New fiscal rules can help the Chancellor deliver a Budget for growth – but won’t solve tough decisions on tax and spend

The Chancellor should use her first Budget to rewrite the existing debt rule to enable higher public investment and boost growth. But this won’t solve wider tax and spend challenges, with £20 billion of tax rises needed to ‘end austerity’, according to the Resolution Foundation’s pre-Budget report.

The report notes that the upcoming Budget is a unique opportunity to set the economic direction for the Parliament, and that Rachel Reeves is right to want to boost investment and growth. However, the public finances look even more strained than they were at the last Budget in March.

The gloomy outlook has been reinforced by the new Government’s revelation that it expects to overspend by £22 billion this year. While an element of this extra spending will be offset by controversial cuts, such as those to Winter Fuel Payments, the Foundation expects £19 billion of the overspend will persist to the end of the five-year forecast.

However, there is also some more positive news for the Chancellor on the economy. Higher growth and inflation – which have come without significantly higher interest rates and debt servicing costs – are set to boost tax receipts, and so reduce borrowing by £16 billion a year by the end of the forecast.

Much of the pre-Budget discussion has centred on whether the Chancellor will change the fiscal rule stipulating that debt must fall as a share of GDP in the fifth year of the forecast. However, the Foundation says that another fiscal rule – ensuring that day-to-day public spending is covered by tax receipts – will also prove challenging to meet, especially if the Chancellor wants to ‘end austerity’.

To end austerity, the Chancellor will need to reverse forthcoming cuts to ‘unprotected’ departments such as local government, justice and the home office that were pencilled in by the last Chancellor Jeremy Hunt. Doing so would require at least £21 billion of extra day-to-day public-service spending by 2029-30.

Around £20 billion of tax rises would be needed to end austerity while meeting the current balance rule – a level of tax rises that would reflect the norm for post-election Budgets over the past 20 years. Part of the Chancellor’s challenge is that these new tax rises would all come on top of around £20 billion of planned taxes rises she has inherited from her predecessor that are due to take effect over the Parliament.

The Foundation says that raising this additional £20 billion could be achieved via a combination of ending Inheritance Tax reliefs, raising Capital Gains Tax rates and applying National Insurance to employer pension contributions.

It adds that the Chancellor should also consider reversing key benefit cuts inherited by the last Government, including the freezing of Local Housing Allowance rates and the two-child limit on support, at a total cost of around £3 billion.

But while tax and spend decisions are the meat and drink of any Budget, the Chancellor’s ambition to set out a pro-investment Budget could mark a step change from recent fiscal events.

The report notes that the Chancellor has inherited plans to cut public investment from 2.4 to 1.7 per cent of GDP by 2028-29. Reversing these damaging cuts and maintaining investment at 2.4 per cent would require £30 billion of additional annual capital expenditure by the end of the Parliament.

This scale of extra investment would be impossible to achieve within the current debt rule, without major cuts to public services or even larger tax rises.

Instead, the Chancellor has indicated that she is considering amending the fiscal rules to facilitate greater investment. Various technical tweaks are possible – including the Bank of England liabilities would raise headroom by £15 billion, while excluding the National Wealth Fund and GB Energy would open the door to additional investment in infrastructure.

However, the Foundation says that if the Government wants its new fiscal rule to capture the benefits of public investment it should opt for a new Public Sector Net Worth rule. This rule could create significantly more room to invest – more than £50 billion if the Chancellor was to target an improvement in net worth in the final year of the forecast.

Such an approach should be coupled with closer scrutiny of infrastructure spending to ensure value for money and well planned projects. Together this would help to deliver the investment that the country so badly needs, and turn the upcoming Budget into a major pro-growth event, says the Foundation.

James Smith, Research Director at the Resolution Foundation, said:

“Rachel Reeves says she wants to use her first ever Budget to boost investment and kickstart growth. However, this laudable goal is clouded by a truly dire outlook for the public finances.

“The strain on many public services – from court backlogs and over-crowded prisons to rundown local services – mean that inherited plans for further austerity should be reversed, at a cost of more than £20 billion. Tax rises on that scale would doubtless make for hostile headlines, but are actually par for the course at post-election Budgets.

“The Budget should set a new course for the Parliament with a long term and large-scale capital investment programme, enabled by a new fiscal rule that takes account of the benefits, as well as the costs, of that investment.

“The short-term reaction to such an approach may be concern about tax rises and extra borrowing, but the long-term prize of restored public services, new infrastructure and stronger growth is what Britain needs to deliver long-needed rises in living standards.”