The three steps needed to climb out of the UK’s fiscal hole

Dear Chancellor (whoever you are),

I advised a few (nine!) Chancellors in my time in the Treasury but never before did I get to write what I think, uninhibited. Even so, Jeremy Hunt said he appreciated me “speaking truth to power with a smile”. So, as you read this unsolicited advice, I promise I’m smiling…

Your first meeting will probably be on the economy, the second on fiscal. You will get a stash of reading where officials attempt to show they can deliver the things they think you want (I feel for them, preparing this without knowing who you are). Instead, let’s cut to the chase. The combination of low growth, high inequality, stagnant living standards and broken public finances means your job will be, um, “challenging”. The country desperately needs to get off the growth-sapping roller-coaster that lurches from market wobbles to optimistic spending plans, with the odd inefficient tax rise in between. It’s time to get real about the depth of the UK’s fiscal hole, and what strategy we need to escape it.

To climb out of a hole, you have to first understand its shape. The hole in the UK’s public finances is deep – public debt has nearly tripled since the financial crisis. Low growth, as well as being disastrous for living standards, is a key driver. But our ageing and ailing population also plays a huge role in our fiscal woes. Even if you stop digging, the hole will keep getting bigger. But while climbing out will be long and hard, it isn’t impossible. Resolution Foundation research published today sets out how to avoid the explosive debt path forecast by the OBR.

Let’s focus on what that means for you, in this Parliament.

Step 1: Balance the books, requiring both spending restraint and fairer tax on non-employment income

Balancing day-to-day spending with taxation is the bare minimum the UK needs to achieve in normal times to avoid that explosive debt path. Indeed, balancing the current budget’ is one of the two fiscal rules that the incoming PM has wisely decided to stick to. A sustainable fiscal policy is quite straightforward. All you have to do is actually strike this balance rather than merely promising to in the future. Unfortunately, the long-run forecasts tell us that striking this balance will only get harder, primarily because the nation’s growing need for both defence and care will create rising pressure on spending.

As you contemplate a first Budget, you face a time-honoured political choice: the balance between public services and taxation. You face it, moreover, alongside manifesto commitments that make broad-based tax rises very hard. Given this, the cost of living crisis, and the priority your boss has placed on putting “more money in people’s pockets”, there are good reasons to avoid trying to rebalance the books on the backs of hard-pressed families through tax rises or crude benefit cuts.

Logically, this road leads to reductions in departmental spending. There is some scope: the day-to-day total has risen 8 per cent in real terms in this Parliament. The tricky thing is that when we look forward restraint is already envisaged, with a rise of only 0.2 per cent penciled in for 2029-30. If you were to grow defence spending to 3 per cent of GDP by then and continue to grow real health spending by 2.5 per cent a year, it would mean a £10.5 billion cut for all other departments in 2029-30, a sizeable 3.4 per cent. That would leave public services outside of health and defence no better funded than in 2025-26. If the growth in defence spending was funded elsewhere those cuts could be tempered to £3.6 billion, or a more manageable 1.2 per cent.

So there’s the real choice – flat real growth for most public services to the end of the Parliament, or take more money from people’s pockets. Do not approach this as a one-off problem, muddling through with several small tax changes and departmental efficiencies. These are symptoms of persistent long-run pressures and the country needs a Chancellor who faces up to them. If the peace dividend has ended, then the state will have to do less and people will have to pay more.

Tactically, you may choose to squeeze public services now and return to tax at the next election. There may be rewards in the bond markets for demonstrating tough spending control. But it remains unlikely that we can sustain internationally low tax rates on median incomes as we climb out of this hole. So you should seriously consider rebalancing the taxes paid by employees versus other forms of income, through a reduction in employee National Insurance and an increase in Income Tax.

Step 2: Tackle the long-run, starting with moving off the triple-lock

The OBR forecasts tell us is that if spending rises while taxes stay constant, then eventually the UK’s public finances will break. In reality, this won’t look like an ever-growing debt to GDP ratio but rather an inability to borrow in financial markets without sudden and painful corrections. It would be better to adjust taxes and spending in advance. Most likely, both will have to take some strain, with taxes rising from where they are but spending being contained some significant way beneath the OBR’s projections.

We need to avoid policies that grow spending faster than the economy by design. The Triple Lock, I’m looking at you. There is no need for pensioner incomes to grow faster than those of the average worker, and particularly not through an arbitrary link to the volatility of our economy. The OBR’s frightening forecasts assume a rise in the State Pension age to 68 in the 2030s and so any delay makes things even worse. More broadly, we will need to contain spending on age and illness if we want to protect some services for the young and healthy. That means reducing the drivers of higher disability benefits spending, ensuring any settlement for social care is sustainable, and imposing some stark priorities within the NHS. Doing so in a way that reduces rather than increases the rate of ailing itself will be crucial.

We also need a tax system that causes less economic damage. Reforming property tax so that local authorities have a better basis on which to take on more powers than the regressive Council Tax would support your devolution agenda. Closing loopholes in UK wealth taxes could fund direct cost of living support. Pick your battles, but please leave the tax system in a better state than you found it.

Step 3: Find ways to boost investment, doubling the national wealth fund immediately

When faced with fiscal challenges, many governments have cut investment. The average advanced OECD country has invested around 55 per cent more than the UK over the past three decades. In the end, this has come back to bite us by sapping growth.

Your predecessor avoided planned cuts to investment but you could go further. While your predecessor has increased capital spending relative to previous plans, a lot of this has now been allocated to defence. Capital spending on everything else is now set to be 0.25 per cent of GDP lower in 2029-30 than last year. One immediate useful step would be to ramp up the size of the National Wealth Fund to the point where it fully, rather than only partially, makes up for the UK’s Brexit-induced loss of access to the European Investment Bank. The Fund concentrates on exactly the sorts of infrastructure projects that often give the highest economic return. Resolution Foundation’s forthcoming detailed proposals would see it invest nearly £7 billion more annually by 2031 – within the existing fiscal rules.

Economics versus politics

It is possible to deliver some of these steps within the strait-jacket of the Labour manifesto, while also supporting growth. Rises in day-to-day defence spending could come from cuts to public services, cost of living support could come from closing wealth tax loopholes, and financial transactions, such as through the National Wealth Fund, could boost investment withing the borrowing rules. But the world has clearly changed since that manifesto was written, from the accelerated decline of rules-based trading to the need for greater defence in Europe. You should seize the opportunity of a reset to address the deeply unsustainable path we are on. The time has come to tackle these problems with honesty – not to defer them yet again. Climbing out of a hole with your hands tied behind your back is undoubtedly more challenging.

This article was originally published on the Resolution Foundation’s Substack. Ruth Curtice is the Chief Executive of the Resolution Foundation. You can follow her on Bluesky here.