IFS warns £25bn in tax rises will be needed to keep public spending on track

Rachel Reeves must find billions of pounds more to help "unprotected" departments keep pace with national income growth, think tank says
Rachel Reeves Photo: Parliament.uk

By Jim Dunton

10 Oct 2024

The Institute for Fiscal Studies has warned that the new government could need to come up with £25bn in tax increases by 2028-29 just to keep public spending rising in step with national income.

Billions of pounds more would be required to rule out real-terms spending cuts, it said.

In a study published ahead of October 30's Autumn Budget, the think tank said chancellor Rachel Reeves may have to live with day-to-day spending on many services falling as a fraction of national income even with the £25bn uplift.

It says that avoiding real-terms cuts to public services and pegging the budgets of unprotected departments to increases in national income could require an additional £47bn.

The IFS says that Labour's general-election pledges not to hike the main rates of income tax and corporation tax, or raise National Insurance or VAT, mean she "might struggle" to deliver a package of fiscal increases that would produce the £25bn identified.

So far, the Labour Party has pledged £9bn in tax rises, less than the £13-14bn hikes delivered by the New Labour government in 1997 and the Conservative-Liberal Democrat coalition in 2010.

In its Green Budget 2024, produced in conjunction with investment bank Citi and the Nuffield Foundation, the IFS says that "merely sparing" some public-service budgets from real-terms cuts may well "prove incompatible" with ambitious performance improvements being sought by Labour.

The IFS says funding this year’s pay pressures on a permanent basis and honouring specific spending commitments in the Labour manifesto – as well as avoiding real-terms cuts to public services – would require increased day-to-day spending of £30bn by 2028-29.

It adds that increasing funding for day-to-day spending on so-called "unprotected" areas such as prisons, the police and local government in line with national income could require an additional £17bn by 2028-29 – making a total funding increase of £47bn.

The report concedes that some of the in-year spending pressures identified by the new government "stem from the poor budgeting practices of the previous government". But it says most spending pressures have their roots in "the fact that the generosity of departmental budgets has become detached from what those departments have been asked to deliver".

In recent weeks there has been mounting speculation that Reeves could change the government's fiscal rules to create new headroom for capital spending. But the Green Budget report says any changes to the fiscal rules to allow more borrowing for investment would "do almost nothing" to ease the pressure on public-service funding.

The IFS argues there is a case for more investment spending that would be focused on productivity-enhancing projects. It says avoiding real-terms cuts to investment spending by departments would likely require an additional £4bn in 2028–29 on top of the £6bn additional investment committed to in Labour’s manifesto.

Growing capital spending in line with national income would require spending to be £19bn higher in 2028-29 than the Sunak government had planned, it says – around £13bn more than the Labour manifesto pledged.

IFS director Paul Johnson said the Autumn Budget was on track to be the "most consequential" since 2010.

"The new chancellor is committed to increasing investment spending, and to funding public services. To do so, she will need to increase taxes, or borrowing, or both," he said.

"Taxes are at an all-time high, and she is tightly constrained by her pledges not to raise the main rates of income tax or corporation tax, or to increase National Insurance or VAT at all.

"The temptation then is to borrow more, perhaps changing the definition of debt targeted by the fiscal rules. But, given her pledge to balance the current budget, that would not free up additional resource for day-to-day spending and in any case is not risk-free given the dual deficits – that is, both budget deficit and current account deficit – being run by the UK."

Johnson said it would be "a mistake" to think that the nation was facing a short-term challenge created by the current fiscal rules.

"Pressures on health and pension spending will continue to increase, and revenues from fuel and tobacco duties will fall," he said.

"That will make remaining on course for current budget balance harder over the course of this parliament. If Ms Reeves does not grasp the nettle on 30 October, it could come back to sting her again before the next election."

An HM Treasury spokesperson said the new government had "inherited a tough financial position" but insisted ministers would not let "the challenges of the past" define the future.

"Despite uncovering a £22bn black hole in our public finances we are focused on making this the most pro-growth Treasury in history, built on the rock of economic stability, including robust fiscal rules that were set out in the manifesto," they said.

"That is how we will fix our public services and deliver on the promise of change."

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