How a last-minute OBR forecast could come to the rescue and save Hunt’s dream of tax cuts

Ben Riley-Smith and Tim Wallace

THE email that sunk Treasury hearts dropped at around midnight on Tuesday.

For weeks, the economic numbers which will determine how much money Jeremy Hunt has to play with for next month’s Budget had been moving away from the Government.

The Chancellor and Rishi Sunak want to follow up November’s announcement of a 2p reduction in workers’ national insurance payments with another tax cut in the hope that grateful voters will reward them at the general election.

But, as Treasury sources tell it, any flicker of hope that a surprise haul of extra cash was coming was extinguished when the Office for Budget Responsibility’s (OBR’s) latest round of forecasts pinged into inboxes.

The fiscal headroom – the amount of money the Government can spend without breaking its promise to get debt falling within five years – is understood to have been roughly where it was last autumn.

Back then it was £13 billion, an unusually small amount compared to past years. It remains hovering around the same level, give or take a few billion, according to Whitehall sources.

However, there may yet be hope after all.

This view of the public finances is entirely at odds with that of economists outside the Treasury who believe the OBR may instead just have handed Hunt the lifeline he needs for tax cuts.

The OBR is basing its forecasts on interest rates in financial markets in the 10 working days to Jan 23. Borrowing costs were significantly lower last month than they were in the run up to the Autumn Statement – so that should hand the Chancellor more room for manoeuvre than feared.

The population is also bigger than previously realised. If the OBR accepts the latest projections from the Office for National Statistics, the country has almost 750,000 more people of working age than was previously realised. More people means more work, more spending and more tax revenue.

So who is right? The fate of critical tax cuts – which Conservative MPs are banking on as a game-changing moment before the election – hangs in the balance.

To understand what Downing Street hoped to do, and why it may now be in jeopardy, the wider story which the Tories are trying to tell must be appreciated. Sunak’s strategists have put regaining economic credibility and getting the reward for a gradually improving situation at the centre of their dreams of an almighty comeback victory.

“The election will be won or lost on the economy,” said one who has the Prime Minister’s ear. And that has led to the leadership falling back in love with action on the T word: taxes.

The gear change in economic strategy came last autumn, when the Prime Minister pressed Hunt to switch the focus from reducing inflation and shoring up the finances, to boosting growth via slashing tax.

It resulted in £20 billion of tax cuts being unveiled, the biggest giveaway of any fiscal event since Nigel Lawson’s famous 1988 Budget – though not nearly enough to stop the overall tax burden rising.

Half of those reductions came in business taxes. This spring, it was meant to be time for personal tax cuts.

The debate has boiled down to how big the Government can go on two specific items: income tax and National Insurance. A reduction in the basic rate of income tax is deemed more popular than one for National Insurance, with public polling cited as proof. Plus pensioners also benefit from such a move – “our people”, as the Tories see it.

National Insurance, though, has its own appeal. A cut here would more directly be linked to work, since only individuals in employment pay it. That means potentially a larger boost to growth – important, with the economy in recession last year. It also costs less than reducing income tax.

Then there is the issue of size, summed up with a Shakespearean misquote. “2p or not 2p” is the question being asked, over and over, in the corridors in No 10 and No 11.

A reduction of not one percentage point but two in the rate of either tax is what Downing Street has long wanted.

A 2p cut in the basic rate of income tax would cost £13 billion, the

Treasury estimates. A 2p cut in National Insurance employee contributions would cost £9 billion. Economists in the City think this should be doable.

Martin Beck at the EY Item Club – which uses the Treasury’s economic model to gain an insight into the data which Number 11 will be watching – says lower debt interest will save the Chancellor £7 billion, with the bigger population boosting the coffers by another £15 billion.

Even after considering knocks to the finances from weak growth and a fall in inflation, “overall you are

‘Treasury briefings that the Chancellor won’t have any extra headroom look a little odd.’

probably talking about headroom of £30 billion rather than £13 billion, so that creates decent room for tax cuts,” he says.

Andrew Goodwin at Oxford Economics agrees. “Treasury briefings that the Chancellor won’t have any extra headroom look a little odd.

“We think this is largely expectations management for Conservative MPs hungry for large tax cuts.”

It would not be the first time the Treasury has engaged in a little misdirection before big announcements. Budget Day is renowned for rabbits pulled out of hats, as Chancellors always want to generate positive headlines and a