Public services are facing a new spending squeeze despite taxes rising to record peacetime levels, a leading economic think tank has warned.
The Institute for Fiscal Studies (IFS) said the rising cost of healthcare in an ageing population was eating into funds available for services such as the courts, prisons and local government.
In a report ahead of Chancellor Rishi Sunak’s Budget later this month, it said the 1.25 percentage point increase in national insurance contributions (NICs) announced by Boris Johnson to pay for extra spending on health and social care may have to more than double by the end of the decade to keep up.
An analysis by Citi estimated the UK economy is expected to be between 2% and 3% smaller in 2024-25 than it was before the pandemic – with Brexit having an even deeper “scarring” effect than Covid.
“The scarring just because of the pandemic may not be as large as we thought last year. The scarring due to Brexit may actually be larger,” said Christian Schulz, the bank’s director of European economics.
“Brexit is casting a long shadow over the economy.”
Following the increase in NICs announced last month, the IFS said public spending was set to settle at 42% of national income – 2% above its pre-pandemic share and the highest sustained level since the mid-1980s.
However, the shrinking economy meant Mr Sunak would have no extra cash to spend on “unprotected” Whitehall departments when he delivers his spending review alongside the Budget on October 27.
Sticking to his planned spending totals, which were fixed only last month, could require cuts in day-to-day budgets of more than £2 billion next year in such “perennially squeezed” areas such as local government, further education, prisons and courts.
Meanwhile the ever-growing NHS budget meant the 1.25% health and social care levy may have to rise 3.15% over the course of the next parliament.
Overall, the IFS said the uncertainty surrounding the current economic forecasts was “incredibly high”.
In the best-case scenario, the £28 billion in tax rises announced by the Chancellor in his last Budget in March could prove unnecessary to get the public finances back to a current budget surplus, allowing him to cut taxes.
Alternatively, if things go badly, Mr Sunak may have to almost treble those tax increases to meet his target for the public finances.
IFS director Paul Johnson said: “Rishi Sunak, a Conservative Chancellor, is presiding over an increase in the tax burden to record levels in the UK and an increase in the size of the state to levels not seen since the days of Mrs Thatcher.
“Yet the combined effects of ever-growing spending on the NHS and an economy smaller than projected pre-pandemic mean that he is still likely to be short of money to spend on many other public services.
“On central forecasts, there will be little or no scope to increase spending on things like local government, the justice system and further education, after a decade of sharp cuts.
“That said, he still faces huge uncertainty over the direction of the economy and hence over the state of the public finances.
“He will be hoping against hope that stronger-than-expected growth in revenues over the next few years will help to dig him out of what still looks like a fair-sized hole.”
A Treasury spokesman said departmental budgets would be set out in the spending review, which would continue to reflect “the public’s key priorities”.
“Core departmental spending will grow in real terms over this Parliament at nearly 4% per year on average – a £140 billion cash increase and the largest real-terms increase in overall departmental spending for any parliament this century,” the spokesman said.