economists expect the Bank to raise the rate by 0.75 percentage points, although trading on financial markets still implies it will rise by one percentage point to 3.25% on 3 November. With sharply rising mortgage costs for households being blamed on the mini-budget, this could help the government’s case.
What are the economic consequences?
The UK’s long-term borrowing costs fell after Hunt’s statement on Monday, indicating some restoration of investor confidence. However, yields – or the interest rate on government debt – remain above the level seen before Kwarteng’s ill-received statement.
The government cutting short its universal support for energy bills, from two years to six months, will influence economic growth and inflation. The Treasury will, however, review its options for targeted support for poorer households from April, making it difficult to estimate the economic impact of the energy U-turn with any precision.
The freeze had been expected to prevent headline inflation from peaking at a higher rate, above September’s 9.9%. However, this relied on a blanket policy being in place for at least a year, because inflation is measured as the annual change in a basket of prices, including energy.
Samuel Tombs, the chief UK economist at the consultancy Pantheon Macroeconomics, said cutting the scheme to just six months could mean headline inflation would peak at about 4.8 percentage points higher by April.
However, a less generous support scheme will dent households’ spending power, potentially reducing the persistence of inflation, which could help limit the pressure on the Bank for a tougher rise in interest rates.
The flipside of this is that cutting the support for households could damage household spending, hitting economic growth at a time when analysts fear the UK could already be in recession. That said, a lower Bank base rate could reduce mortgage costs, bolstering households’ spending power.
What next?
Hunt warned of further “difficult decisions”, and concluded by saying “some areas of spending will need to be cut”.
Much of the focus will be on whether state pensions and benefits are increased next year in line with September’s inflation rate, as well as on public-sector pay and day-to-day spending.
The Resolution Foundation expects cuts totalling several tens of billions of pounds to be announced, if the government is to meet its public finances target of the national debt falling as a share of GDP in the medium term.
The Institute for Fiscal Studies believes Hunt may choose to cut long-term investment spending, but this would risk coming at the cost of longer-run growth and public service capacity.
Paul Johnson, the IFS director, said: “It is hard to see which of the big chunks of spending – health, pensions, welfare, education and defence – can be cut.”
