Tax cuts would put ‘scary’ UK finances in greater danger, warns top economist | Tax and spending

Unveiling significant tax cuts before next year’s general election would put Britain’s “scary” public finances in further peril and risk the nightmare scenario of even higher interest rates, one of the country’s most influential economists has said.

Paul Johnson, director of the Institute for Fiscal Studies, also made a plea for honesty from both main parties over the profound tax and spending choices they would face should they win power.

Rishi Sunak and his chancellor Jeremy Hunt remain under intense pressure from their own MPs to cut taxes in March, in the run-up to the next election. While the prime minister has been clear that cutting inflation is his only economic priority for now, officials have privately hinted he is interested in making a cut, such as reducing income tax by up to 2p.

However, Johnson said such a cut would be a “political and not an economic decision” that came with risks. “Two pence off income tax is quite a big change,” he said. “That’s something like £15bn. The big question for the chancellor then would be, how’s the Bank of England going to respond?

“The nightmare scenario will be a nasty market reaction, a la Truss. But an almost equal nightmare reaction would be the Bank saying, ‘We were effectively saying that we were keeping interest rates steady, but now you’ve just injected an extra £15bn into the economy. We’re still worried about inflation and we’re going to put them up’. That should weigh very heavily in any decision on tax cuts.

“A £15bn cut in tax this side of March – without concrete tax rises or spending cuts proposed to offset it – it would be a political and not an economic decision.”

Cabinet sources said the government had been desperate to return economically inactive people to the workforce because doing so had a major impact on economic models produced by the Office for Budget Responsibility, which serves as the official arbiter of the state of the public finances. There remains hope among senior ministers that achieving an increase in active workers will give Sunak and Hunt enough wiggle room to make a major tax cut next spring.

In a plea to both main parties, however, Johnson called for an honest acknowledgement that large swathes of the electorate would have to pay more tax if incoming ministers wanted to improve public services.

“I characterise it as quite scary, actually,” Johnson said. “If you look at the OBR at budget time, they were essentially saying that on the set of assumptions then, debt would be stable at the end of the five-year period. That is in a world in which we’ve had the biggest tax increases in living memory and completely implausibly tight spending plans, post-election. Things have got worse since then.

“My plea, in a sense, is that it would be really quite helpful if [both parties] could be open about the scale of the challenges … The part we’re not going to get any honesty on, I don’t think, is on tax and spending.

“If you, oh electorate, want more spending on health and education then you, oh electorate, and not someone else – not the rich and not the multinational corporations – are going to have to pay more tax. That’s the bit where I didn’t expect anyone to be standing up saying that.”

Sunak pledged to cut tax by 1p in 2024 while serving as Boris Johnson’s chancellor – a measure costing about £6bn a year. It was cancelled in the wake of the market turmoil that followed last year’s mini budget. During his leadership battle with Liz Truss last year, Sunak also pledged to cut the basic rate of income tax to 16p by the end of the decade.

However, he said last month that he and Hunt were “completely united in wanting to reduce taxes for people”. He added: “Of course we are, we’re Conservatives. We want people to be able to keep more of their own money. But the number one priority right now is to reduce inflation and be responsible with government borrowing. That is absolutely the overriding priority. That takes precedence over everything else.”