Black holes and consolidations • Resolution Foundation

Key findings

Our best guess is that the OBR will mark down its estimate of trend growth by 0.3 percentage points, putting it in line with the Bank of England, and reducing its forecast for the size of the economy by 0.7 per cent. We estimate that this would add around £14 billion to borrowing in 2029-30.
There is, however, a good chance that other changes to the economic outlook provide some relief for the Chancellor. We expect the OBR to judge that its March forecast for wage growth was too weak and mark it up despite lower assumed productivity growth. We estimate that this could reduce borrowing by around £13 billion in 2029-30.
Our modelling suggests that the impact of these judgements combined with £7 billion in ‘u-turns since the Spring Statement, higher debt-interest costs and the impact of weaker public-finances data, is for borrowing to be around £14 billion higher in 2029-30 than expected at the time of the Spring Statement.
Against a backdrop of volatility in the cost of government borrowing, this is a big deterioration in the public finances. The Chancellor should aim not just to fill the fiscal ‘black hole’, but to take steps to boost financial-market confidence by doubling the level of headroom held against her fiscal rules to £20 billion, or at least increasing it to £15 billion.

Recommendations

The Chancellor should put in place measures to helping families struggling with the cost of living. A credible strategy to support living standards and reduce poverty must scrap the two-child limit, reducing child poverty by 480,000 by 2029-30 compared to our projection based on current policy. This would cost £3.5 billion in 2029-30 and is the most cost-effective way to bring down child poverty.
Another priority should be to help lower-income families struggling with the cost of living. The most effective way to do this is to move social and net zero policy costs into general taxation, again costing £3.5 billion in 2029-30. This would cut typical energy bills by £160 a year, bringing down inflation by 0.3 percentage points, as well as reducing the relative price of electricity compared to gas, supporting the move to net zero.
Part of the response to the deterioration in the public finances will come from spending cuts. Here the best option is to cut day-to-day public services spending in 2029-30 which is not covered by the Spending Review published in June. The scope for cuts here is limited, but freezing departmental spending in real terms in 2029-30 – itself no mean feat – would yield £5 billion of savings.
All this would leave the Chancellor needing to raise taxes by £21-26 billion (to raise headroom by £5-10 billion). So tax rises are inevitable. We argue the best option is to raise Income Tax by a 2p rise across all three rates, offset by a 2p cut in employee National Insurance. This would raise £6 billion while protecting most workers.
Other measures are almost certainly going to include some form of extension to the freeze in personal tax thresholds, potentially raising £7.5 billion if done for two years, and should also include sensible reforms to raising dividend tax and closing Capital Gains Tax loopholes (up to £7 billion of extra revenue); boosting growth – such as reducing the VAT threshold (£2 billion); and future-proofing the tax system – such as by reforming Vehicle Excise Duty (£2 billion).

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