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The UK government lacks budgetary capacity for new rounds of tax cuts and will struggle to keep a lid on spending growth, the IMF has said, as it warned of the need to close a near £30bn gap in the public finances.
In its annual health check on the UK economy, the fund predicted that higher-than-expected departmental spending will lead to a breach of UK fiscal goals late in the decade, given pressures for more health spending and public investment.
The government should seek to raise revenue via measures including reforms to VAT, capital gains and inheritance tax and road charges, the IMF said, as well as by charging for a wider range of public services.
“The government faces pressing service delivery and investment needs which, in [IMF] staff’s view, will be difficult to accommodate within the official medium-term spending plans,” the fund said in its yearly Article IV report on the UK.
“Absent a major boost to potential growth, assuredly stabilising debt in the medium term will likely involve some tough choices.”
The findings come at a sensitive time as chancellor Jeremy Hunt seeks room for further reductions to taxes before the next general election. The Washington-based IMF in January warned against new tax cuts given the UK’s straitened budgetary circumstances, but Hunt went ahead anyway and lopped another 2p off national insurance in March.
In its new report, the fund said it recognised that those national insurance reductions may help to boost the labour supply and were partly offset by other measures such as the ending of non-domicile tax status.
Nevertheless, it said the chancellor should not have lowered national insurance “in light of the medium-term fiscal challenge” facing the UK.
“Against the backdrop of these challenges, as a general principle, staff would advise against additional tax cuts, unless they are credibly growth-enhancing and appropriately offset by high-quality deficit-reducing measures.”
The gloomy outlook will also make for sobering reading in the Labour party, which has declined to reverse the national insurance reductions and will adopt tight departmental spending plans that have been dubbed “fiscal fiction” by the Resolution Foundation think-tank.
In its report the IMF cast doubt on official UK projections for day-to-day departmental spending to rise by 1 per cent a year in real terms in the coming years. It said it was not realistic given the demands on public services and “critical growth-enhancing investment needs (including for the green transition)”.
The IMF said a 2 per cent pace of real-terms growth in departmental spending every year would be more realistic. But this level of spending would help push the ratio of public debt to GDP to 97 per cent in 2028-29, well above the Office for Budget Responsibility’s 93 per cent projection.
To get debt on the right trajectory, the government will need to improve the primary budget balance, which excludes interest payments, by 1 percentage point of GDP on average starting in 2025-26 — the equivalent of just under £30bn that year.
Despite the harsh fiscal outlook, the fund found that the UK is now approaching an economic “soft landing” after its mild technical recession in 2023, as it modestly lifted its prediction for 2024 GDP growth from 0.5 per cent to 0.7 per cent.
Responding to the IMF report, Hunt seized on the growth outlook, saying it confirmed that the UK economy has turned a corner.
“The IMF have upgraded our growth for this year and forecast we will grow faster than any other large European country over the next six years — so it is time to shake off some of the unjustified pessimism about our prospects.”
Inflation is projected to return “durably” to the Bank of England’s 2 per cent target in early 2025. This should pave the way for interest-rate cuts this year, the fund said, as it predicted cuts of 0.5 to 0.75 per cent in 2024 and a percentage point reduction in 2025.
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