Since Liz Truss spooked financial markets seven weeks ago with a madness of unfunded tax cuts, Britain has become a global case study in how to mismanage public finances in a time of rising inflation and rising interest rates. Jeremy Hunt, the UK’s fourth chancellor since July, is set to address that in Thursday’s autumn statement by putting the country’s debt on a sustainable path. If the government sets a five-year target, it could cost more than £50bn in tax hikes and spending cuts, or around 2% of gross domestic product. It will be a necessary price to pay to help Britain regain its credibility, but it will involve a delicate act of juggling.
Hunt’s plan will have to satisfy the markets, his party and voters, while limiting damage to the economy. It won’t be easy. The Bank of England’s forecast last week showed the UK slipping into a prolonged recession. A quick tightening would add to the economic woes after a decade of lackluster growth. With the cost of living soaring and public services strained, tax hikes and spending cuts will be particularly unwelcome. But to reassure investors, the Chancellor must unveil credible measures that reduce the government’s borrowing needs. Too much delay risks disrupting financial markets, raising gilt yields and deepening the fiscal hole.
Hunt will have to show investors that the budget arithmetic really adds up. Aiming for a decline in the debt-to-GDP ratio in five years is already less stringent than previous fiscal rules. However, since Truss’s resignation, markets have calmed down: gilt yields and expectations for the Bank’s interest rate path have fallen and Hunt is seen as a safer pair of hands than his daredevil predecessor, Kwasi Kwarteng. But that could quickly turn. The war in Ukraine remains an unknown and inflation could prove more persistent. Failure to achieve the absolute consolidation necessary to bring down the debt ratio by 2027-28 is therefore not wise.
The challenge is to choose from a menu of austere measures that would do the least harm to an already struggling economy while raising enough funds. Spending cuts tend to dampen economic activity more than tax hikes, but there are few easy options for generating significant revenue quickly. A significant increase in income tax and national insurance is politically heavy, while a higher VAT would increase short-term inflation. Hunt will likely rely on stealth tax hikes: freezing various thresholds and allowances. Expenses will not escape the knife. It is a question of distributing the cuts between the already strained departmental budgets and public investments, which are important for growth.
While the focus will be on government results, Hunt should not entirely set aside the growth agenda: any boost to potential growth will improve fiscal arithmetic. Given the fiscal quagmire Britain finds itself in, a lot may not be possible, but sensible measures do exist. More generous tax allowances could encourage companies to invest at lower cost. Initiatives to help inactive people get back to work – which is still below pre-pandemic levels – are also essential. The same goes for avoiding cuts to the skills and education agenda. Indeed, better growth prospects could give the government leeway to reverse its tightening later.
Prime Minister Rishi Sunak and Hunt have a huge economic and political puzzle ahead of them. The scale of fiscal consolidation required is comparable to Britain’s 2010 ‘austerity’ budget. will increase. The budget plan must appease more than one. But if he fails to satisfy the markets, he will further shred Britain’s international credibility.