United Kingdom

IFS warns UK is in 'wholly uncharted territory' after Covid crisis

Rishi Sunak will need to find £40billion a year in tax rises and spending cuts by the middle of the decade if he is to restore balance to the nation's finances, the respected Institute for Fiscal Studies think tank warned today. 

The Chancellor said yesterday at the Spending Review that the UK's 'economic emergency has only just begun' as official forecasts showed the economy will shrink by 11.3 per cent in 2020 because of the coronavirus crisis.

That is the biggest economic contraction in 300 years, with ministers on course to borrow an eye-watering £394billion this year to keep the country afloat - the highest amount ever recorded in peacetime. 

The Government's spending watchdog, the Office for Budget Responsibility, suggested in its central forecast that Mr Sunak would need to find £27billlion in tax rises and spending cuts to balance the books.      

But IFS chief Paul Johnson said he believed the figure could be significantly higher as he argued the Chancellor had likely been too optimistic in some of his plans.    

Mr Johnson said he believed Mr Sunak will end up having to spend more on public services, the coronavirus response and on welfare than he has set out. 

The think tank boss said the UK's finances were in 'wholly uncharted territory' but he predicted the long term impact of the pandemic will be 'way less painful than the impact of the financial crisis'. 

Paul Johnson, the director of the Institute for Fiscal Studies, said Rishi Sunak could have to find £40billion in tax rises and spending cuts by the middle of the decade if he want to balance the books

Mr Sunak has refused to be drawn on future tax rises, insisting this morning they are a matter for a future Budget

Mr Johnson said Government spending and borrowing during the coronavirus crisis meant the UK economy is in 'wholly uncharted territory' 

How could Rishi Sunak generate £40bn in tax rises?

Any attempt by the Chancellor to balance the books would almost certainly be based on a combination of tax rises and spending cuts.

Concentrating solely on tax increases to fill the hole would be politically impossible. 

But if consequences at the ballot box were not an issue, it would be possible to generate £40bn just through tax rises. Here is how he could do it. 

Increase the basic rate of income tax by two pennies: £9.4bn

Increase the higher rate of income tax by one penny: £1bn

Reduce the personal tax allowance by 10 per cent: £8bn

Increase corporation tax by one per cent: £2.4bn

Increase National Insurance contribution rate for most workers by one per cent: £4.5bn

Increase National Insurance contribution rate for employers by one per cent: £6.6bn

Increase standard rate of VAT by one per cent: £6.9bn

Total: £38.8bn 

Source: HMRC 

Mr Johnson told a briefing today that he was not convinced by the OBR's central scenario for how the next five years could play out.   

He said the Spending Review was 'pretty austere' with non-Covid public spending set to fall by more than £10billion next year and in subsequent years. 

Mr Johnson said it is 'not obvious that either the need or the appetite for public spending has diminished since March' and that 'frankly I would be most surprised if these plans were adhered to'. 

He also questioned the Chancellor allocating £55billion next year for the Government's coronavirus response but allocating 'precisely zero for subsequent years'.

He said he 'wouldn't bet on' the UK not having to spend any money on Covid-19 issues beyond next year. 

He also suggested the Government could be forced to U-turn on a decision not to extend a temporary increase in the value of Universal Credit.  

He said: 'Put these pressures together and my central scenario would have borrowing at least another one per cent of national income higher in 2024-25 and subsequently, even given the perhaps relatively benign central economic scenario outlined by the OBR. 

'In that case if the Chancellor did want to aim for current budget balance he’d eventually need a two per cent of national income fiscal tightening – about £40 billion in today’s terms.' 

Mr Sunak has refused to be drawn on potential tax rises, insisting this morning that 'future fiscal policy' would be a matter for a future Budget. 

The Chancellor told MPs yesterday that the 'long-term scarring' from the coronavirus crisis would mean that in 2025 the economy will still be approximately three per cent smaller than had been expected in March this year.

Mr Johnson said the economic damage done by the pandemic to the nation's finances was 'record-breaking, breathtaking, huge' and that the UK is now in 'wholly uncharted territory'. 

But he said there was 'some reason for reassurance here' because the long term impact is not expected to be as bad as that caused by the 2008 financial crash. 

He said: 'Obviously it is not great news but the OBR’s central scenario has only a three per cent long term hit to the size of the real economy.' 

He added: ‘Now, a three per cent hit to the economy is obviously painful, especially after such a long period of poor income growth and especially given the hit we have had from Brexit.

‘But it is way less painful than the impact of the financial crisis.’ 

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