Big Rows Over Small Pledges Risk Missing Wider Uncertainties That Could Leave The Next Government Confronting A £12 Billion Black Hole In The Public Finances

6th June 2024

The narrow focus of the election campaign on relatively small spending pledges by the main political parties risks missing bigger economic uncertainties that the next government may need to confront, including a possible £12 billion black hole in the public finances from a productivity downgrade, higher market interest rates and infected-blood compensation, according to new Resolution Foundation research published on Wednesday 5 June 2024.

With the public finances at the forefront of the 2024 General Election campaign, the Foundation's first election briefing - funded by the Nuffield Foundation - examines how we got to where we are today, and the challenges ahead for the next parliament.

The briefing notes that the size of the state shrunk between 2009-10 and 2018-19 - by the equivalent of around £1,500 per household in today's money - but has grown considerably since then.

The combination of increases at the 2019 Spending Round, along with efforts to tackle the pandemic and cost of living crisis mean that the size of the state today - at 44 per cent of GDP - is not far off the pre-austerity peak. And yet despite this, real, per-person day-to-day public service spending is still 6 per cent below 2009-10 levels, with departments outside Health and Social Care, such as the Home Office and Transport, experiencing far deeper cuts.

Against this backdrop, the main parties have announced relatively modest (and largely costed) spending pledges in the election so far.

However, the scale of the pledges, how they're funded, and how much they'd cost, could well be dwarfed by other changes to the public finance outlook that neither party has any control over.

Whoever wins will be looking for a quick economic upturn ahead of the first fiscal event of the new parliament. For example, every one percentage point fall in long- and short-term interest rates reduces borrowing by around £12 billion a year. But the report warns that the public finances could instead get even tougher soon after the election.

Some additional costs have become clearer since the last Office for Budget Responsibility (OBR) economic outlook in March, such as compensation for the victims of infected blood products, which totals £10 billion over the next five years.

An even bigger uncertainty surrounds possible changes to the OBR's forecast for future productivity growth, which remains significantly above levels sustained since the financial crisis (0.7 per cent between 2013 and 2019) and the Bank of England's forecast.

Even a relatively modest downward revision in the OBR's forecast from 1.1 to 0.9 per cent a year - which would still be stronger than the Bank and recent history – would add around £17 billion a year to borrowing by the end of the forecast period.

With current plans having just £9 billion of headroom against the binding fiscal rule of having debt falling by the fifth year of the forecast, this additional borrowing alone would force the next government to make further tough tax and spend choices if it wishes to meet this fiscal rule.

Furthermore, the £19 billion of cuts to unprotected departmental spending – from prisons to local government – pencilled in for after the election, will be extremely challenging to deliver given the current state of public services. The share of crime victims not satisfied with the police has risen from three-in-ten in 2010 to four-in-ten today, while dissatisfaction with the performance of local councils has risen by a third over the past decade.

Avoiding these cuts by maintaining public spending in real, per-person terms, along with £4 billion of extra spending on asylum claims, currently being funded out of HM Treasury’s reserves, could increase the size of the fiscal black hole to around £33 billion.

It is right that politicians are making their case for an economic strategy that would boost growth and therefore ease the pressure on the public finances, says the Foundation. But they should also have a plan that is credible given the far tougher fiscal climate they may well encounter early in the next parliament, and the difficult choices it would bring.

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

"The state of the public finances has dominated the election campaign so far, with the inevitable arguments over how each spending pledge is funded. But this narrow focus risks distracting the electorate from the bigger question of how each party would manage the uncertainties facing the public finances.

"This question is crucial, as whoever wins the election could be confronting a fiscal hole of £12 billion, if today’s uncertainties turn into bad news after the election. And if the next government wants to avoid a fresh round of austerity, that black hole could rise to over £33 billion.

"The parties should explain how they would confront these challenges, as well as rightly making their case for an economic strategy that would boost growth."

Debt dramas
Putting the public finances in context ahead of general election 2024

The public finances have already emerged as a key issue in this election. So, in this briefing note, we step back and ask how we got to where we are today, discuss where the public finances might be heading, and consider what this means for whoever forms the next government.

Key findings
The size of the state has shrunk and then expanded since 2010, ending up in a similar place to where it started. Total government spending fell as a proportion of the economy from 46.5 per cent in 2009-10 to 39.5 per cent in 2018-19 – the equivalent of £1,500 per household in today’s money. The size of the state has risen since then reflecting political choices and the big shocks that have hit the country so that such spending now stands at 44 per cent of GDP, not far off the pre-austerity peak.

But since 2010 the shape of the state has changed significantly. There has been a fall in day-to-day spending on public services: on a real, per-person basis, day-to-day spending on public services is set to be 6 per cent below 2009-10 levels in 2024-25. This has been partially offset by the rise in debt interest, which has nearly doubled from 1.8 per cent of GDP in 2009-10 to 3.2 per cent in 2024-25.

Spending pressures have led to a rise in taxes – but not enough to stop debt rising. Increases in taxes have offset over 90 per cent of the rise in total public spending since 2019. As a result, public debt is set to increase by 15 percentage points of GDP between 2019-20 and 2024-25, the second largest rise over a parliament since the Second World War, and the largest rise in the G7 (to 2023).

The uncertainty surrounding the fiscal outlook dwarfs sums involved in political arguments made in the campaign. Although the outlook is uncertain, if bad news for the new government arrives on additional costs (for example for compensation for the victims of infected-blood products), higher market interest rates, and even a modest downgrade to the OBR’s assumption around trend growth could leave a £12 billion gap against commitments to get debt falling.

The £19 billion of cuts to unprotected departmental spending – from Justice to Local Government – pencilled in for after the election, will be extremely challenging to deliver given the current state of public services. If the next government wants to avoid a return to austerity-style cuts, this implies that around £33 billion of savings would be needed to get debt falling as a proportion of GDP.

All this leaves the next government facing a difficult fiscal outlook. Some options have been proposed as part of the wider fiscal debate if uncertainty turns into bad news after the election. Two examples include: tweaking the fiscal rules to one based on total public debt and asking the Bank of England to move to a system of ‘tiered’ reserves remuneration.

It is likely, however, that winner of the election will still face difficult choices about how to manage these challenges. But the debate so far has focused on the funding of relatively small policy commitments with much less on these far more material, big-picture fiscal challenges. All this means that the fiscal debate has become detached from the fiscal reality.

Read the full Resolution Foundation Nuffield report HERE
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