The Chancellor faces an increasingly stark choice on whether to prioritise deficit reduction or public spending according to new analysis predicting a near £20bn Budget black hole.
Philip Hammond may have to abandon his goal to balance the books if, as expected, official forecasters sharply downgrade prospects for productivity growth, the Institute for Fiscal Studies (IFS) said.
The IFS said a downgrade could put the deficit on course to be £36bn in the 2021/22 financial year, nearly £20bn higher than the £17bn pencilled in by the independent Office for Budget Responsibility (OBR) earlier this year.
An additional headache is the uncertainty surrounding the “nature and impact” of Brexit, the analysis found.
It said the Chancellor would be stuck “between a rock and a hard place” and “trapped between his own fiscal targets, deteriorating economic outlook and growing pressures on spending”.
The analysis found that it was hard to see how Mr Hammond could maintain the credibility of his target to bring the public finances into surplus by the mid-2020s while also responding to “increasingly intense” pressure to loosen spending restraint.
It concluded that sticking to the Budget surplus plan may be “no longer sensible”.
The Government has been trying to bring down the deficit – the shortfall between how much it spends and how much revenue it brings in – partly by keeping a tight rein on spending.
But it must also rely on economic growth producing increasing tax revenues.
Better productivity – effectively “doing more with less” – is seen as key to improving growth potential and public finance forecasts are “hugely sensitive” to the productivity assumptions made by the OBR, the IFS said.
But the OBR is likely to worsen its outlook for productivity growth at next month’s Budget, producing a worse picture for Government receipts and the wider Budget black hole.
A cut in productivity growth from the current outlook of 1.6% a year to 1% would see the 2021/22 deficit widen to £36bn – though if the rate remained at the “terrible” 0.4% pace seen in recent years this could rise to £70bn, the IFS found.
The effect of these forecast changes would outweigh recent improvements in the public finances, which could see borrowing come in around £7bn lower than forecast for 2017/18.
It comes as the Government faces demands for more money from public sector workers, the NHS and schools and benefit recipients.
Carl Emmerson, deputy director if the IFS and co-author of the report, said: “Given all the current pressures and uncertainties … it is perhaps time to admit that a firm commitment to running a Budget surplus from the mid 2020s onward is no longer sensible.”
The Treasury said it had made good progress in reducing borrowing but that the national debt was far too high.
A spokesman said: “We will continue to take a balanced approach, dealing with our debts while also investing in our public services, to build an economy that works for everyone.”
For Labour, shadow chancellor John McDonnell said the IFS analysis showed Tory economic policies had failed and that it was time for a change of direction.
“Instead of dragging millions of ordinary people through the endless misery of Tory spending cuts, the Chancellor now needs to make a decisive break with past Tory failure and end austerity,” he said.