What the chancellor really means when he says tax cuts are 'impossible'

The nights are drawing in, money for many households is tight - but the chancellor has told people not to expect treats in his Autumn Statement.

Jeremy Hunt has said tax cuts are "virtually impossible" and instead warned of "frankly very difficult decisions".

But are his hands really tied? Is he being forced to be Scrooge rather than Santa? Or is it a matter of choice?

Does it boil down to what the chancellor - any chancellor in the same circumstances - decides? After all, he and the prime minister set the boundaries and their political priorities.

Here are some things to contemplate when judging any chancellor's claims:

Playing by your own rules

Almost all rich countries have a set of rules, to maintain credibility with financial markets, but it's the government which sets its own rules.

The financial markets - or the bond markets to be more precise - help fund the government's plans. But if they aren't convinced of a government's creditworthiness, or if they are concerned its plans are risky, the interest rate they charge for that funding will go up. So governments want to convince them to lend at affordable rates.

To do that the UK government sets some rules for themselves called fiscal rules. These rules currently include getting the annual deficit down to less than the equivalent of 3% of national income (or GDP) within five years. And secondly making sure that by then, the total debt amassed over the years is falling when measured as a proportion of GDP.

Breaching such rules can be costly: the big giveaway in Kwasi Kwarteng's mini-Budget of September 2022 led to a surge in borrowing rates (which also swelled mortgage rates). That's because of market concerns about the implications for inflation and the amount the government would have to borrow.

The OBR matters

The fiscal rules are self-imposed, but it's the independent Office for Budget Responsibility (OBR) that assesses if the government is meeting those rules. It produces two forecasts a year of how the economy might perform, based on technical models and assumptions about what will happen to things like energy prices for example.

Those models are used to predict what will happen to government finances. Forecasts are a best stab at what might happen in, what has of late been a particularly, uncertain world.

They'll differ from other economists' forecasts - but it's the OBR's ones that matter when it comes to assessing the government's projected finances in relation to the rules. A projected shortfall is often referred to as a black hole, any wiggle room is called headroom.

There is likely to be some headroom

As Jeremy Hunt says higher interest rates have been deployed by the Bank of England to fight the recent stubborn bout of inflation. And that has vastly bumped up the government's borrowing costs.

But higher inflation has also delivered the chancellor a boost in revenues from things like VAT and income tax. VAT is a percentage of an item's value, so when things go up in price, the government gets more tax.

Also as prices rise, there's pressure to put up wages, then workers get dragged into higher tax brackets - known as fiscal drag - which means the government collects more income tax.

So economists reckon the chancellor could have over £10bn of headroom. But what matters is what the OBR thinks - and even headroom of this size would mean this chancellor has far less to "play" with then many of his predecessors in relation to his rules.

Policy measures are political choices

Whether and how the government meets its rules, how it uses headroom, depends on its policy choices, the tax and spending plans aligned with its political priorities, as well as on how the economy is performing.

Those choices mean there are trade-offs, winners and losers. So it's not a case of the chancellor unable to "afford" to do something or that he "must" adopt a particular policy. For example, if he wanted to extend the freeze in fuel duty that would cost £4bn (as the OBR is obliged to assume that duty rises annually). If he didn't have headroom, he could offset that by raising taxes elsewhere or squeezing spending.

Timing is another political choice

Even if the OBR agrees the chancellor has several billions of pounds of headroom, he may not opt to splash it right now. There is after all, a general election looming - and likely a spring Budget beforehand.

It might be considered more politically advantageous to dole out sweeteners to voters then. Moreover, if the economy suffers an unexpectedly sharp downturn in the meantime, that could wipe out some of that headroom - potentially leaving the chancellor in the embarrassing position of having to claw back cash to meet his rules.

Or, come the spring, there could actually be more headroom; which he may well choose to use up rather than leave as a generous gift to whoever is chancellor following the election. So instead, this Autumn Statement may focus on the key terms and longer-term measures, such as levelling up, boosting the supply of workers, tackling growth, that the government wants to use to frame its election strategy.

So a pre-Christmas spree seems unlikely, regardless of your wishlist. That's not to say Mr Hunt won't be tempted to offer around a little platter of canapés, a taster of what could come in the spring.

But don't get too distracted by any nibbles served up. Remember, whatever a chancellor says in this or any such speech, tax cuts aren't "impossible" - they've just chosen not to put them on the menu this time.