Hunt explores fresh squeeze on public spending to fund tax cuts

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Jeremy Hunt is considering slashing billions of pounds from public spending plans to fund pre-election tax cuts if he is penned in by tight finances in his March 6 Budget.

Treasury insiders say the UK chancellor is looking at “further spending restraint” after 2025, if official forecasts suggest he does not have enough fiscal headroom to pay for “smart tax cuts”.

Economists have warned Hunt’s current plans for a 1 percentage point increase in public spending until 2029 are a “fiction”, as they would imply serious real-term cuts to some stretched public services.

But people close to Hunt said Treasury officials were considering going further and reducing projected spending rises to about 0.75 percentage points a year, releasing £5bn-£6bn for Budget tax cuts.

The manoeuvre is being considered because tax cuts are seen as politically essential ahead of a general election expected this year but the government’s headroom has become more constrained by higher borrowing costs.

“It doesn’t look like the chancellor will have as much space for tax cuts compared to last autumn, so senior folk internally are starting to look at further spending restraint and productivity gains in the future if the numbers move against us again,” said a Treasury insider.

“It is a tough call, but it isn’t clear whether there will be easier alternatives.”

The news will be seen by some as an exercise in expectation management by Hunt, who would prefer to be able to reduce taxes without further cuts to underfunded public services on March 6.

Much depends on how big a “fiscal headroom” the Office for Budget Responsibility gives Hunt; the independent body handed its latest forecasts to the chancellor on Wednesday.

At the Autumn Statement in November, the OBR said Hunt had £13bn of headroom left against his self-imposed borrowing target of cutting debt as a share of gross domestic product in five years’ time, after taking account of £20bn of personal and business tax cuts.

Some of that will have been eroded by rising gilt yields, which have added to the cost of servicing government debt. The Treasury believes this could have wiped up to £8bn off the headroom figure since the start of the year.

If Hunt did cut spending assumptions in the next parliament it would set a potential political trap for Labour leader Sir Keir Starmer, who claims the chancellor is bent on a “scorched earth” policy.

Labour officials say the party would vote for any Budget cuts to national insurance or income taxes, raising the question of how a Starmer government would fund a reversal of a public spending squeeze.

Richard Hughes, chair of the OBR, last month said the government’s forecasts for public spending after 2025 were beyond “a work of fiction”, saying ministers had not written down how they could be achieved.

Torsten Bell, chief executive of the Resolution Foundation, said: “Taking a fiscal fiction and making it even more fictional doesn’t deal with the underlying problem facing us after the election.”

The government’s projected spending plans are especially tight given that higher levels of funding for the NHS have been guaranteed.

The OBR calculated in November that unprotected departments such as the Ministry of Justice could face 2.3 per cent real-terms cuts annually from 2025 under spending plans set out in the Autumn budget.

Paul Johnson, director of the Institute for Fiscal Studies think-tank, said at the time that funding tax cuts by instigating a bigger squeeze on public service budgets posed a “material risk that those plans prove undeliverable and today’s tax cuts will not prove to be sustainable”.

Despite expectations that the Bank of England will start cutting interest rates this year, UK borrowing costs have surged in recent weeks, leaving Hunt with less fiscal room for manoeuvre than he might have expected at the start of 2024. 

The benchmark 10-year gilt yield has risen to 4 per cent from 3.6 per cent at the start of the year, which could raise the cost of government financing by 0.25 per cent to 0.35 per cent as a share of GDP, said Tomasz Wieladek, chief European economist at T Rowe Price.