Page last updated at 18:52 GMT, Thursday, 23 April 2009 19:52 UK

UK economy 'faces decade of pain'

By Steve Schifferes
Economics reporter, BBC News

Alistair Darling
The Tories have accused the chancellor of hiding a "tax bombshell".

The UK is facing "two parliaments of pain" following the "breathtaking" damage to the economy, the Institute for Fiscal Studies (IFS) has warned.

The government must close a £90bn hole to bring the budget into balance, the independent think-tank said.

That would cost every UK family £2,840 per year by 2017-18 in higher taxes or public spending cuts, it added.

The Treasury said this week's Budget had set out a plan to reduce borrowing while supporting the economy now.

'Benefit'

The IFS analysis came after the chancellor delivered his Budget which forecast the biggest deficit in UK post-war history.

Alistair Darling told the House of Commons on Wednesday the government would be forced to borrow £175bn this year as the recession battered the UK economy.

Shadow chancellor George Osborne said the IFS calculations showed the country was facing a "secret tax bombshell".

But Downing Street insisted it was "not entirely clear" how the £2,840 figure had been calculated.

The Treasury said that reducing our borrowing overnight would lead to greater losses in the long term.

The Treasury's assessment of the fiscal damage wrought by the current economic and financial crisis is breathtaking
Robert Chote, IFS

"By investing in the economy and protecting our front-line services through greater efficiency, we will be much better positioned to benefit from the recovery when it comes."

'Mounting austerity'

The squeeze on spending would duplicate that seen during the Thatcher years in the mid-1980s, the IFS said.

The independent think-tank forecast overall public spending would fall by 0.1% annually in real terms from 2011 to 2014.

It said if the budget squeeze continued to fall on spending up to 2017-18, total public spending would fall back to the level of 2002.

This would wipe out all the spending increases made by the Labour party in its last two terms in office.

government spending plans

"The Treasury's assessment of the fiscal damage wrought by the current economic and financial crisis is breathtaking," said IFS director Robert Chote.

"It will require two full parliaments of mounting austerity to repair."

The IFS said the taxes on the rich will raise relatively little money in comparison with the size of the budget gap.

Only 10% of the gap will be raised by new taxes, while 40% will be accounted for by spending cuts up to 2014, it added. The remainder (50%) is scheduled for the parliament after next.

public spendnig

The IFS pointed out the government is planning a huge cut in public investment, reducing it by more than half, and reversing its previous approach that aimed at preserving capital investment.

This would mean much less money available was to build new schools, roads, and hospitals after 2011.

In addition, it pointed out that all of the very modest increase planned in current spending (on wages and running costs) would be taken up with the higher cost of debt interest and paying out more social security benefits.

Photo of a woman having her blood pressure taken
Health and education could face spending curbs

This meant departmental spending (including areas such as health, education, and policing) would need to fall by 2.3% annually.

If these departments, which make up more than half of all departmental spending, were protected, then there would be even bigger cuts in other departments, of up to 5%.

It was not clear that these can be achieved by "efficiency savings" alone, the IFS said.

And it added that in the following four years, to 2017-8, public spending would also have to grow at just 0.5% annually to meet the budget cut targets without further tax increase.

Output gap

Woolworths branch
Its not just the recession that is troubling the chancellor

The need for big cuts in spending or the raising of taxes does not only arise from the depth and the severity of the recession.

The IFS said that it was also due to a permanent loss of output by the UK economy as a result of the credit crunch, and added the Treasury had doubled its estimate for the size of that loss.

The loss of output, and thus of tax revenues, for example from financial sector, had put a permanent hole in the public finances, its report said, meaning the government could not simply rely on the end of the recession to plug the structural gap in the public finances.

And it said that it would be 2032 before government debt returned to the level of 40% of GDP that had been Mr Brown's target.

Hitting the rich

The IFS also cast doubt on the Treasury's belief that it would raise an extra £7bn per year by taxing the rich, especially those earning over £150,000 per year.

TAXING THE RICH
50% tax rate: £2.6bn
lower pension tax relief: £3.1bn
Personal allowances: £1.6bn
Source: Treasury estimates

It said there was tremendous uncertainty about how much the new 50% tax rate would generate, adding that it could raise no money at all if the rich changed their behaviour.

And it warned if some rich people chose to leave the country and spend less in the UK, that would also lower tax receipts in other areas, such as VAT receipts, perhaps by as much as £1.5bn.

It was also sceptical about the plan to reduce tax relief on pension contributions, which the Treasury said would raise £3.1bn. This scheme is flawed in its principles, it said, and will be difficult to implement in practice.

budget deficit



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