IFS warns Chancellor faces £35bn Budget gap without credible plan

The Institute for Fiscal Studies has warned that the Chancellor's first autumn Budget risks being a 'work of fiction' unless it sets out a credible plan to cover a shortfall that could reach £35 billion.

In its Green Budget ahead of the Budget, the independent think tank said spending plans already implied cuts of around £9 billion to some public services, after reasonable assumptions about protecting the NHS budget and not cutting defence. The war between the US and Iran has pushed up inflation, and the IFS says that turns the £9 billion challenge into £24 billion because departmental budgets will not stretch as far. A commitment to raise defence spending to 3% of GDP would add another £11 billion, producing the £35 billion figure.

The IFS said the Chancellor has a spectrum of choices. He could tolerate lower quality and quantity of some public services, raise taxes or cut benefits, or take a mix of measures. But he cannot do nothing. If spending plans are left untouched, inflation will blow them off course. The think tank added that the Budget must set out a credible overall total for government spending, not just departmental totals, because without one there is no credible plan to reduce borrowing, whatever headroom exists against the fiscal rules.

The fiscal rules require the current budget, which is taxes minus spending excluding investment, to be in positive territory by 2029 to 30. The last official forecast from the Office for Budget Responsibility had left the Chancellor with headroom of about £23.6 billion. Higher interest rates have increased debt interest costs, taking about £12 billion off that headroom, while higher inflation adds around £10 billion to benefit spending. But higher inflation also increases tax receipts. The IFS estimates that higher earnings could add up to £9 billion in income tax and that VAT and other taxes could bring in another £10 billion. On that basis, headroom falls only slightly, to around £21 billion, rather than disappearing. Even so, unprotected departments still face average real cuts of about £9 billion under existing plans.

The Budget comes amid a difficult global backdrop. Inflation is 3.1%, above the Bank of England's 2% target. Government borrowing costs have risen, although the UK is not currently under particular pressure in the bond market, which is paying more attention to France and the United States. The UK spends more than £100 billion a year on debt interest, more than any department outside the NHS. One Labour figure said the Government is dealing with international economic turbulence and pointed to lower borrowing costs last year, as well as measures such as the £2 bus fare cap, removing VAT from electricity and free breakfast clubs. The same figure said there is no doubt that a credible plan will be presented by John Healey at the Budget.

Analysts expect the Chancellor to try to offer targeted and minor help to families and businesses, possibly alongside small tax rises. They do not see the UK as near crisis point. The IFS said the bond market is looking elsewhere at the moment, but that credible plans would help keep investors happy and borrowing costs down.

Events in the Middle East add another risk. Twelve people were killed in Saudi Arabia over the weekend. World markets have so far been calm, but the attacks are a reminder of the risks to oil and liquid gas supplies from the region. As winter approaches, that could feed into energy prices, although there is not thought to be much risk to supply at present.