The British government will head into the next election with a black hole in the public finances almost three times bigger than when Boris Johnson came to power, a leading thinktank has warned.
The Institute for Fiscal Studies (IFS) said the scale of the Covid recession and Britain’s slow economic recovery would inflict lasting damage for the exchequer, leaving borrowing about £100bn higher by the time of the election in 2024 than forecast before the pandemic struck.
In more pessimistic scenarios, with the effects of Covid-19 lingering for longer, IFS said the government deficit – the gap between spending and tax income – could exceed £200bn in that year. Such a borrowing figure would easily outstrip the scale of the deficit inflicted by the 2008 financial crisis, which was used by the Tories as the basis for unseating Gordon Brown’s Labour government at the 2010 election.
Setting the scene for a delicate economic backdrop for the Conservative campaign to win a fifth consecutive term in power, the IFS said the government would probably need to make “tough decisions” over whether to raise taxes or reduce spending if it wanted to bring down borrowing levels. It said the budget deficit was set to remain at about £151bn in 2024-25, almost three times higher than the £58bn forecast before the pandemic struck, as the fallout from the crisis leaves lasting scars for the economy.
As government spending increases in response to the pandemic and income from taxes drops during the deepest recession on record, the IFS said public borrowing this year was set to hit £350bn – the highest peacetime borrowing figure since the 1700s. However, despite the record increase in borrowing pushing the national debt – the sum total of every budget deficit – to the highest levels since the 1960s, it warned the government against imposing a fresh austerity drive or hiking tax levels any time soon.
In a warning to the chancellor, Rishi Sunak, the IFS said government policy needed to focus on supporting the economy “almost irrespective” of the short-term fallout for the budget deficit for the next 18 months at least. Despite the national debt hitting more than £2tn – more than 100% of national income – the IFS said the cost of borrowing had also fallen to the lowest levels since the foundation of the Bank of England in the 1690s.
It also said the scale of the national debt remained low relative to previous periods in history and was comparable with other advanced economies, including the US and France. Some economists and the International Monetary Fund have told governments not to worry about higher levels of debt, as borrowing costs have plummeted and inflation remains low.
However, the IFS said an increase in borrowing costs could, if not accompanied by stronger growth, prove “hugely problematic” for the public finances because debt payments would take up a higher share of government spending. It said at least £40bn of tax rises or spending cuts would be needed in 2024-25 to maintain the national debt at about 100% of GDP, let alone return the debt to pre-pandemic levels.
Paul Johnson, director of the IFS, said: “For now, with borrowing costs extremely low, Mr Sunak shouldn’t worry unduly about the debt being accrued as a result. It is necessary. Well-directed investment spending over the coming period could help with growth and hence, eventually, the fiscal numbers.
“Unfortunately, none of this will be enough fully to protect the economy into the medium run. We are heading for a significantly smaller economy than expected pre-Covid, and probably higher spending too. Without action, debt – already at its highest level in more than half a century – would carry on rising. Tax rises, and big ones, look all but inevitable, though likely not until the middle years of this decade.”
