The government will need to spend an extra £44billion over the next three years on public services to keep pace with rising inflation and avoid deep cuts, according to analysis by the Institute for Fiscal Studies .
In a review of the rising costs facing the public sector, the IFS said that without additional funding Whitehall’s budgets were overwhelmed by mounting cost pressures that would force departments to cut staff and services.
The government said in its November spending review that it would increase departmental budgets by an average of 3.3% above the rate of inflation at the time. But with prices soaring since then, the Tax and Spending think tank predicts the rise in budgets should no longer exceed 1.9%.
“In other words, higher inflation should wipe out more than 40% of projected increases in real terms,” he said.
Most of the increase in public spending budgets last year was targeted at the health and social care sector and paid for with the £39billion raised over three years by a 1.25 % of national insurance contributions.
In other areas of government that were due to receive allocations above inflation, including education and defence, regulations that reversed deep cuts made over several years before the pandemic would be less generous.
Spending on education “would barely increase over the three-year spending review period”, the IFS said, while “the Ministry of Defense’s daily budget would, according to these estimates, be lower by more than from 8% in 2024-2025 to that of 2021−22”.
Inflation in the public sector was forecast at 2.3% on average over three years in last year’s spending review. In March this year, the figure was revised upwards to 2.8% and the increase in real spending fell to 2.8%. The IFS has now increased the three-year average inflation to 3.7% and, as a result, the increase in real spending has fallen to 1.9%.
In what will be seen as a warning to Tory candidates vying to be the next prime minister, the IFS said the Treasury will have to increase spending by more than £8billion in the financial year to April 2023 and around £18 billion in each of the next two years to April 2025 to reduce the average increase in real terms to 3.3%.
Ben Zaranko, senior research economist at IFS and author of the report, said the government’s spending plans are now less generous than they were originally projected last fall, “while public services – notably the NHS – are under considerable and visible strain”.
He said: “Choosing not to compensate departments for surprisingly high cost pressures would be a possible response to a cocktail of global economic shocks that would impoverish us as a nation, but would increase considerable pressures on public services at the winter is coming.”
The two Tory leadership challengers have committed funds from the £30billion financial margin over the next four years calculated by the Office for Budget Responsibility in its March assessment to support their political and economic agendas.
However, the IFS review shows that this leeway is likely to be eaten up by departments in Whitehall if the government is to keep public spending at current levels.
“Notably, none of the Conservative leadership candidates have said whether they intend to spend additional money to top up current spending plans or, if not, how they would handle the pressures that result in public services,” Zaranko said.
The Bank of England has forecast the Consumer Price Index (CPI) to reach 13% before the end of the year and remain high in 2023. It is expected to fall back in 2024 and by the end of this year s set below the center the bank’s 2% target.
The next prime minister will have some flexibility as inflation increases tax revenue, as the income and expenditure on which taxes are levied grows faster, the IFS said.
“But higher inflation also means a squeeze on public services, whose budgets are set in terms of cash and therefore do not automatically increase in the face of higher-than-expected inflation.”
James Jamieson, chairman of the Local Government Association, said inflation, energy costs and planned ‘national living wage’ increases will add an additional £2.4bn of pressure on council budgets this year alone, reaching £3.6bn in 2024/25. .
“[These] the pressures put municipal services at risk. Budgets need to be reset with potential cuts to essential services people rely on, amid a cost of living crisis,’ said the Conservative councilor and former leader of Central Bedfordshire council.
With inflation expected to remain high over the next year, he said the impact on our local services “could be disastrous”.
He added: “It will stifle our economic recovery, entrench disadvantage and undermine the government’s ambitions to level the country.”
A Treasury spokesman said it was customary for budgets to be agreed in cash terms and for departments to deal with the impact of inflation in coming years.
“The plans announced at the 2021 spending review mean that the department’s total spending is set to reach £566bn in 2024-25, representing a cash increase of £150bn.
“The government is continuously focused on delivering our priorities efficiently and within budget, providing value for money for the taxpayer,” they added.