Cutting taxes will lead to worse public services, IFS warns ahead of budget

The debate ahead of the Budget has so far focused on whether or not the chancellor is in a position to deliver tax cuts, months away from the General Election.

The Institute for Fiscal Studies (IFS) thinks we should be having a different conversation.

The IFS refuses to play the game of “How Much Headroom Has The Chancellor Got?”

Unsportingly, it refuses to even hazard a guess. Instead, it wants to talk about trade-offs.

If the chancellor does insist on cutting taxes on March 6 then the IFS says he should also be honest about what the consequences will be.

Not least for public services, which the IFS argues are showing clear signs of creaking.

“We have huge backlogs in the Justice system and local authorities are going bust, left, right and centre,” says Paul Johnson, Director of the IFS.

“We have huge waiting lists in the health service; universities who are increasingly, I think, genuinely starting to struggle with more than ten years of frozen income; a social care system which is struggling and quite dependent on immigration, which none of the parties seem terribly keen on; and a prison system that is full”.

The chancellor seems determined to cut either National Insurance or Income Tax next week.

And he appears to be preparing to create the room he needs to do this against his fiscal target (to get national debt falling as a share of national income in five years time) by making cuts to departmental spending on public services after the election.

The IFS implies that such a plan is both unwise and unworkable.

As it stands, real-terms (adjusted for inflation) spending on public services is set to rise by 0.9% a year on average from next April onwards.

But the IFS points out that if you factor in the new, higher population projections that the Office for National Statistics has published and assume that budgets for the NHS, childcare, defence, schools and overseas aid will continue to be either protected or enhanced in ways which have already been announced, then the reality is other areas of government spending face an even tighter squeeze on resources.

As things stand, the IFS estimates the budgets of unprotected departments - local government, the courts, HMRC and prisons - require cash top-ups of £20 billion a year by 2028/29 to avoid a return to “austerity”.

If the chancellor does reduce the planned rate of growth in spending on public services from 0.9% to 0.75% in the Budget, the IFS calculates it would free up £3 billion a year for tax cuts but at the expense of the budgets of these unprotected areas.

You can understand the government’s desire to cut taxes.

Allowing people to retain more of their earnings in the run-up to a general election is likely to be popular.

And the tax “burden” in the UK - measured as a share of national income - has risen sharply during this parliament and is on course to rise to reach its highest level since 1948.

The government is currently raising £66 billion a year more in tax than it was in 2018/19 but the IFS says it’s difficult to see how the overall burden can easily be reduced.

'Higher taxes look like they are going to be a permanent rather than temporary feature'

"[Higher taxes] looks to us like a permanent rather than a temporary feature,” says Carl Emmerson, Deputy Director of The IFS.

"The government is spending more on servicing the national debt, the government is busily expanding the programme of childcare, the NHS is requiring more and more resources each year, as is social care…it seems hard to see where significant spending cuts would come from [on a scale] that would be required to finance a substantial reduction in the tax burden”.

The tax rises of the last few years have helped to fund the extraordinary amount of financial support (£500 billion) that the government has made available for households and businesses.

Privately, the chancellor accepts that not all of these can be rolled back.

Publicly, he is committed to pursuing what he calls “smart” tax cuts - those which boost the supply side of the economy and increase growth.

Reducing either National Insurance or Income Tax appears to be his preference.

The IFS says that while both taxes would stimulate growth, neither would be self-financing.

“A genuine tax cut is going to require some spending cuts to help pay for it,” says Emmerson.

Inflation is fading faster than the OBR forecast last November but the outlook for growth remains weak in the short-term.

The chancellor doesn’t have much room for manoeuvre in his Budget but he does have choices he can make.

The IFS argues that, if Jeremy Hunt decides to prioritise tax cuts before the election, he will be doing so at the expense of the quality of public services after the election.

He would also be leaving government debt at a level which is high and rising in the short-term and barely falling five years, which carries risk.

The expected path of interest rates in the UK is lower than it was at the Autumn Statement but the future is impossible to predict and the government still looks set to be spending £55 billion a year more servicing its debts than the OBR forecast just three years ago - which is roughly the equivalent of the annual defence budget.

In his Autumn Statement, the chancellor used the benefits of high inflation (higher tax revenues) to cut taxes while ignoring the costs (more pressure on the budgets of departments which deliver public services).

The IFS says there’s a danger that, in this Budget, Jeremy Hunt’s next “trick” will be to “bank the higher revenue which come from a larger population while ignoring the additional pressures that a larger population puts on the NHS, local government and other services”.

Next week, we may end up in the odd (and the IFS would argue unsatisfactory) situation where the government announces a tax cut or cuts which it knows may need to be reversed if it wins the next election.

And where Labour votes to support those tax cuts, with the clear understanding it may have to do the same.

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