Philip Hammond fears the Treasury is in danger of turning into a cash machine for disgruntled MPs © FT Montage
A week of backroom deals by Theresa May to secure her position after losing her majority in the election will leave a £4bn annual hole in the public finances.
The prime minister’s deal with Northern Ireland’s Democratic Unionist party, her abandonment of several manifesto promises and her hint at an end to public sector austerity are set to land Philip Hammond, the chancellor, with a hefty bill.
Mr Hammond’s relations with Mrs May, already strained, have worsened during a week in which the prime minister made a series of promises which will further constrain his room for manoeuvre in his autumn Budget.
Nick Macpherson, until last year the top civil servant at the Treasury, tweeted: “Triple lock. Winter fuel. Public sector pay. NI bung. Tories implementing Labour & DUP policies. Defeat in victory. #highertaxinevitable.”
The biggest bill facing the government is likely to arise from pressure to end the 1 per cent pay cap on public sector workers, which was due to last until 2020. Several senior Conservatives believe the party’s poor result at the general election can partly be explained by public anger at continuing austerity.
Some 20 Tory MPs were told by Mrs May’s chief of staff, Gavin Barwell, this week to expect good news in the Budget — a position briefed to the press on Wednesday. Linking pay to inflation could cost the Treasury a net £1.4bn in 2018.
Although a furious Mr Hammond insisted a retraction from Number 10, which said the government position “has not changed”, one Tory MP said: “It’s obvious. Unless they end the pay cap, they won’t get the Budget through.”
The Queen’s Speech, approved this week, ditched plans to raise about £1bn from ending universal winter fuel payments — according to the Institute for Fiscal Studies — and a further £600m by ending universal free school meals for infants.
Meanwhile, the fragile parliamentary majority makes it unlikely Mr Hammond will risk reviving his abortive plan to raise £500m from national insurance rises, abandoned earlier in the year after a Tory rebellion.
The £1bn of extra spending for Northern Ireland — costing £455m a year for the next two years — was the price of securing DUP support for the Queen’s Speech; it is unclear where that money will come from.
Mrs May, who repeatedly insisted there was “no magic money tree” during the election, hoped to win a big majority to allow her to carry out longer term money saving policies, including ending the pensions triple lock and reforming social care.
Instead, Mr Hammond fears the Treasury is in danger of turning into a cash machine for disgruntled MPs, including Conservative rebels, who will be able to demand concessions for their support in any number of knife-edge votes.
The chancellor has some leeway after relaxing his fiscal rules from a commitment to run a budget surplus in 2019-20.
Nevertheless, Lord Macpherson believes Mr Hammond will have to put up taxes to fill the hole: the chancellor has promised not to put up taxes on “working families” but has left open the possibility of higher taxes on the wealthy.
Oliver Letwin, David Cameron’s former policy chief, also said this week that “targeted” tax rises might be needed to take the edge off austerity but to retain the Conservatives’ claim to fiscal discipline.
“The policy changes we have seen in the past few weeks will not increase borrowing a huge amount,” said Carl Emmerson, deputy director of the IFS. “But there is a risk that borrowing could end up higher if recent events are a signal that the public spending plans are less likely to be seen through and the willingness to put up taxes to pay for any easing is not be there.”
Tax professionals say that the government’s proposal to “make tax digital”, which was one of many measures dropped from April’s Finance Bill following opposition from Labour MPs, could also well be delayed. The Treasury predicts these measures will increase revenue by around £900m a year once fully implemented by reducing errors.