UK's Healey can't risk a 'steady as you go' budget, think tank warns

By William Schomberg

LONDON, Oct 12 (Reuters) - British finance minister John Healey will need to find £36 billion ($47.6 billion) in tax hikes or welfare cuts in his first budget just to offset the inflation hit to public services and meet a defence spending pledge, a think tank said.

The Institute for Fiscal Studies warned a "steady-as-she-goes" budget on October 28 was not an option because the tax and spending plans set out by Healey's predecessor Rachel Reeves had been impacted by the inflation rise caused by the Iran war and not adjusting them might not be seen as credible by investors.

"It would be a choice to tolerate chunky cuts to the quantity or quality of some public services," IFS Director Helen Miller said.

Healey and Prime Minister Andy Burnham say they will reduce the cost of living. But they are limited by the strain on the public finances and by more than 60 billion pounds of tax hikes in Reeves' previous two budgets.

They are also under pressure to spell out when they will raise defence spending to 3% of ​GDP.

Finding another 36 billion pounds of tax would be equivalent to adding 3 percentage points on to the main rate of income tax.

Healey and Burnham say they will stick to the previous government's promise not to raise the main rates of taxation but they are expected to find some ways to increases revenues.

They are also under pressure to reduce Britain's rising welfare spending, especially after a sharp rise in government borrowing costs since the start of the conflict in the Gulf.

Much of that extra debt interest bill, and higher inflation-linked welfare costs, could be offset if the government's budget forecasters decide higher inflation will push up earnings growth and income tax revenues, the IFS said.

If that happens, Healey's fiscal headroom - or the gap between borrowing for day-to-day government spending and tax revenues in the 2029/30 fiscal year - was likely to fall only modestly to around 20 billion pounds from a previous estimate of 24 billion pounds in March.

While low by historical standards, the forecast was higher than estimates from analysts of 12 billion pounds.

The IFS report was based on forecasts for inflation to average 3.1% this year and 3.0% in 2027, higher than the official projections of 2.3% and 2.0% made in March.

Economic growth this year was likely to be revised up to 1.4% from March's estimate of 1.1% but could be cut to 1.2% for next year, down from 1.6%.

Healey might choose to delay big changes to the government's fiscal plans until a Spending Review in 2027, by which time the Iran war might be over and borrowing costs could be lower.

But Miller said investors who have pushed up yields on government debt around the world might balk.

"You can't have hope as your core strategy," she said.

(Writing by William Schomberg, editing by Andy Bruce)