How the UK Chancellor could fill the country’s £22 billion “black hole”

The labor Party’s manifesto commitments will make it tricky for Rachel Reeves to fix the public finances in her first Budget. We set out what options are at her disposal to plug the fiscal shortfall – by George Brown

 
UK gilt yields have risen as investors are starting to question in earnest how Rachel Reeves is going to balance the books at her first Budget on 30 October. If she doesn’t succeed in easing the fiscal rules she’ll have a tightrope to walk over achieving spending plans and filling an identified £22 billion “black hole” in the public finances.

Quite how the Treasury arrived at the £22 billion figure is unclear, as it has not provided a detailed breakdown for the £8.6 billion earmarked for “normal reserve claims”. But the bar has been set and Britain’s first female chancellor has committed to clearing it. So far, the corrective action she has taken includes scrapping infrastructure projects, means‑testing winter fuel payments and cancelling the planned cap on social care charges. This ought to save £5.5 billion, according to estimates of the government. So how will she plug the remaining £16.4 billion shortfall?

Sweeping spending cuts appear to be off the table after the Chancellor promised there would be “no return to austerity” in her party conference speech. In its place, the emphasis is set to be on raising more revenue for the exchequer. But this will be a challenge given that labor’s manifesto pledged not to raise income tax, national insurance or VAT and to cap the headline rate of corporation tax at its current rate of 25%. Providing that these commitments are kept, this would ringfence off three quarters of the total £1 trillion tax take for the chancellor, leaving her with far fewer options for the Budget.

Admittedly, labor do have a bit of wiggle room. While the manifesto stated there will be no hike to the basic, higher or additional rates of income tax, it made no mention about the personal allowance nor the thresholds. Reducing the main allowances by 10%, starting and basic rate limits would raise £14.7 billion according to government estimates. But we think this is a non-starter for the chancellor. Firstly, it would not be in the spirit of the party’s promise not to “raise taxes on working people”. Secondly, it would come on top of the £27.0 billion that the existing freeze of thresholds is already set to extract from taxpayers, based on forecasts by the Office for Budget Responsibility (OBR).

Instead, it is more likely that the chancellor is weighing up changes to a range of personal allowances, rates and reliefs. There has been much speculation as to the detail of these, but the areas potentially in focus include:

Pensions

*Reducing relief on contributions

*Changing rules on inheritance tax exemptions

Capital gains tax (CGT)

*Adjusting the rates and/or exemptions

*Scrapping certain CGT reliefs

But whilst these tax proposals would go some way towards the plugging the £16.4 billion fiscal shortfall, it seems likely that the Chancellor will still come up short. She faces a further headache in that she is reportedly set to water down plans to raise a further £1 billion from “non-doms” over fears it will lead to an exodus of wealthy foreigners. And so, without widespread cuts to spending, this leaves just one option remaining: higher borrowing. But again, the Chancellor has been boxed into a corner by the labor manifesto, which has pledged two “non-negotiable” fiscal rules.

What is the scope to ease the fiscal rules?

The first rule states that it will balance the current budget, which excludes investment, such that day-to-day spending is funded by revenue. Whereas the second rule has said that government debt must be falling as a share of GDP in five years’ time. While the current budget rule was deliberately designed to create fresh space for investment, the debt rule constrains the amount of capital spending the Chancellor can commit to. However, media reports suggest she is considering tweaking the debt rule to enable her to unlock public investment in roads, rail and green infrastructure.

There are a few ways she could do this. One would be to exclude the £20 billion to £30 billion annual losses being incurred by the Bank of England’s quantitative tightening (QT). She has already been given an additional £10 billion of headroom due to the pace of QT being lower than the OBR assumed in March, which could rise by a further £5.5 billion if the forecaster takes the view that this pace continues going forward. Or the Chancellor could simply shift to the old public sector debt measure instead to exclude these losses, which the IFS estimates would create £16 billion of headroom.

There have also been suggestions that the Chancellor is considering moving the new National Wealth Fund and GB Energy off the Government’s books, which former OBR official Andy King estimates could unlock a further £15 billion of borrowing.

 
As such, we can expect the Budget to include a mix of higher taxes and more borrowing to plug the £16.4 billion fiscal shortfall. Going forward, it is imperative that the government of the day does not find itself in such a predicament again. In this vein, the multi-year Spending Review in spring 2025 will be important. This is sorely needed given that one has not been conducted since late 2021, when inflation and public sector wage growth was forecast to be in the region of 2% to 3% per year, leading to departments being considerably underfunded. But legislating biannual Spending Reviews with a minimum duration of three years should go some way to ensuring these mistakes are not repeated.
 

 

_{Please remember that the value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.}

_{This marketing material is for professional clients or advisers only. This site is not suitable for retail clients.}

_{Issued by Schroder Unit Trusts Limited, 1 London Wall Place, London EC2Y 5AU. Registered Number 4191730 England.}

_{For illustrative purposes only and does not constitute a recommendation to invest in the above-mentioned security / sector / country.}

_{Schroder Unit Trusts Limited is an authorised corporate director, authorised unit trust manager and an ISA plan manager, and is authorised and regulated by the Financial Conduct Authority.}

_{On 17 September 2018 our remaining dual priced funds converted to single pricing and a list of the funds affected can be found in our Changes to Funds. To view historic dual prices from the launch date to 14 September 2018 click on Historic prices.}

The post How the UK Chancellor could fill the country’s £22 billion “black hole” appeared first on USNewsRank.