The hard Budget choices facing a cash-strapped UK

As Chancellor Jeremy Hunt and his Treasury team work through the detail of fiscal policy ahead of the Budget on March 6, officials in Manchester are occupied by a very different set of problems.

By last week, council offices in the northwestern city were experiencing queues of 70 to 80 refugees every day in search of housing, according to Bev Craig, leader of the Labour-controlled authority. This comes on top of acute problems with homelessness and a 16,000-strong waiting list for social housing.

“You see swaths of desperate people turning up at our front door for help that in a normal, functioning system would be delivered elsewhere,” she says. 

Craig blames the queues on “cost shunting” of national problems on to local authorities by Whitehall departments — in this case the Home Office, which has begun moving more and more people out of asylum accommodation in a bid to clear national backlogs.

Britain, a country gently mocked for its love of queues, is facing waiting lists of epic proportions to access public services ranging from housing to dentistry and childcare. The state-run healthcare system has 7.6mn people in England alone waiting for non-emergency hospital treatment.

As each silo of public spending has had its finances squeezed by inflation and past budgetary restraint, pressures have been pushed from one part of the system on to another, leaving local authorities like Manchester looking for ways to pick up the pieces. 

“You can witness the human cost simply by walking the streets of any major town in the UK at the moment,” says Craig.  

Voters have certainly noticed. Even though the overall tax burden is at a postwar high, opinion polling suggests that households want public services fixed before taxes are cut. Yet in the run-up to the Budget, the political focus in Westminster is on whether Hunt can use what may be the last fiscal event before a general election to offer a headline-grabbing tax cut.

Rishi Sunak, the prime minister, had hoped to go to the polls with a tax-cutting Tory manifesto. In the summer of 2022, while vying with Liz Truss to succeed Boris Johnson, Sunak claimed he could cut the basic rate of income tax from 20p to 16p by 2029 if he won the next general election.

Some Tory MPs on the right have become convinced that ambitious tax reductions are the only way that Sunak can drag the Tories away from a path towards apparent electoral doom.

The opposition Labour party, which currently averages a 20-point lead in the polls, has derided the government’s “scorched earth” policies. But it has so far been reluctant to oppose most tax cuts or say whether it would reverse them if elected, for fear of being cast as the party of high taxes and high spending.

A forensic look at the state of the public finances and current economic projections suggests that the bill for any tax cuts now — on top of £20bn worth announced in November — will need to be paid for later on.

Voters will at some point have to decide what kind of pain the country would prefer to endure: more years of declining public services, as departments already struggling to meet demand face further deep real-terms spending reductions, or higher taxes that might begin the job of repairing them.

“Neither party is being that honest with the electorate about what the current spending plans imply,” says Stuart Hoddinott, a senior researcher at the Institute for Government think-tank. “The plans would be very damaging for public services and in reality I don’t think either party would stick to them,” he adds.

“That implies either tax rises or more borrowing [after the election] to fund spending increases.”

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Local government is one of the areas where services are most visibly suffering. The Local Government Association points to a 24 per cent real-terms reduction in spending power since 2010 overall, although the exact figures vary geographically. 

Whitehall has provided a funding increase in its latest financial settlement. But the impact of statutory minimum wage rises and other cost pressures in social care have wiped that out, according to the LGA, leaving a £2.4bn gap this year and a £1.6bn gap in 2024/25.

That has left councils looking for more cuts. Eight local authorities in England in the past six years have had to issue so-called Section 114 notices, in effect declaring themselves insolvent. Around 10 more are currently seeking permission to borrow for current spending and sell assets in order to avoid the same outcome.

Meanwhile, access to services gets harder for the public as backlogs grow and demand is pushed around the system. A spending review that was touted as the most generous in years when launched by the government in 2021 has since been eroded by inflation that hit double-digit levels a year later.

Laura Neilson, an emergency doctor who also heads the Greater Manchester homelessness charity Shared Health, is at the sharp end of the reductions. She highlights the impact of a recent decision by many UK police forces to stop attending call-outs relating to people in mental health crisis.

“That’s a symptom of them being overwhelmed and trying to shift work on,” she says. “You’ve got backlogs in the NHS, backlogs in housing, backlogs in support services — even the debt-advice charities have got backlogs now,” she adds, noting that the poor, the sick and the vulnerable are hit hardest.

A government spokesperson said: “We recognise councils are facing challenges and are increasing their overall proposed funding for next year to £64.7bn — a 7.5 per cent increase in cash terms — on top of the £2bn [over three years] we are giving them to help reduce the need for temporary accommodation and tackle homelessness in their areas.”

But further pain lies ahead. The government has not set out any specific departmental spending plans beyond the 2024-25 fiscal year, instead pencilling in an average increase of 0.9 per cent a year in day-to-day spending. 

Within that, Sunak has a number of priority areas including the NHS and defence, which implicitly stand to win a bigger slice of the pie. Core schools spending is meant to be frozen. 

That would leave expenditure at so-called unprotected departments needing to fall 3.4 per cent a year in real terms for four years from 2025-26 in order to keep overall spending in line with plans, according to the Institute for Fiscal Studies think-tank. Capital investment budgets face 2 per cent annual cuts after inflation. 

Real-terms cuts of that scale are not necessarily impossible, argues Ben Zaranko, a researcher at the IFS, who points to the austerity imposed by former chancellor George Osborne back in 2010. 

But they would require an acceptance among the general public that the state would simply no longer deliver a full gamut of services at the standards they expect. This seems highly unlikely to wash with voters, some 52 per cent of whom think the government should invest any Budget windfall in long-term measures to improve the quality and efficiency of public services, according to a poll by the Tony Blair Institute and Deltapoll.

The same survey showed only 11 per cent of voters now think any extra budget flexibility should be spent on more tax cuts, and even Sunak’s allies admit to being disappointed that a 2p cut in national insurance rates, announced last November and rushed into effect for the start of 2024, made no impact at all on the Tories’ dismal poll ratings.

Many analysts predict instead that the public’s demands for shorter NHS waiting lists and better neighbourhood services will force the next government to top up departmental budgets, which have been crushed by inflation that has substantially exceeded the government’s 2 per cent target since the second half of 2021. 

To avoid making real-terms per-person cuts in day-to-day spending at unprotected departments, the government would need to find roughly £25bn extra a year by 2028-29, factoring in new, higher population projections, Zaranko says.

Even that figure excludes the need to top up capital investment to maintain crumbling public buildings and upgrade equipment in hospitals, according to the IFS. Keeping such spending at its current level relative to national income would require an extra £20bn a year. 

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Such expenditure would be even more difficult to finance were the government to embark on further tax reductions in March. 

Hunt’s ability to offer new pre-election giveaways will be determined by a self-imposed fiscal rule that has been widely lambasted by economists. It requires the Treasury to ensure the public debt-to-GDP ratio is falling between the fourth and fifth years of the government’s forecast horizon. 

Given the target rolls forward every year, it has been disparagingly dubbed a “mañana rule” by Richard Hughes, the head of the Office for Budget Responsibility, which provides independent scrutiny of government finances.

In November the OBR forecast the rule would be met by just £13bn — a wafer-thin 0.4 per cent of GDP — after factoring in cuts to national insurance and business tax. 

The margin is highly susceptible to small movements in variables such as nominal growth, inflation, market interest rates and assumptions about public spending. Hughes said in January that it was “probably generous” to refer to these assumptions as a work of fiction, given there are no department-specific plans in place. 

Simon French, head of research at stockbroker Panmure, says both parties are probably “playing for time” rather than talking about the fiscal realities that loom after the election. They are hoping for a better macroeconomic backdrop to come to the rescue; inflation is moderating, interest rates are expected to fall this year, and the UK looks set to emerge from a shallow technical recession. 

But the Bank of England’s current projection is for GDP growth of just 0.25 per cent this year, 0.75 per cent in 2025 and 1 per cent in 2026 — well short of the kind of pick-up needed to swell tax revenues in a substantial way. 

Analysts disagree over the amount of headroom the chancellor will have against his key fiscal rule. While some predict the picture will be somewhat better than November’s £13bn figure, Treasury insiders have sought to suppress expectations. Allan Monks of JPMorgan expects the Treasury to have £7bn of extra headroom, enough in itself to enable a one percentage point reduction in income tax.  

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If further tax cuts do arrive in the Budget, they are unlikely to be vocally opposed by Labour. The party’s leader, Sir Keir Starmer, has a curious relationship with the supposedly reckless economic policies being pursued by the government. 

He has denounced Sunak for “maxing out the credit card” on unaffordable tax cuts and “salting the earth” when it comes to public services. But he is determined not to allow the Conservatives to open up an election dividing line on tax.

When Hunt cut national insurance rates last November, at an annual cost of £10bn, Labour backed him. In fact, in a Conservative fiscal statement that contained 110 separate measures, Labour did not oppose a single one and party officials expect Starmer to adopt the same approach if Hunt introduces further tax cuts on March 6 — even if that starves key public services of yet more cash.

“We are going to present as small a target as possible,” says one Starmer aide.

Ed Balls, an economic adviser in Tony Blair’s incoming Labour government in 1997, says the situation that Starmer will inherit will be far worse than the one that Blair faced. He says growth forecasts are weaker, taxes and debt are much higher, and NHS waiting lists are many times worse.

But Starmer’s team has studied closely what Blair and his chancellor, Gordon Brown, did in office and it may provide a template for what happens next. In 1997, Brown did not immediately announce an increase in public spending, sticking instead to the very tight spending plans of his predecessor Ken Clarke for two years. Even Clarke later admitted he would not have adhered to them.

“We decided we didn’t want the first question for a Labour government to be ‘what more you would spend?’, instead of asking the question of whether we were spending the existing departmental budgets,” Balls recalls. “We realised that having been out of government for a long time, cabinet ministers must not come in and immediately start thinking about the next million.”

So far Starmer has only committed to specific tax increases — raising low billions of pounds to fund very targeted extra spending on schools and hospitals. Labour insiders believe that an incoming Starmer government would not immediately open the floodgates on public spending. That suggests several more years of pain for the public realm.

Such restraint could strengthen the hand of self-proclaimed reformers in Starmer’s team such as the highly rated shadow health secretary Wes Streeting, who has already pointedly declared that the NHS is “a service, not a shrine”.

For his part, Hunt insists that he can cut taxes without undermining stretched public services by improving efficiency. “If we increase public sector productivity growth by just half a per cent, we can stabilise public spending as a proportion of GDP,” he told Tory activists in Manchester last year. “Increase it by more and we can bring the tax burden down.

“For those of us with private sector backgrounds, [half a per cent] doesn’t seem too much, does it?” he continued. “In the public sector, I’m telling you, it’s harder — but we are up for the challenge.”

Raising public sector productivity is a subject devouring attention in both the Treasury and in Number 10, given official figures that suggest it remains below pre-pandemic highs. Sunak has deployed his former policy unit chief Eleanor Shawcross to work on the issue. Both he and Hunt are evangelists for the possibilities of artificial intelligence as a public sector game changer.

With economic growth forecast to increase at an anaemic rate through the next parliament, Sunak has a lot of work to do to persuade voters that he can actually afford ambitious tax cuts without laying waste to the public realm — and adding to the kind of problems seen every day on the streets of Manchester.

Data visualisation by Keith Fray

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