Chancellor may reduce spending by £6bn to help fund 2p cut in NI or income tax

The Chancellor has more fiscal manoeuvering space to cut income taxes than is widely appreciated.

I would therefore be amazed if he doesn't announce either a 2p cut in National Insurance or a 2p cut in the basic rate of income tax - or perhaps 1p off each - in Wednesday's budget.It is largely electoral politics that drives such planned cuts in taxes on income, namely the repeated pledges of Jeremy Hunt and of the prime minister that they are determined to hand more money back to citizens, especially working people - and this is probably the last opportunity they'll have to translate such intent into action before the general election.But the Chancellor should be able to demonstrate that he would not be playing fast and loose with the public finances, in the way that Liz Truss and Kwasi Kwarteng did in their notorious mini budget of the autumn of 2022.That said, the one decision I expect Hunt to make that would be both politically and economically explosive is a cut in the planned allocation of funding for all public services during the next parliament from an inflation-adjusted or "real" increase of 1% a year to just 0.75%. This would yield £6 billion of savings in five years.If Hunt were to announce such a reduction in the available funding - and that is what I anticipate - he would be criticised for being both unrealistic and also imposing harm on public services that are struggling.He'd create a huge dilemma for Labour - and some may think that's his main motivation - because a Labour government would have even less money for their spending priorities, unless they were to reverse Hunt's tax cuts. And Rachel Reeves, the shadow chancellor, has said she won't reverse cuts in income taxes.

Here is the basic math that confronts Hunt.The so-called "headroom" for any tax cuts or spending increases, were he to do nothing at all, would be around £13 billion. That's what the latest still-confidential forecast of the Office for Budget Responsibility says.As I understand it, the Chancellor has decided that, in the exceptional circumstances of a looming general election and a stagnating economy, it would be just-about acceptable to reduce that headroom to £6bn.Headroom of £6 billion is low by historical standards, but Hunt feels it would be defendable - just.This "headroom" is the monetary buffer that exists to absorb unexpected calls on the public finances, such that debt as a share of GDP, or national income, falls marginally in five year's time, as per the so-called fiscal rules, or the rules that are supposed to deter chancellors from profligacy.

We can talk another time about whether this rule is sensible or Dali-esque nonsense. It is what it is.If Hunt is content with £6 billion of headroom, he would have £7 billion to deploy to his political preference of cutting taxes on income or enough for just a penny off the basic rate of income tax. A 1p cut in the rate of employee national insurance would be £2 billion a year cheaper.However, and as I've pointed out, it would be a political disaster for both Hunt and Rishi Sunak to deliver income tax cuts as small as that. All their political rhetoric for weeks has been about the urgency of doing more.

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So close to a general election, they do not want to brand themselves as fiscal Grand Old Dukes of York, especially when so many of their Tory MP colleagues are crying out for tax cuts.That is why Hunt and his Treasury team have been straining every sinew to make 2p cuts "affordable", at least in the narrow sense of the OBR forecasts.The most controversial announcement to be made by the chancellor will be to cut the "envelope" or projection for public spending increases in the course of the next parliament from 1% above the rate of inflation, 1% "real" in the jargon, to 0.75%. It would yield Hunt a further £ 6illion to deploy.This would be contentious because - as the IFS and other think tanks point out - the current 1% framework implies cuts and austerity for many public services, such as justice and local government. The reason is that significant resource increases are already baked in for health, defence and education.

The chancellor and prime minister have been and will make the political and economic case that public services need to achieve more with less, that they must become more productive.Keir Starmer's Labour accepts the case for such reform, but as prime minister he would need cash for so many of his projects and to start the long process of fixing public services.

As it happens, opinion polls would tend to support Labour that reducing hospital waiting lists, for example, should take precedent over tax cuts.However, Starmer and Reeves have said they won't reverse Tory cuts to income taxes, so it is reasonable to see Hunt's forthcoming budget as in part an exercise in boxing in Starmer.That said, to make a 2p cut in NI or income tax anything but reckless, and to fund other initiatives - including the traditional refusal to uprate fuel duty in line with inflation - Hunt needs to find other funding sources.My assumption is that Hunt will nick two of Labour's pledges, namely to end the non-dom tax break for wealthy foreign citizens who live and work in the UK and also increase the take from the windfall tax on oil and gas producers. He'll also introduce a new duty on vapes, increase the tax on short-term holiday lets and increase air passenger duty on sales of business class tickets.All of those measures would perhaps raise £5 billion.The combination therefore of selective tax increases, the reduction in fiscal "headroom" and cuts to public spending would yield £18 billion, enough for 2p off whatever tax Hunt and Sunak choose and have a few billion left over for gimmicks and giveaways.There seems to be still something of debate at the top of government on whether to do 2p off income tax for £14 billion or 2p off employees' National Insurance for £10 billion.Reducing National Insurance is seen by Hunt as the most effective way of reducing the costs of employment, and stimulating business, though it doesn't help an important group of potential and actual Tory voters, notably retired people living off pensions and savings.

It would also be relatively less valuable to those earning more than £50,000 a year, a demographic the Tories want and need to woo, than a cut in the basic rate of income tax would be.My hunch, therefore, is that Hunt will announce a penny off each, at a cost of £12 billion a year.That would leave him with £6 billion for assorted other measures, including perhaps a long-awaited tax break for investing in UK companies via a new more generous form of ISA.

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