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New tax rise and spending cuts warning over £7bn extra debt costs

High government borrowing may force Chancellor to tighten belts further

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Rachel Reeves faces raising taxes or cutting spending in spring (Photo: Peter Cziborra/AFP)
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Rachel Reeves faces being forced to further raise taxes or deliver deeper cuts to public spending due to stubbornly high government borrowing costs, economists have warned.

On Wednesday the Chancellor refused to rule out imposing further tax rises on businesses in the spring, despite setting out a raft of new policies intended to kickstart growth in the UK economy.

Economists at the Resolution Foundation (RF) have warned that Reeves may have to make deeper spending cuts, or raise taxes, if she is to avoid breaking her own fiscal rules due to the recent volatility in the bond markets ahead of Donald Trump’s return to the White House.

While much of the jitters in the markets -which prompted gilt yields to soar two weeks ago – have since calmed down, the foundation said 10-year gilt yields remain 0.5 percentage points above the level forecast by the Office for Budget Responsibility (OBR) last autumn. Should they remain at this level, UK debt-servicing costs would increase by around £7bn a year.

James Smith, research director at the Resolution Foundation, said the chance of the Chancellor falling foul of her own fiscal rules “remains on a knife-edge”.

“Having set out these rules only last autumn, and repeatedly recommitted to them in recent weeks, the Chancellor will have to meet them on 26 March or risk further market jitters,” he said.

“While the Chancellor is rightly focused on fleshing out her long-term strategy for economic growth, tough short-term decisions, including fresh tax rises or spending cuts, may also be needed in the coming weeks to demonstrate her commitment to sustainable public finances.”

Higher interest rates and gloomier economic outlooks meant Reeves was unable to reject the suggestion that she may be forced to come back with further tax increases despite raising £40bn in taxes, largely on businesses, in her autumn Budget.

Asked whether she could rule out tweaking her fiscal rules or hiking business taxes, the Chancellor told reporters: “I am not going to write five years’ worth of budgets in the first six months of office, but that was a once-in-a-generation Budget to fix the inheritance and to draw a line under the economic and fiscal mismanagement of the Conservatives.”

Reeves is due to deliver a fiscal statement in response to the OBR’s official forecasts on 26 March.

The Treasury is due to send its first set of data, known as the “scorecard”, to the OBR on 3 February, which will allow the watchdog to begin formulating its fiscal and economic forecast ahead of the statement.

Reeves is likely to see tax rises as too politically damaging, but if she is forced to increase taxation then she could look to further put up capital gains tax, or scrap the inheritance tax gifting rule, which allows people to gift assets to family members up to seven years before their death.

Treasury officials also admitted that despite the Chancellor’s public backing, several major infrastructure schemes, such as the Lower Thames Crossing, remain highly dependent on the future fiscal position because they have not yet been fully funded.

The plan for a new road tunnel under the Thames, and a proposed a mass transit scheme in West Yorkshire, will require cash in the upcoming spending review if they are to go ahead in full.

Meanwhile, the Government is ruling out committing any public money to the expansion of Heathrow – meaning billions of pounds of private funding must be pledged in the next couple of years if work is to start before the next election, as the Chancellor wants.

One minister suggested Heathrow’s third runway may never be built, warning that “it’s going to be really difficult” for the airport to produce a plan that fits in with the UK’s carbon budgets.

They expressed hope that the project could help drive take-up of low carbon aviation fuels as the industry is “really behind where they should be on that”, and that this would help the runway get approval.

In her speech, Reeves acknowledged that “the increase in employers’ national insurance contributions has consequences on business and beyond”, adding: “I accept that there are costs to responsibility.”

But she insisted that “the costs of irresponsibility would have been far higher” had she not implemented the measures in her Budget.

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