The remaining legacy of "Trussonomics" — £17bn of unfunded tax cuts — coupled with a struggling economy and higher interest rates makes it likely that Rishi Sunak will opt for tax rises to cover the £40bn fiscal hole.
The Resolution Foundation think-tank warned that the new prime minister will not be able to put the public finances back on a sustainable path by cutting spending alone.
“The government has a little over two weeks to finalise its plans to repair its economic credibility and the sustainability of the public finances," said James Smith, research director at the Resolution Foundation.
"While the recent focus has been on conditions improving post-Trussonomics, the central picture remains one of a weaker growth, higher borrowing costs and expensive tax cuts that have left a fiscal hole of at least £40bn to fill," he added.
“History tells us that this will involve cuts to public investment, which are easy to announce but reduce growth in the longer term. Further austerity for public services is also likely, but there are limits to how big these can credibly be, as public services are already facing cuts of £22bn thanks to high inflation.
“This reality means that the autumn statement is likely to involve tax rises, not just spending cuts,” he added.
Prime Minister @RishiSunak and Chancellor @Jeremy_Hunt met today to discuss the Autumn Statement on 17 November.
They acknowledged that while tough decisions will need to be taken, this government will work to support the most vulnerable in society. pic.twitter.com/cblBWS6uFp
— HM Treasury (@hmtreasury) October 31, 2022
The think tank said that there are four ways Sunak can go about it.
Number 10 can go with an "anti-growth" option, where the government cuts investment spending when belt tightening is needed.
The Resolution Foundation warned that such an approach would damage growth, with investment in the likes of transport, science and regional economic development cut.
This option is also limited as only roughly £10bn of these cuts can contribute to meeting the government’s fiscal rules. This would also mean Sunak would cancel three-quarters of the investment increases planned while he was chancellor.
The second path is the "austerity" option. With inflation at its highest level for 40 years, the think-tank warned that government departments are already seeing their budgets fall in real terms by around £22bn by 2024-25.
“It is hard to see how the Treasury could credibly save more than £20bn by announcing cuts to day-to-day public service spending. Even that would require a real-terms freeze in the total levels of such spending, and cutting unprotected departs by around 9%,” the Resolution Foundation said.
Another way to go about it is the "income cutting" option. The PM could save £9bn by reneging on pledges he made as chancellor this summer to raise working-age benefits and the state pension in line with prices next year.
But the living standards cost of doing this would be devastating to already struggling UK households amid a once in a generation cost of living crisis.
Figures from the think-tank show that a low-income working family with two children would lose around £750, and a pensioner £342.
Finally, the "tax raising" option. The new chancellor Jeremy Hunt could go full circle on mini-budget U-turns by reinstating Sunak’s health and social care levy, raising around £15bn by 2026-27.
Other options include raising £2bn by extending the "stealth" freezes in income tax thresholds by a further year to 2026-27.
The think-tank called this “the unpalatable menu of options the government has to choose from” in order to put public finances back on track.
Meanwhile, the Institute for Public Policy Research (IPPR) has published a blueprint for the government that would create £90bn of "fiscal space" in 2023 to support people and businesses.
The plan includes keeping the energy price guarantee to April alongside Truss's cuts to national insurance contributions (NICs) and stamp duty and increasing taxes on windfall profits and the richest.
Sunak and chancellor Jeremy Hunt will reveal the fiscal statement, which will be a new budget, on 17 November, after two delays.