Unfunded tax cuts will result in £60bn spending cuts says the IFS

The competition watchdog has been told to carry out an “urgent review” of the fuel industry amid concerns that retailers are not passing on the 5p cut in duty to motorists.

Kwasi Kwarteng will need to find £60bn of savings by 2026 to fill the gap left by unfunded tax cuts and the costs of extra borrowing triggered by a panicked reaction on international money markets to the chancellor’s “mini-budget”, according to the Institute for Fiscal Studies.

The UK will also struggle to hit the chancellor’s 2.5% growth target, with economic forecasts by the investment bank Citigroup that the IFS uses to underpin its analysis showing the UK will struggle to grow at more than 0.8% on average over the next five years.

That sluggish growth rate, thanks to a toxic cocktail of a slowing global economy, the UK’s weakened trade balance after Brexit and the fallout from the mini-budget, would be slightly less than half the growth rate forecast by the Office for Budget Responsibility in March.

The £45bn cost of the mini-budget will wipe out any financial space left to the chancellor by his predecessor, swelling Britain’s debt as as share of national income for at least the next five years.

The IFS director, Paul Johnson, said that while it was “technically possible” for Kwarteng to balance the books via spending cuts, he warned public sector spending had already suffered a huge hit over the last decade and that there was “not much fat left to cut”.

In 2026 the government is likely to still be borrowing £100bn a year when previous forecasts showed it falling to nearer £30bn, the IFS said.

A proportion of the rise in borrowing is accounted for by the energy price cap that ministers agreed to maintain the average household bill at £2,500 a year.

The IFS said the cost of the package was likely to be lower than the £150bn expected by the Treasury at about £114bn, though it would still add to the avalanche of unfunded proposals put forward to boost growth.

Kwarteng and Liz Truss have argued that their policies of tax cuts and deregulation will improve the business environment and boost profits, lifting tax revenues to pay for state services.

However, the IFS said government plans to inject vigour into the UK economy over the next five years to pay for a boost in spending were likely to have only a limited effect, leaving ministers to make hefty reductions in public services and to keep a tight rein on welfare benefits.

The chancellor has announced a 1p cut in the basic rate of income tax from next April and a reduction in national insurance contributions by 1.25%. In addition he plans to freeze corporation tax at 19%, costing an estimated £19bn compared with the previous plan to raise the rate to 25%.

Johnson said all the options open to Kwarteng were unpalatable as they either increased the public deficit, or to avoid this, involved swingeing cuts to public spending or broke manifesto commitments.

In one scenario, he said Kwarteng could retain his tax cuts if he indexed working age benefits to earnings and not inflation, reducing the uplift to about 5% from 10%, to save £13bn. A reduction in public investment by a third to 2% would save £14bn, while a return of austerity across most Whitehall departments – excluding health and defence – could save £35bn.

Johnson said the scenario also only protected the NHS and defence budgets from inflation when the health sector was likely to need even more cash to cope with higher demand and the prime minister wanted to increase defence spending from 2% of GDP to 3%.

“Uncertainties about the path of the economy over the next few years make public finance forecasts very difficult indeed. We project borrowing of £100bn a year in the medium term – but that could be wrong by tens of billions in either direction,” he said.

“A credible fiscal plan will recognise that uncertainty, but cannot ignore the fact that, on a reasonable central forecast, debt is forecast to continue rising in the medium term,” he added.

Local authority bosses reacted angrily to the prospect of further cuts to council budgets.

The Tory councillor James Jamieson, the chair of the Local Government Association, said councils had implemented £15bn worth of cuts between 2010 and 2020.

“Given the funding gaps they are seeing, councils will have no choice but to implement significant cuts to services including to those for the most vulnerable in our societies,” he said.

The IFS report said the mini-budget prompted a seismic shock to the outlook for the public finances that left them deeper in the red.

“This is because the permanent tax cuts were bigger than had been expected,” and because the expectations for Bank of England interest rates have rocketed to almost 6%, pushing mortgage rates towards 8%.

Most economists have warned ministers their plans to lift the economy come at the wrong time, with inflation soaring to about 10% and unemployment at a 40-year low.

Handing households extra funds via tax cuts is likely to push inflation higher, adding pressure on the central bank to increase interest rates by even more than currently expected.

The OBR is the Treasury’s independent forecaster and will provide estimates for economic growth and the impact of the budget on the public finances when the chancellor publishes his autumn statement on 31 October.

Citigroup said the weaker outlook was likely to temper the Bank of England’s appetite for interest rate rises next year and it would cap rates at a peak of 4.5%, rather than the 6% investors currently expect.

Benjamin Nabarro, the bank’s chief UK economist, said the devaluation of the pound towards parity with the dollar would previously have made exports cheaper, boosting output and productivity and giving the government a quick exit from economic stagnation.

He said the negative impact of Brexit and the lack of skilled workers meant industry would struggle to benefit from a lower value currency, meaning stagnation was likely to persist.

“The medium-term outlook for investment remains strikingly weak. Aggressive monetary tightening [by the Bank of England] suggests any meaningful recovery is likely to be pushed into 2025,” he said.