Higher debt interest payments means government will have ‘no room’ for tax cuts, IFS says
The government will have “no room” for tax cuts as rising interest payments and slowing growth puts politicians in an increasingly tight fiscal space, the Institute for Fiscal Studies (IFS) has said.
In a new report using economic forecasting by Citi, the IFS warned that the government faced a bleak fiscal outlook while the economy would slip into recession next year.
Although government borrowing is likely to be around £20bn lower this year than official forecasts from the Office for Budgetary Responsibility (OBR), the IFS pointed out that borrowing is still “much higher than the long-run average” and more than £60bn higher than forecast in March 2022.
Total public sector debt climbed to £2.59 trillion in August – around 98.8 per cent of GDP – despite taxes heading to their highest ever level.
The swelling government debt bill reflects higher debt interest payments and increasing demand for government services.
Spending on debt interest will sit above four per cent of national income this year, the IFS said. This is the highest level of spending on debt interest since the late 1940s.
At the same time, demand for government services is only increasing due to demographic changes. Spending on the NHS and pensions is also set to rise further, with the NHS workforce plan set to increase spending by two per cent of national income by the mid-2030s.
Even while government debt rises, the IFS predicted the UK would fall into a “moderate recession” over the first half of next year due to the delayed impact of higher interest rates.
Paul Johnson, director of IFS, said: “We are in a horrible fiscal bind…poor growth and very high spending on debt interest over the next few years mean that the national debt is stuck at close to 100 per cent of national income, even with tight spending settlements and further big tax rises in the pipeline.”
Some sections of the Conservative party have been calling for tax cuts in an attempt to boost flagging growth, but the IFS pointed out that a big fiscal stimulus would boost inflation just as it appears to be decisively falling to target.
It even warned that tax cuts might create a “protracted recession” by forcing the Bank of England to raise interest rates higher.
“The MPC [Monetary Policy Committee] could certainly do without its job being made even harder by an ill-timed fiscal giveaway,” the report noted.
Without any stimulus, inflation is expected to fall to just over four per cent by the end of the year.
Looking forward, Johnson suggested there was little chance that the pile of debt would fall. “The price of our high levels of indebtedness, failure to stimulate growth, and high borrowing costs is likely to be a protracted period of high taxes and tight spending,” he said.
A spokesman for the Treasury said: “After we stepped in to support families and businesses during the pandemic, Putin’s invasion pushed up inflation and interest rates – meaning we spent twice as much on servicing our debt last year as the year before.
“To secure our public finances we must stick to our plan which is on track to halve inflation, reduce public sector waste and get debt falling.”