The next Tory leader will find it all but impossible to slash taxes as Britain reels under a £185bn blow from net zero policies and its ageing population, the fiscal watchdog has said.
The Office for Budget Responsibility warned Tory challengers that funding tax cuts through borrowing will pile pressure on the public finances and risk fuelling inflation, as it raised the spectre of the national debt hitting three times the size of the economy.
It said that tax cuts cannot pay for themselves, with the UK’s public finances already on an “unsustainable path” in the long term unless even more money is raised.
Keeping debt at pre-pandemic levels, around 75pc of GDP, would require finding an extra £37bn every decade for the next 50 years, raised either through tax increases or spending cuts.
Tax promises are expected to be at the heart of the Conservative leadership election after Boris Johnson’s resignation fired the starting pistol on the race. New Chancellor Nadhim Zahawi has already promised cuts as disquiet among Tory MPs grows over plans to increase the tax burden to levels last seen under Clement Attlee’s Labour in the 1940s.
However, the OBR poured cold water on hopes of reversing the wave of increases to pay for a bigger state following the pandemic and the invasion of Ukraine.
It warned in its Fiscal Risks and Sustainability report on Thursday that "global shocks [will] add to ageing and other domestic cost pressures to place public debt on an unsustainable path".
The OBR said that some £185bn of tax increases or spending cuts will be needed over the next half-century to offset pressure on the public finances.
A loss of revenue from motoring taxes because of the shift to electric cars will squeeze the country’s coffers, as well as higher spending on an ageing population through pensions, health and social care.
Andy King, a member of the OBR's budget responsibility committee, said: “Cutting taxes reduces revenue and does put pressure on fiscal balances.
“Tax cuts can of course be financed by spending reductions. But if they are financed by greater borrowing, then yes, it puts more pressure on and arguably comes with additional risks in an economy that is running with high inflation.”
Reducing budgets to pay for tax cuts will be fiendishly difficult as spending pressures from healthcare and defence rises. Mr King said that keeping a slew of tax hikes planned by Rishi Sunak, the former Chancellor, is “key to having debt on a declining path”.
He also said that the evidence suggests tax cuts do not pay for themselves by boosting economic growth, a view held by Mr Johnson.
The OBR said a loss of revenue from motoring taxes and soaring spending on old age care will cause debt to exceed 100pc of GDP by the middle of the century, and 267pc in 50 years. Factoring in occasional economic shocks could push debt to almost 320pc of GDP.
The watchdog said the £185bn needed to keep debt at what it was before Covid is a “significant sum, but over the space of a decade not an inconceivable one”.
Without action, debt would be at higher levels than seen during the Second World War, the OBR said. It revealed the Government will spend as much this year on cost of living support as it did helping the economy at the peak of the financial crisis.
A Treasury spokesman said: “The government has made responsible decisions to strengthen the public finances and reduce debt levels over the medium-term - which the OBR have noted today.
"The Government will continue taking a balanced approach to getting debt down, keeping taxes low, supporting our valuable public services, and investing in Britain’s future so we can raise our productivity.”
How the net zero crusade will crush Britain under a record mountain of debt
By Tom Rees
With prices at the pump rocketing to record highs, it is little surprise more electric cars than ever are being driven on Britain’s roads.
The surge in petrol costs to almost £2 per litre is adding fresh impetus to the electric vehicle (EV) sales boom. The Tesla Model Y was the second best-selling car in Britain in June, when one in six sales were for battery EVs.
While environmentally friendly, the boost in sales may not be good for the public finances, according to projections by the budget watchdog on Thursday.
The Office for Budget Responsibility (OBR) laid bare how the net zero drive will inflict long-term costs on the taxpayer, as revenue from key taxes dries up and the war in Ukraine forces an acceleration towards clean energy.
Its statisticians said the pandemic will have “remarkably little impact” on the medium-term fiscal health of the country.
Yet, in the long term, the OBR said damage will come from the side effects of the climate push and an ageing population. It predicts the end of taxes on petrol cars and the cost of the green transition will drive the country's debt up to an eye-watering 267pc of GDP over the next 50 years, when coupled with the impact of an ageing population.
Talking of accelerating the clean energy transition following Vladimir Putin’s invasion of Ukraine, Richard Hughes, chair of OBR, says: “Resolving this dilemma could involve some fiscal costs, especially given a greater focus on energy security alongside net zero prompted by the geopolitical situation.”
Meanwhile, a plunge in motoring tax take - such as fuel duty which is to be wiped out by electric cars - and soaring costs from higher pension, health and social care spending will put “public debt on an unsustainable path in the long term”, according to the OBR’s Fiscal Risks and Sustainability report.
It expects debt to soar above 100pc of GDP by the middle of the century and 267pc in 50 years if these two key pressures are not tackled. Getting debt back to pre-pandemic levels at around 75pc of GDP would require tax rises or spending cuts worth an extra £185bn to plug the blackhole in the country’s finances over the next 50 years, a £37bn jump every decade.
The OBR admits this is a “significant sum, but over the space of a decade not an inconceivable one”.
On the tax side, economists expect fuel duty - which will raise £26bn this year even with Rishi Sunak’s 5p per litre cut - will dwindle to practically nothing as fewer petrol and diesel cars are bought.
While the revenue made from petrol and diesel is dwarfed by worker taxes and VAT, it is still the Government's seventh biggest money raiser. It brings in more than tobacco and alcohol duties, and business rates, accounting for almost 3pc of tax take.
However, the OBR expects that revenue to fall quicker than first assumed as EV sales soar. It says Putin’s war could increase the pressure if persistently high fuel costs incentivise a move en masse to EVs, it says.
If, as expected, 95pc of cars are electric by 2042 and all are by 2050, the losses from fuel and vehicle excise duty would be equivalent to 1.6pc of GDP a year by the middle of the century - or £39bn.
To plug the blackhole in the country’s coffers, economists believe ministers are most likely to turn to a pay-per-mile road tax system.
The Climate Change Committee, the Government’s official net zero adviser, said last month that ministers will need to introduce a road pricing system of some sort, calling this approach “sensible and fair”.
It said: “It will be necessary for the UK to introduce some form of road pricing to fill the fiscal hole that will be left by the erosion of fuel duty, and to prevent the low costs of electric vehicles leading to increased congestion.”
Tax revenue may also be put under pressure by carbon taxes not being used or needed as much as thought amid a faster shift away from fossil fuels following the war in Ukraine, according to the OBR.
Its economists say there is a “greater fiscal risk” if future governments choose not to “significantly expand and increase carbon taxes and were instead more reliant on subsidies and regulation to deliver net zero”.
On the spending side, the clean energy shift will come at a considerable price totted up as Putin’s aggression fuels calls for faster action.
While renewable sources can replace the bulk of the energy needed for a cleaner Britain, experts say a consistent alternative supply will be required for when the sun isn’t shining and the wind isn’t blowing.
Nuclear is often proposed as a possible solution with ministers planning to boost supply to 24 gigawatts by 2050 as part of the UK’s new energy security strategy. Picking up the bill can be costly, however.
The OBR estimates the UK’s additional targeted nuclear capacity will cost approaching £170bn in the coming decades, and building storage capacity to overcome wind and solar intermittency will cost up to £20bn.
“Nuclear energy is clean and reliable but nuclear power plants have proven very expensive to build, and even more expensive to decommission,” says Hughes.
“The Government could come under pressure to pick up some of these huge construction costs.”
Revamping the UK’s energy supply is just one of many net zero costs, with green upgrades needed for everything from buildings to transport.
The CCC estimates £50bn per year will be needed by 2030 to help Britain reach net zero, up from £10bn in 2020. Whole industries from food production to steelmaking need to be transformed, perhaps at the cost of taxpayers through subsidies and support.
The price of inaction on the climate crisis may be greater but the OBR’s figures suggest net zero transition will still come at a hefty cost - and debt.