Chancellor must choose between tax cuts and balancing the books in Budget

The Chancellor Jeremy Hunt has little choice but to pencil in further reductions in public spending if he is to deliver big vote-catching tax cuts in his March 6 Budget.

The latest forecast from the Office for Budget Responsibility (OBR), to be delivered to No 11 this weekend, will leave insufficient room for the scale of tax reductions necessary to bolster core Tory support and move the electoral dial.

At the time of the Autumn Statement in November, it was estimated that the Chancellor had assumed up to £12 billion of unidentified reductions in public spending.

Hunt knows he cannot risk unfunded tax changes which could lead to ructions on the financial markets – potentially scuppering interest rate cuts and better mortgage deals for homebuyers.

Despite the UK economy falling into a shallow recession in the second half of last year, the authorities remain confident the slowdown is not sufficient to have a material impact on prospects for an upturn this year and in 2025, when growth is projected to pick up to 1.4 per cent.

Decision time: Jeremy Hunt has little choice but to pencil in further reductions in public spending if he is to deliver big vote-catching tax cuts

However, a key concern is that the headroom for further cuts in taxes – beyond the £20 billion delivered in the Autumn Statement – will erode sharply as inflation drops towards the 2 per cent target set by the Government.

Fiscal drag – the revenue bonanza from freezing allowances on income tax, capital gains tax and inheritance tax – will vanish as fast as it arrived as inflation falls. As inflation drops, the extra income from pushing taxpayers into high brackets will taper off too.

Hunt is keen to use such fiscal space as he has to continue the drive for higher productivity begun in his Autumn Statement with employment and benefit reforms. Together with the one percentage point reduction in National Insurance contributions these are intended to make work pay and improve the labour supply.

In particular he wants to encourage back to work the 700,000 people who have left the workforce since Covid-19 struck. The Chancellor also is keen to put more heft behind the UK’s dynamic life sciences, IT and financial services industries.

Among the specific measures he is looking at ahead of the Budget is ending the so-called tourist tax, the VAT charge on overseas visitors driving travellers to Paris, Milan and other cities. Having informally looked at shopping patterns, Hunt asked the OBR to return to the drawing board and come up with an assessment by this weekend.

Previously, the OBR reported it would cost £2 billion to restore VAT-free shopping for overseas visitors. But one forecaster, the Centre for Economics and Business Research, says the measure is robbing Britain of £11.2 billion of national output.

The Chancellor is also keen to launch a British Isa – a tax-efficient individual savings account to get private investors into funds that invest in UK-listed companies.

British pension funds have diverted investment from shares quoted on the London stock market into Government bonds.

Just 4.7 per cent of stock in the FTSE 350 – the index of the 350 biggest companies traded on the London Stock Exchange – is held by British pension funds – thereby undervaluing UK shares and bolstering private equity and overseas takeovers.

Official January data for the public finances suggested the Chancellor has £12 billion to £15 billion of headroom for tax and spending changes, down from earlier estimates of £24 billion.

The extra cash is the result of the OBR underestimating savings from lower market interest rates and the impact of tumbling inflation on index-linked Government bonds.

In January alone the Government’s debt interest bill dropped to £4.1 billion, which is £2.7 billion less than the £7.1 billion OBR forecast.

This post first appeared on Dailymail.co.uk