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Osborne 'may have to raise taxes or slash spending to balance books by 2020'

Published 08/02/2016

The Chancellor has set a target of balanced books by 2020
The Chancellor has set a target of balanced books by 2020

Chancellor George Osborne may have to impose large additional tax rises or spending cuts at very short notice to meet his target of balancing the nation's books by 2019/20, an influential economic think-tank has warned.

With a surplus of just £10 billion - or 0.5% of national income - forecast for the last year of this Parliament, Mr Osborne has very little margin for manoeuvre and could be knocked off course by bad news on GDP growth, share prices or wages, said the Institute for Fiscal Studies (IFS).

Even if he makes it to the March 2019 Budget with his plans intact, the chances of Mr Osborne having to hike taxes or slash spending further are greater than one in four, the think-tank warned in its Green Budget report, published ahead of the Chancellor's March 16 Budget.

And it said that, even if economic figures turn out well, meeting the surplus target will mean hiking fuel duties in line with inflation, taking child benefit away from more high-earning families and allowing the number of wealthy households paying the 45% top rate of income tax to grow further by keeping the threshold frozen at £150,000.

Although the real-terms cuts of 1% in public spending planned by 2019/20 are smaller than some expected, they "won't be easy" to deliver, the IFS said.

On current plans, total public spending in 2019/20 will reach its lowest share of national income for more than 60 years with the exception of 1999/2000 and 2000/01. Spending on public services other than health will be at its lowest level as a fraction of national income since at least 1948/49, at a time when the population continues to grow and age.

The target announced by Mr Osborne last year of running a surplus "in normal times" is "very inflexible" and radically different from those adopted by previous governments - who achieved surpluses only eight times in the past 60 years - said IFS director Paul Johnson.

He warned that "this could come at a cost", requiring " big tax rises or spending cuts with very little notice in order to ensure it is met."

Mr Johnson said: "Mr Osborne's new fiscal charter is much more constraining than his previous fiscal rules.

"Uncertainty in the fiscal forecasts means that he may well have to cut spending further or raise taxes to get to surplus in 2019/20. With public spending reaching historically low levels relative to national income, promises on tax cuts to keep and pay for, and pressure on revenues from a number of taxes, there may be more tough decisions to come.

"How he responds to any further unpleasant fiscal surprises may, more than anything we have seen so far, come to define his period as Chancellor."

The IFS warned that pressures the Chancellor could face include:

:: A failure of tax revenues to rise in the way he is hoping. If earnings increase by just 1% lower than forecast by 2019/20, the Exchequer could lose £5 billion in income tax and National Insurance. Falls in equity prices since November could cost £2 billion lower capital tax receipts by 2020 unless they are reversed;

:: Finding £8 billion a year to pay for unfunded promises to raise the personal income tax allowance and increase the higher-rate threshold for the 40p rate;

:: A decision on whether to raise fuel duties in line with inflation, which he has avoided doing since 2011. Further freezes would cost £3 billion by 2020;

:: Public sector employers, such as the NHS and schools, will need to find more than £3 billion a year from 2016/17 to pay higher National Insurance contributions;

:: Spending plans are based on pay in the public sector rising by at most 1% a year, bringing it to its lowest level relative to the private sector for at least 25 years, which "may prove difficult to sustain".

The current forecast of a surplus assumes no change in the £150,000 earnings threshold for the 45% income tax rate, pulling in more people by the process of "fiscal drag" - which has already resulted in a 40% increase in the number of top-rate taxpayers since 2010, said the IFS. And current policy implies no change in the £50,000 threshold at which child benefit is withdrawn, which would result in 50% more households losing some or all of the payment within five years.

The IFS also warned that Mr Osborne's target - known as the "fiscal mandate" - rules out borrowing to invest even when low interest rates mean such investment would boost the economy.

The think-tank urged the Chancellor to consider adjusting his rules to allow borrowing for infrastructure investment where it can be shown it will produce revenues from additional taxes or charges that more than offset the cost of the investment.

Oxford Economics, which co-authored the report, forecast "relatively disappointing" UK growth of 2.2% in 2016, but said strong consumer spending driven by low oil prices is likely to continue and the environment for business investment remains "favourable".

But it said the Chancellor's tightening fiscal policy and continuing uncertainties abroad mean risks to growth are "very much skewed to the downside".

Speaking at the Green Budget launch in London's Guildhall, Oxford Economics lead UK economist Andrew Goodwin warned that economic growth is likely to be harmed if the UK quits Europe.

And he predicted that a British exit from the EU - or even a run of opinion polls suggesting voters may opt for Brexit in the upcoming referendum - would undermine business investment as firms prepare for a period of uncertainty.

"There are so many different possibilities in terms of the relationship the UK may have with the rest of the EU and the rest of the world," said Mr Goodwin.

But he added: "It's very apparent that most of the scenarios in terms of Brexit fall on the downside and imply a worse outcome in terms of GDP growth."

Mr Goodwin said that Mr Osborne's stance on tax and spending is "far too tight" and the Chancellor could relax austerity to boost growth without creating upwards pressure on inflation.

Growth last year was "quite some significant distance below par" at a time when tumbling oil prices have put more money in consumers' pockets, he said.

And the "sugar rush" to consumer spending from low oil prices can be expected to be reduced as welfare cuts totalling £12.5 billion bite, cutting the sector's contribution to overall growth.

Andrew Ratcliffe, president of the Institute of Chartered Accountants in England and Wales (ICAEW), told the launch event it would be "remarkable" for Mr Osborne to meet his surplus target while completing investments in infrastructure as planned.

"These competing policy priorities certainly need deft financial management over this Parliament, on realistic assessments of what is affordable and how these projects can be funded," said Mr Ratcliffe.

A Treasury spokesman said: "The latest growth figures show that despite turbulence in the global economy, Britain is pushing ahead.

"With the risks we see elsewhere in the world, there may be bumpy times ahead - so here in the UK we must stick to the plan that's cutting the deficit, attracting business investment and creating jobs."

Rob Whiteman, chief executive of the Chartered Institute of Public Finance and Accountancy, said: "The Chancellor's surplus target hangs on a knife edge, with very little margin for error. Any further downturn in growth or weakening of the world economy could tip the scales and mean many more cuts to public spending or increases in taxes.

"Before making any further cuts, it is vital the Government makes clear what reductions to expenditure have been achieved to date and what the impacts have been on the productivity of public services."

Shadow chancellor John McDonnell: "The IFS are warning what Labour has been saying for months now that the Chancellor is gambling with the public finances and it'll be taxpayers and our public services that will have to pay the price.

"The truth is that no one believes the targets that the Chancellor sets anyway as he hardly ever meets them. After all, last year was supposed to be the year the deficit was cleared, according to his first budget.

"But by trying to play this silly political game with his fiscal rule, instead of setting a sensible target, George Osborne is risking not equipping our economy for any dangers ahead, increasing cuts to our public services and big tax hikes for working families."

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