The narrow focus of the election campaign on relatively small spending pledges by the main political parties risks missing bigger economic uncertainties that the next government may need to confront, warns the Resolution Foundation. 

New research from the think tank warns of a possible £12bn black hole in the public finances from a productivity downgrade, higher market interest rates and infected blood compensation.

It notes that even though the size of the state today – at 44% of GDP – is not far off the pre-austerity peak, public service spending is still 6% below 2009-10 levels. And departments outside Health and Social Care, such as the Home Office and Transport, are experiencing far deeper cuts, the Resolution Foundation says.

Against this backdrop, the main parties have announced relatively modest spending pledges in the election so far. However, the scale of the pledges, how they’re funded and how much they’d cost, could well be dwarfed by other changes to the public finance outlook that neither party has any control over.

Whoever wins will be looking for a quick economic upturn ahead of the first fiscal event of the new parliament. For example, every one percentage point fall in long- and short-term interest rates reduces borrowing by around £12bn a year. But the report warns that the public finances could instead get even tougher soon after the election.

Some additional costs have become clearer since the last Office for Budget Responsibility (OBR) economic outlook in March, such as compensation for the victims of infected blood products, which totals £10bn over the next five years. 

Even a relatively modest downward revision in the OBR’s forecast for future productivity growth from 1.1 to 0.9% a year would add around £17bn a year to borrowing by the end of the forecast period, the think tank says. This additional borrowing alone would force the next government to make further tough tax and spending choices if it wishes to meet the fiscal rule of having debt falling by the fifth year of the forecast.

Furthermore, the £19bn of cuts to unprotected departmental spending pencilled in for after the election will be extremely challenging to deliver given the current state of public services. The share of crime victims not satisfied with the police has risen from three in 10 in 2010 to four in 10 today, while dissatisfaction with the performance of local councils has risen by a third over the past decade. 

The Resolution Foundation calculates that avoiding these cuts by maintaining public spending in real, per-person terms, along with £4bn of extra spending on asylum claims – currently being funded out of HM Treasury’s reserves – could increase the size of the fiscal black hole to around £33bn.

James Smith, Research Director at the Resolution Foundation, says the parties should explain how they would confront the challenges they face, as well as making their case for an economic strategy that would boost growth.

“The state of the public finances has dominated the election campaign so far, with the inevitable arguments over how each spending pledge is funded. But this narrow focus risks distracting the electorate from the bigger question of how each party would manage the uncertainties facing the public finances. 

“This question is crucial, as whoever wins the election could be confronting a fiscal hole of £12bn, if today’s uncertainties turn into bad news after the election. And if the next government wants to avoid a fresh round of austerity, that black hole could rise to more than £33bn.”

Alison Ring OBE FCA, ICAEW Director of Public Sector and Taxation, says: “The Resolution Foundation is just one of several economic commentators highlighting the difficult financial situation that the incoming government will face after the general election. 

“Not only are there ‘known’ financial obligations such as compensation for the contaminated blood and Post Office scandals, but there are also significant ‘known-unknown’ costs that are expected to be surfaced by the Spending Review that the Chancellor deferred until after the general election. This is in addition to the ‘unknown-unknown’ risks that can affect any government at any time.

“While an improving economy might help to some extent, the prospects are that both taxes and borrowing are likely to increase in the first Budget after the general election, irrespective of who wins. It is unfortunate that both main parties have decided to push discussion of how they plan to address the weak state of the public finances until after the general election.”