The UK government's manifesto-breaking announcements of tax rises are the biggest tax increases in more than 25 years but this will still leave chancellor Rishi Sunak with "little room for manoeuvre" in this month’s Budget and Spending Review, according to the Institute for Fiscal Studies' (IFS) Green Budget 2021.
The tax rises will increase the UK’s tax take to its highest sustained level in peacetime and spending will amount to 42% of national income, more than 2% above the pre-pandemic spending level and its highest level in "normal times" since 1985, the IFS predicted.
The IFS said this was "more the inevitable consequences of population ageing and pressures on health and care spending, than they are consequences of the pandemic. Tax rises that were always inevitable have been smuggled in under cover of the pandemic."
Decisions over NHS funding increasingly shape the funding outlook for other departments, as well as overall fiscal policy. Health spending has risen to make up an ever-growing share of day-to-day public service spending — an estimated 44% by 2024/25, up from 42% in 2019/20, 32% in 2009/10 and 27% in 1999/2000.
If the new tax rises meant to fund health and social care are to meet future health and social care pressures then the tax rate could need to more than double from 1.25% to 3.15% by the end of this decade, the IFS estimated.
Day-to-day public service spending is set to rise by 3.4% a year over the next five years but Sunak will have to increase spending on public services other than health, defence, schools and aid by less than he was planning pre-pandemic in order to meet his planned objective of achieving current budget balance and may even end up cutting some budgets over the next two years, the Green Budget said.
Cuts to "unprotected" day-to-day budgets in areas such as local government, further education, prisons and courts could total more than £2bn (2.5%) next year.
"These challenges are heightened by the fact that no allowance has been made for pandemic-related pressures outside of the NHS. Ongoing support for public transport operators and a catch-up package for schools alone could easily require £3bn of extra spending each year," according to the Green Budget.
The IFS expects borrowing to continue to run at least £20bn a year below the March 2021 budget forecast from 2022−23 onwards, and thinks the current budget should return to surplus from 2023/24. However, this would still leave debt at 89% of national income in 2025/26 — 17 percentage points of national income above its pre-pandemic share.
High debt, as well as rising interest rates and retail price index (RPI) inflation in 2021, pushes up forecast debt interest spending by around £15bn, compared with the March budget forecast. Each additional 1% on interest rates adds £10bn to annual debt interest spending. Each additional 1% on the RPI adds £6bn.
"Rishi Sunak, a Conservative chancellor, is presiding over an increase in the tax burden to record levels in the UK and an increase in the size of the state (public spending as a fraction of national income) to levels not seen since the days of Mrs Thatcher. Yet the combined effects of ever-growing spending on the NHS and an economy smaller than projected pre-pandemic mean that he is still likely to be short of money to spend on many other public services," said Paul Johnson, IFS director and an editor of the Green Budget.
"On central forecasts, there will be little or no scope to increase spending on things like local government, the justice system and further education, after a decade of sharp cuts. That said, he still faces huge uncertainty over the direction of the economy and hence over the state of the public finances.
"He will be hoping against hope that stronger-than-expected growth in revenues over the next few years will help to dig him out of what still looks like a fair-sized hole."