Sunak Faces a Tax Reckoning After $38 Billion Summer Splurge

Chancellor of the Exchequer Rishi Sunak faces the prospect of having to raise taxes to repair the public finances after his 30 billion-pound ($38 billion) stimulus package left the U.K. on course to borrow more this year than any time since World War II.

The extra spending and tax cuts will increase the cost of the government’s response to the coronavirus crisis to almost 190 billion pounds, putting the budget deficit on course to hit 350 billion pounds in the current fiscal year, according to the Resolution Foundation and the Institute for Fiscal Studies. That would be equivalent to about 17% of GDP.

For now, the pressure on the chancellor is political, rather than market driven. He needs to avoid a second wave of the virus and a wave of mass unemployment. With U.K. 10-year gilt yields close to zero, and hovering around record lows, he can afford to borrow, and postpone the question of how to pay for his largess during the crisis.

“The time to pay for all this will come -- but not this year and not next,” said Paul Johnson, director of the IFS. “Our capacity to do so will depend above all on how the economy recovers. A reckoning, in the form of higher taxes, will come eventually.”

That would be a problem for Sunak, given his Conseravaive Party’s election promise not to raise income tax, national insurance or the U.K.’s sales tax, VAT. Any increases could also see some of the stardust fall from the chancellor, whose spending announcements during the crisis have boosted his popularity and left some considering him as a future prime minister. Increases are likely to fall hardest on high earners and the wealthy.

In a briefing Thursday, the IFS said tax rises or, less likely, spending cuts of as much as 40 billion pounds would be needed merely to stabilize debt as a share of the economy. In broadcast interviews earlier, Sunak appeared to acknowledged that he will have to take action at some point.

“These interventions will cost an extraordinary amount of money,” he told the BBC on Thursday. “We can’t sustainably live like this, and over the medium term we can and will return our public finances to a sustainable position.”

Sunak Faces a Tax Reckoning After $38 Billion Summer Splurge

So far, Sunak has been helped by the Bank of England’s vast program of government bond purchases, which have kept borrowing costs near the lowest on record. The central bank has supported demand and left billions of pounds of bonds funded at the BOE’s 0.1% interest rate, rather than market rates, bringing down the cost of debt servicing even further.

Yields on 10-year gilts barely budged after Sunak’s announcement on Wednesday, and are currently at about 0.18%.

But the scale of the budget deficit risks testing the equanimity of investors, with debt issuance in the first five months of the fiscal year already dwarfing the full-year record reached during the height of the financial crisis. The budget deficit could easily total 500 billion pounds over the next two years and the coronavirus crisis has intensified pressure for more spending on the National Health Service and social care, according to the IFS.

“We are borrowing at record-low rates that enable us to carry a higher degree of debt,” Sunak told the BBC. “But it would be important that we remain alert to changes in those interest rates.”

Sunak Faces a Tax Reckoning After $38 Billion Summer Splurge

A sudden rise in interest rates isn’t the only risk he faces. This week, he also published a reminder of the threat the virus poses to his efforts to balance the books.

Buried in the Treasury document accompanying his statement was an announcement that he had allocated an additional 49 billion pounds to Britain’s public services since March, three times the latest estimate from the Office for Budget Responsibility.

Of that money, almost 32 billion pounds is going to health services, including 15 billion pounds for personal protective equipment and 10 billion pounds for the government’s track and trace program.

Johnson at the IFS questioned whether these huge sums represented good value for money. “Committing 15 billion pounds for PPE may be necessary, but we can expect expensive equipment,” he said. He also said questions remain over how the kit is going to be sourced and contracted, explaining why Sunak “probably didn’t want to draw attention to it.”

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