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16/10/2018 08:38 BST | Updated 16/10/2018 08:38 BST

Philip Hammond Faces A Tricky Balancing Act For This Year's Budget

With pressing needs emerging and Brexit uncertainty weighing on the economy, the Chancellor faces a big challenge

Reuters

On Monday 29 October, Chancellor Philip Hammond will deliver the Budget. This will be the first Monday budget since 1962 – but it will stand out for more important reasons.

Mr Hammond faces big challenges. Of course, Chancellors have often been dealt a tricky hand – but this year’s Budget promises to be an even more difficult circle to square. Pressures on public spending will bump up against the government’s overall target to eliminate the deficit by the mid-2020s. And with Brexit uncertainty still weighing heavily on the economy, there’s little prospect that growth will make these trade-offs disappear.

“Ending austerity”?

In her party conference speech two weeks ago, Prime Minister Theresa May declared that, ‘a decade after the financial crisis, people need to know that the austerity it led to is over.’

There are many different ways that a Prime Minister could claim to “end austerity”. One of the most minimal definitions would be to meet existing spending commitments – on the NHS, defence, and overseas aid – while stopping the planned cuts to other, unprotected departments in real terms.

Given promises for lots more spending on the NHS we’ll need to be spending £19billion more in 2022–23 than current plans imply just to achieve this aim of meeting current commitments while stopping further cuts to other departments. But this would still leave around £7billion of welfare cuts working their way through the system. Their impact on families is yet to be felt.

Bringing down borrowing, driving down debt?

In the short term, one of the easiest ways to meet these pressures would be to finance a loosening of the purse strings through more government borrowing. And indeed, Mr Hammond is likely to get some good news in advance of this year’s budget: Borrowing this year could come in around £5billion lower than the Office for Budget Responsibility (the government’s fiscal watchdog) projected back in March.

But that would still leave the deficit at £32billion, falling to perhaps £15billion in 2022–23 if the Spring Statement policy plans are maintained (and before spending more to ‘end austerity’). So meeting the government’s overall goal of eliminating the deficit by the mid-2020s would still require more reductions in borrowing – not increases to fund extra spending.

At first glance, further reducing the deficit might not seem essential. The March forecast has the deficit at 1.8% of national income this year – lower than the average deficit run in the 50 years up to the financial crisis. But while the deficit run each year has returned to below pre-crisis levels, public sector net debt is still higher than it was by 50% of national income, or roughly £1trillion. While borrowing doesn’t necessarily need to be cut immediately, maintaining the deficit at its current level outside of recessions could leave this debt continuing to rise as a share of national income.

There are suggestions from some quarters that the UK will be able to use a ‘Brexit dividend’ to spend more on public services without increasing borrowing. But even ignoring any impacts that Brexit might have on the economy, the best estimate of ‘new’ money for public services freed up by leaving the EU over the next five years is close to zero. After taking into account the spending that the EU already does in the UK and on the UK’s behalf, as well as the cost of divorce payments under the withdrawal agreement, net savings on contributions to the EU are likely to be under £1billion in 2022–23. Higher administration costs – for example, on customs agents or border patrols – could easily exceed this modest saving.

Squaring the circle

Mr Hammond has not been dealt an easy hand in this year’s budget. On the one hand, public services are under pressure, and Mr Hammond would need to find at least £19billion in new spending by 2022–23 just to avoid any more cuts to the budgets of unprotected areas. But if the government wants to meet its overall fiscal target of eliminating the deficit, borrowing must continue to fall. Economic growth and the ‘Brexit dividend’ offer little help in addressing this. And while there are good candidates for tax rises, these would need to affect much of the population – not just ‘the rich’ – if they’re going to have a realistic shot at meeting the scale of the challenge. But tax rises for the many, not the few, might be politically difficult to implement.

With pressing needs emerging in many areas and Brexit uncertainty continuing to weigh on the economy, how the Chancellor chooses to meet these challenges will have a big impact not just on the UK’s public finances but on the political climate.

Christine Farquharson is a research economist at the IFS and an editor of the IFS Green Budget