Next government may struggle to fund public services due to biggest debt challenge since 1950s
The next government could struggle to fund public services because of the biggest debt challenge since the 1950s, according to a respected thinktank.
Whichever party wins the next election may be unable to fund key services if politicians are not transparent about the trade-offs they face, the Institute for Fiscal Studies (IFS) says in a new report.
Higher borrowing costs, as a result of increased interest rates, as well as low economic growth and both the Conservatives and Labour committing to reduce debt, leave the next government with little financial flexibility, the IFS adds.
It could be one of the most difficult parliaments for tax and spending since the 1950s, according to the report.
It says: “These challenges – unlike a conflict, pandemic or financial crisis – are entirely predictable.
“None can be meaningfully confronted by a government that wilfully ignores reality and the need to choose between difficult competing options.
“As tempting as it may be to engage in ‘cakeism’ – to seek to have the government’s fiscal cake and eat it – any party serious about governing after the election should resist the urge. The electorate surely deserves better than that.”
The government will have to achieve something that hasn’t been done in 20 years – tax takes and state revenue streams will have to rise to become greater than government outgoings.
This is more difficult at present with the current high debt interest payments and low growth forecasts.
Achieving debt reduction goals by raising taxes may also be politically unpalatable as the UK tax burden, the amount of taxes paid as a percentage of national income, is at a high not seen since the Second World War.
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What is fiscal headroom?
Potential budget cuts will be difficult, too, the IFS says – as living standards have been in a period of “record-long stagnation” and public services are “visibly struggling, and performing less well than they were back in 2010”.
But public services, except health, are to have an effective budget cut as funding isn’t being “sufficiently topped up”, the IFS said at the time of the autumn statement.
The thinktank says political parties need to “be honest with the public about the tough trade-offs they will inevitably have to make on tax and spending”.
“If they are promising tax cuts, let’s hear where the spending cuts will fall. If they are going to raise, or even protect, spending, they should tell us where taxes will rise,” IFS director Paul Johnson said.
“Or parties might think that further increases in government debt are justified: in which case they should make the argument for why debt should be rising.”
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The UK economy grew by 0.1% between July and September, according to the Office for National Statistics (ONS).
However, despite the small positive GDP growth recorded in the third quarter, the economy shrank by 0.1% in September, dragging down overall growth for the three month period.
The growth was also slower than what had been expected by experts and a drop from the 0.5% growth between April and June, the ONS said.
Economists polled by Reuters and the Bank of England had forecast an expansion of 0.2%, slowing from the rapid growth seen over the first half of 2024 when the economy was rebounding from last year’s shallow recession.
And the metric that Labour has said it is most focused on – the GDP per capita, or the economic output divided by the number of people in the country – also fell by 0.1%.
Pic: Reuters
Reacting to the figures, Chancellor of the Exchequer Rachel Reeves said: “Am I satisfied with the numbers published today? Of course not. I want growth to be stronger, to come sooner, and also to be felt by families right across the country.”
“It’s why in my Mansion House speech last night, I announced some of the biggest reforms of our pension system in a generation to unlock long term patient capital, up to £80bn to help invest in small businesses and scale up businesses and in the infrastructure needs,” Ms Reeves later told Sky News in an interview.
“We’re four months into this government. There’s a lot more to do to turn around the growth performance of the last decade or so.”
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The sluggish services sector – which makes up the bulk of the British economy – was a particular drag on growth over the past three months. It expanded by 0.1%, cancelling out the 0.8% growth in the construction sector.
The UK’s GDP for the most recent quarter is lower than the 0.7% growth in the US and 0.4% in the Eurozone.
The figures have pushed the UK towards the bottom of the G7 growth table for the third quarter of the year.
It was expected to meet the same 0.2% growth figures reported in Germany and Japan – but fell below that after a slow September.
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The pound remained stable following the news, hovering around $1.267. The FTSE 100, meanwhile, opened the day down by 0.4%.
The Bank of England last week predicted that Ms Reeves’s first budget as chancellor will increase inflation by up to half a percentage point over the next two years, contributing to a slower decline in interest rates than previously thought.
Announcing a widely anticipated 0.25 percentage point cut in the base rate to 4.75%, the Bank’s Monetary Policy Committee (MPC) forecast that inflation will return “sustainably” to its target of 2% in the first half of 2027, a year later than at its last meeting.
The Bank’s quarterly report found Ms Reeves’s £70bn package of tax and borrowing measures will place upward pressure on prices, as well as delivering a three-quarter point increase to GDP next year.
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