Jeremy Hunt was dealt a poor hand when he entered No 11 in October 2022. The public finances were in a mess after Liz Truss and her chancellor, Kwasi Kwarteng, had splurged £45bn on tax cuts in a mini-budget that was considered so reckless it spooked financial markets.
Interest rates spiralled higher, leaving Hunt to wrestle with rising debt-financing costs at a time when double-digit inflation was already pushing up the cost of providing government services.
Since then, he has steadied the ship. But now there are demands for tax cuts – not least from the prime minister – when Hunt delivers his second budget to parliament in March, to bolster the party’s standing ahead of an expected general election.
On what basis are tax cuts affordable – and where will Hunt’s strategy leave Labour’s Rachel Reeves, should she become chancellor? Here we discuss the issues.
How much money does the government spend?
Public expenditure rocketed during the pandemic and the first year of the Ukraine war, far outpacing government income. In the year to April 2024, spending is expected to hit £1.222tn, up £71bn from £1.15tn in the previous financial year.
This will leave a £124bn shortfall on an expected income of £1.098tn, according to projections last November put together by the Office for Budget Responsibility (OBR), the Treasury’s independent forecaster.
What are the government’s spending rules?
There is only one constraint on Hunt’s spending. He has pledged to bring down the overall level of debt as a proportion of national income, or gross domestic product (GDP), in the fifth year of the OBR’s five-year forecast.
The debt-to-GDP ratio is currently 99.6% after a brief rise above 100% last year, leaving both the UK’s total accumulated debt and GDP at almost the same level of £2.6tn.
The OBR must benchmark its forecasts of government income and spending against this rule.
Such is the (modest) improvement in the economic outlook, the OBR is expected to hand Hunt £20bn more to play with than it forecast at the time of last November’s autumn statement. The £20bn will be his fiscal headroom.
Why does Hunt have headroom to spend more?
The OBR’s forecast for the deficit, equivalent to 4.5% of GDP, is now expected to be too gloomy after the need for fuel subsidies ebbed away faster than had previously been foreseen. There are many moving parts in the government budget, but one significant factor is the precipitous fall in inflation last year, which will mean the Bank of England can cut interest rates at a faster pace over the next couple of years, bringing down debt interest bills more quickly than expected.
Debt interest has risen from about 1.5% of government spending to almost 10% in recent years, so any reduction will be welcomed by the chancellor.
Much of the UK’s debt is also tied to index-linked bonds and lower inflation will bring about a cut in the monthly payments needed to finance them.
Do the chancellor’s spending plans make sense?
Last week, the head of the OBR, Richard Hughes, said forecasts of government spending over five-year periods had often been described as fiction, adding that he found it difficult to argue with that portrayal.
According to official projections, the government spending deficit this year of 4.5% of GDP is due to fall to 2.7% in 2025 and to 1.1% in 2028-29. However, these figures are based on scant information from Whitehall departments; Hunt has handed the OBR the equivalent of one side of A4 paper in response to the OBR’s request for his five-year spending plans.
Ruth Gregory, deputy chief UK economist at Capital Economics, said Hunt’s refusal to give any details about Whitehall spending meant there was a “fiscal fiction”.
She said commitments to increase spending on health, education, defence and international development would mean a 2.3% cut in unprotected departments’ budgets, without any clue about what that would look like.
What can we expect from Labour?
The shadow chancellor, Rachel Reeves, has said she will adopt Hunt’s fiscal rule. That will limit her ability to spend and borrow unless she modifies the commitment once in office.
Many of Labour’s pledges will be based on reorganisations and efficiency drives to release cash for investment, especially in high-spending areas such as welfare and the NHS. But promises to maintain the pension triple lock will mean retirement payments will account for a higher proportion of spending.
Why will Labour play the Conservatives’ game?
After the Corbyn years, Keir Starmer is keen to establish Labour’s credentials with the public as a safe pair of hands when dealing with taxpayer cash. While the polls have Labour far ahead, Starmer and Reeves believe the public need to be reassured they will restrict borrowing to the same level as the Tories have promised.
More than that, they fear that a radical plan to overhaul the economy would spark the same reaction from the financial markets that wrecked Truss’s administration.
Does Labour have any wriggle room?
There will be many calls on Labour to increase spending if they get into office. But it won’t be easy. The Tories will have committed every spare pound to tax cuts – a policy that will be politically difficult to unwind – and left plenty of ticking “debt bombs” behind.
Reeves expects Hunt’s scorched-earth policy will leave the financial cupboard bare – and, worse, dump large unaccounted debts in her lap, such as defence budget overspends, student loan repayment shortfalls, bankrupt local authorities and backlogs of NHS operations.
A policy of higher borrowing may be possible but will need to be carefully calibrated to mollify financial markets, which will want to see that the extra spending can be shown to improve the UK’s economic productivity and with that, its ability to repay debt.
