What is the UK’s £55bn fiscal hole and why do we face Budget tax hikes?

Britain has spent the past few weeks trying to get the new chancellor to close a supposed ‘fiscal black hole’ estimated at around £55 billion.

This fiscal loophole has resulted in a double threat: a round of public service cuts and a wave of tax hikes, which Jeremy Hunt will deliver today.

Rumor has it that pretty much every tax you can think of will rise leading up to the fall statement and while it’s unlikely that all of them will rise, rest assured that some will.

But what is this fiscal black hole, why is it bad enough to warrant it, and is it true that if you tinker with the numbers in the forecasts a bit, it will go away?

How have we evolved from Rishi Sunak as chancellor with a £30bn margin to meet his targets, to Rishi Sunak as prime minister with a perceived black hole twice that size?

Rishi Sunak’s fiscal rule

The first thing to note is that it is Rishi’s goals that underlie this so-called black hole.

A year ago, as Chancellor, he introduced the UK’s latest tax rules, intended to show that we were being careful and not just continuing to borrow and spend money on stuff.

To put this in the context of how good Britain is at complying with such rules, the Institute for Fiscal Studies noted ahead of the announcement that the UK had 11 fiscal targets over the past seven years.

Nevertheless, the feeling that we should try to live within our means and not borrow money for everyday expenses is something that many would appreciate.

Sunak stated to parliament that his tax rules would apply over a three-year time horizon and were:

“Underlying public sector net debt excluding the impact of the Bank of England, as a percentage of GDP, should fall.”

And

“Second, in normal times the state should borrow only to invest in our future growth and prosperity.”

Earlier this week I spoke to Carl Emmerson of the IFS about this and asked him to explain what was going on with the tax rule and the black hole.

He said that, given fiscal targets, this was not bad: the three-year period was arbitrary, but it allowed for debt to rise in bad years, while acknowledging that it cannot rise as part of the national income. forever.

Instead the rules are for using the good years to reduce debt as a percentage of GDP and government bonds are fine for investing in our future but not for filling gaps where we don’t balance the books can bring.

Where the fiscal black hole came from

In March, when Sunak made his spring statement, the accompanying report from the Office for Budget Responsibility said there was a margin of around £30bn to meet the fiscal target. But Emmerson says “since then the outlook has obviously gotten much worse,” with higher spending coupled with lower growth meaning less tax coming in.

The OBR forecasts came before the Russian invasion of Ukraine, which pushed up energy and food prices and pushed inflation much higher.

As a result, interest rates have risen more than expected and the cost of government borrowing and servicing our debt has risen, with investors demanding higher rates for holding government bonds, as British bonds are called.

UK debt growth needs to be slower than GDP growth to meet the budget target, but forecasts for this have changed abruptly.

A report in the FT this week suggested that the OBR has told the Treasury that a previously forecast budget deficit of £31.6bn in 2026 to 2027 could now reach nearly £100bn – with around half of the increase being driven by higher interest on Britain’s £2 trillion debt pile.

Gold-plated government bond yields had already risen in the summer, but spiked after Kwasi Kwarteng’s poorly executed mini-Budget giveaway, which cut taxes in hopes of growth without an OBR report on the side.

In the wake of that, a few days before Kwarteng was sacked as Chancellor, the IFS assessed the state of Britain’s finances and said the margin had evaporated and instead we were out about £60bn at the time.

Other forecasters made similar estimates and this is where the £55 billion black holes come from.

However, Emmerson added that we have since rolled back almost all of those tax cuts – except for National Insurance and Stamp Duty – and we may now be down to £30bn.

It’s true that if you change the numbers on expected growth, inflation and interest rates it might go away, but so will any longer term forecast and the OBR will bring out a range of outcomes – but the government usually tends to focus on the central to use.

Meanwhile, while this may mean things aren’t as bad as reported, the Treasury will need some leeway to meet its targets.

Is raising taxes in a recession wise?

In a bit of kitchen sinking, Hunt will probably prefer to get all the bad news out at once rather than have to come back with more tax hikes in the future.

Politically, Sunak and Hunt would also rather get those unpopular tax hikes now than closer to a general election — and they have only two years left to play with.

In assessing the situation, Emmerson said Hunt needs to weigh up how far he needs to push through tax increases now to appear credible, versus taking a more nimble approach and what for years to come.

The advantage of the latter is that they do not harm the economy now and can be canceled later if things go a little better than planned.

“There are risks of both over-tightening and under-tightening,” said Emmerson.

This is a message that echoes elsewhere, as markets have now calmed down due to the harsh treatment of Sunak and Hunt’s school teacher rather than Truss and Kwarteng’s children on a school trip. A much greater sense of credibility and caution has been restored.

Government borrowing costs have fallen, with ten-year government bond yields falling to 3.29 percent from 4.5 percent at the end of September.

Meanwhile, the pound has risen to a three-month high, trading at $1.19, the same level as mid-July.

Many in the financial world are concerned that the Chancellor is unnecessarily at risk of passing austerity mark two and that the problems in the bond market were related to Truss and Kwarteng and their delivery of the mini-budget, rather than the desire of Britain Britain on his hair shirt.

When I speak to people outside of finance, I keep hearing a similar question, is raising taxes and wiping out any remaining trace of consumer confidence in the face of a recession really a wise move?

Hunt’s version of the mini-budget is expected to include a commitment to sticking to the triple lock and an increase in benefits in line with inflation to protect the poorest, but little cheer for anyone else.

Households are already struggling with much higher mortgage costs, rapidly rising rents, food inflation of 15 percent and sky-high energy bills.

That will do enough to hurt growth.

Let’s hope a hard round of tax hikes doesn’t make the recession much worse, because I fear Jeremy Hunt will.