The worsening economic outlook could leave Philip Hammond facing a black hole of more than £80bn when he lays out the government’s spending plans next month.
The Resolution Foundation thinktank warned the chancellor that lower tax receipts and higher spending following the Brexit vote would leave the Treasury with a shortfall in every year until 2020-21.
It said a widening gap would open up between income and expenditure to leave a £23bn deficit at the end of the parliament, forcing the government to find savings or allow extra borrowing amounting to a cumulative £84bn to balance the books over the next five years.
The stark warning on the impact of the short-term hit to the economy from the Brexit vote illustrates the mammoth task confronting the chancellor as he seeks to boost investment spending to protect the economy during negotiations to leave the European Union.
Business lobby groups have reported large numbers of companies delaying investment until the government offers a clearer picture of its negotiating stance in Brexit talks.
Most economic forecasters have predicted that falling investment over the next few years coupled with higher inflation and a return to higher unemployment will push GDP growth down to about 1% in 2017, half the 2.2% forecast made by the Office for Budget Responsibility (OBR) in March.
GDP figures published on Thursday are expected to say the growth rate has fallen from 0.7% in the second quarter to 0.3% in the third quarter.
Hammond has insisted he will tackle the government’s spending deficit while also under pressure to carry through commitments by Theresa May to support families that are “just managing” and allay business concerns about the impact of Brexit.
An internal briefing document for ministers, marked “sensitive”, revealed that the government was “unlikely to bring deficit reduction entirely back on track” and that the “continuing run of disappointing data” meant there was a “severe worsening in the public finances”.
“For the year to date, the deficit is £2.3bn lower than last year; at a fall of 4.8%, well behind the 27.0% reduction forecast,” the document says.
A report by the Institute for Fiscal Studies said the government was already off track and higher borrowing costs and lower tax receipts could push the deficit up £14bn in the current financial year.
But the “new reality” of higher than expected government debt should not prevent Hammond from boosting public investment spending and increasing support for “just-managing families”, the foundation said.
In its report, Pressing the Reset Button, the thinktank said Hammond should accept that he would break his predecessor’s fiscal rules and press ahead with extra spending in infrastructure and reducing income tax while reversing planned cuts to universal credit.
Matt Whittaker, the foundation’s chief economist, said a strong consensus among economists that post-referendum uncertainty would lead to deterioration in the public finances, meant the chancellor needed to “set a new economic course for the remainder of the parliament”.
Hammond could give himself £17bn to spend in 2019-20 if he softened the current financial targets, said Whittaker, “even after accounting for the £23bn deterioration in the outlook, he would still be on course to deliver a current budget surplus in 2019-20”.
He said: “But the trade-off for this approach is significantly higher borrowing in the coming years. The chancellor will need to decide if that is a price he is prepared to pay for adjusting to new economic times and setting out a direction for the new government.”
