MNI INTERVIEW: UK Needs To Slash Spending Share Of GDP- Chadha

The UK government needs to slash its spending as a proportion of output towards 40% of gross domestic product and be ready to raise major levies such as income tax and VAT if it is to reduce borrowing to sustainable levels and avoid the danger of being priced out of financial markets, the former head of the National Institute of Economic and Social Research Jagjit Chadha told MNI.

Fiscal consolidation of such a magnitude would have to tackle big ticket items such as the National Health Service and the civil service, as well as include increases in the taxes which raise most revenue, said Chadha. Total managed expenditure was around 44.4% of GDP in 2024-25, according to Office for Budget Responsibility data, about four percentage points above the post-war norm.

The government’s fiscal rules are inadequate and based on uncertain forecasts , Chadha, who left NIESR at the end of last year and is an economics professor at Cambridge, said in an interview, adding that it is the private sector, underpinned by a well-functioning public sector, which ultimately creates wealth.

NIESR has estimated the current financing shortfall between the government’s spending plans and its revenues and borrowing at GBP41 billion or around 1.3% of GDP. 

"Were we to raise VAT by two and a half percent, that would probably raise over 1% of GDP in tax revenues," Chadha said.  Income tax could also be raised on a broad swathe of higher earners rather than just aiming at the very top set. (See MNI INTERVIEW2: UK Tax Hikes Before Fiscal Rule Change - NIESR)

"The 50th to 90th percentile account for 41% of income, but only pay 30% of income tax. So you can nudge it up a little bit … to 33 or 34%. Along with the VAT, along with stamp duty, the deficit is gone," Chadha said.

IMF WARNING

While Chadha made headlines with recent comments about the possibility of a "sudden stop" in UK debt financing, potentially even requiring the assistance of the International Monetary Fund, he stressed that this was not a prediction but rather a call to action. 

"We need to ask ourselves 'what are the preconditions for a sudden stop?', rather than is it going to happen tomorrow?  ... If we've got the preconditions, do we act now and change the framework, or do we wait for the sudden stop?" Chadha said.

"International debt markets, are sending us a signal that they don't particularly want to lend to the UK at the same rates as other economies. Our 30-year rate is ... the highest of the G7 by some margin, and about a 90-basis-point premium over 10-year rates," Chadha said.

The yield on 30-year gilts moved over 5.7% on Tuesday, its highest since 1998. 

"Looking forward without radical change, we're cranking deficits of 5% of GDP a year, which is why financial markets are getting scared," Chadha said.

UNSOUND FISCAL RULES 

He was critical of the government’s fiscal rules. These stipulate that the current budget must be projected to be in surplus in 2029-30, and then in balance with some leeway in the third year of the rolling forecast period, while the investment rule demands debt-to-GDP is falling in 2029-30 and then on a three-year rolling basis. Chancellor of the Exchequer Rachel Reeves is due to present her budget on Nov 26, with little market expectation for her to do more than barely comply with the existing fiscal framework.

"You're not really tying the government down in any meaningful manner to a reduction in debt-to-GDP. You're aiming for a fall in the final year of the parliament compared to the previous year. You're not talking about a fall in absolute terms from where we are now,” Chadha said. “Ultimately, it's not a fiscal framework that underpins what I would call sound money, and relying on the forecasts doesn't really pin down government action.”

The economic and fiscal parts of the ruling Labour Party's 2024 election campaign centred on raising productivity and a pledge not to raise income or VAT. (See MNI INTERVIEW: Ex-OBR's King See Productivity Cut, Loan Boost)

"The more I think about the more misguided it was for the government to focus on productivity in the lead up to the election, and subsequently on growth. There's no magic or silver bullet ... to bring about growth or productivity," Chadha said.

"The one thing the government can control is the fiscal stance. It can control its revenues and it can control its expenditures. So the government could make a new commitment to a fiscal consolidation,” he said, “A genuine commitment to reduce debt-to-GDP, to which the government is prepared to have its feet held to fire for, would be incredibly important.”