Philip Hammond should drop his commitment to run a budget surplus by the mid-2020s amid mounting demands on departmental budgets including pressure to end the 1% public sector pay cap, the Institute for Fiscal Studies has suggested.
Researchers at the institute have said the chancellor may have to admit that it “is no longer sensible” to aim to wipe out the deficit by 2025, a target that would require him to continue slashing the day-to-day spending of government departments.
Ahead of Hammond’s first Budget of this parliament on 22 November, the IFS has set out the challenges he faces, which in addition to calls to end the 1% cap on pay increases also include the “political arithmetic” of a minority government that would make tax increases difficult to deliver, the fragile state of public services following seven years of austerity, and economic unknowns surrounding Brexit.
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Paul Johnson, IFS director, said that if UK economic growth continues to disappoint, the chancellor would have to raise taxes or continue to cut spending in order to create a budget surplus by the mid 2020s.
“All the pressure on him at the moment is to do quite the reverse,” he told BBC Radio 4’s Today programme. “There’s no chance, probably, of getting any tax increases through parliament and the demands for more money for the NHS, for increased pay for public sector workers, potentially to reverse some of the very large benefit cuts that are coming through the pipeline – those demands are pretty significant.”
The report points to the mounting pressure on Hammond to lift the 1% public sector pay cap. Failing to lift the cap over the next two years “would see public sector pay fall to its lowest level relative to private sector pay for at least 20 years, which is likely to risk greater problems with recruitment, retention and morale”.
Loosening it, however, would cost £6bn more in 2019-20 (if pay was increased in line with inflation, relative to the 1% cap). This would either mean more borrowing, or an even greater squeeze on departmental budgets, according to the report.
"Any relaxation of the public sector pay cap might require additional funding for public services across the board. A more targeted approach could see more spending for services under most pressure. Both the NHS and prisons show signs of strain," it said.
The analysis also highlighted that Hammond might choose to devote additional funds to reducing the six-week period before Universal Credit claimants receive payments following criticism of the delay. However, such a move would also require greater-than-planned borrowing.
Johnson added that Hammond could decide to increase borrowing while interest rates are low, but this would be “junking the fiscal rules and the fiscal austerity” the government has advocated for the past seven years.
“In the end, I think we’re going to have to see a world in which he’s saying, ‘I’m not absolutely fixated on this getting to balance by 2025. I’m going to take some risks with that because the pressure for everything else is so significant’,” he said.
In the report, the IFS said the forecast as set out in the March 2017 Budget – which assumed that planned public spending cuts and increased revenue through tax rises would return a deficit of just 0.7% of national income by 2021-22, and a surplus by around 2025 – would have necessitated more austerity measures in the next few years.
By far the largest contribution to deficit reduction was to come from spending by government departments, which was to fall almost 5% between now and 2021-22, on top of reductions of 13% between 2010-11 and 2017-18.
These cuts were not planned to be shared evenly. “While the budgets of international development, health, education and defence were all relatively protected, real-terms cuts of almost 20% were planned for Department for Environment, Food and Rural Affairsand the Ministry of Justice over the next two years, despite the fact that these departments have already experienced large cuts since 2010,” said the report.
Cuts at the MoJ have already led to significant problems in prisons, while the Defra’s spending review was set prior to the vote to leave the EU, which has increased demands on the department.
The IFS said that eliminating the deficit in the stated timescale would have been difficult even on March forecasts – but was even more challenging now given the expected downgrade to estimates for productivity growth, which has been “terrible” since 2010.