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Rachel Reeves had a difficult task: she had to please her backbenchers, comfort bond markets, sustain the promise of faster UK economic growth and stick to a plausible version of Labour’s manifesto commitment not to “increase national insurance, the basic, higher, or additional rates of income tax, or VAT”. The Office for Budget Responsibility had also made achieving all this far more difficult by at last recognising that it had long proved too optimistic on future productivity growth. A plausible judgment is that the chancellor did not make things worse. But she did not make them very much better either. Not least, there is much at risk in a Budget that, according to the OBR, offers higher public sector net borrowing in every year before 2029-30 than it forecast last March. This underlines the absurdity of targets that bite years ahead.
Yet one must also have great sympathy with Reeves’ critique of the governments that preceded hers. The mistimed and misshaped austerity from 2010, Brexit and, not least, the Liz Truss “mini” Budget are hard to forgive. But it is, alas, clear that this government does not have the nerve or, surprisingly, despite its apparently huge majority, even the ability to make radical pro-growth reforms. It is, as this Budget also shows, “Old Labour” in its attitudes to incentives and growth. Yes, investment matters. But it is not all that matters. The increases in the costs of hiring and the upcoming difficulties in firing are bound to affect both growth and jobs, precisely the things Labour professes to want.
Let us start with the economy. As the OBR notes, growth is now forecast to be 1.5 per cent this year, 0.5 percentage points faster than in March. But what this gives is taken away by the OBR’s downgrade of productivity growth to 1 per cent a year, or 0.3 percentage points below its March forecast. The main reason for the downgrade is a reduction in the growth of “total factor productivity” — a measure of the rate of innovation — from 1.1 to 0.8 per cent a year.
This downgrade is not the fault of this government. It is a reflection rather of bitter experience since 2007. But it does show that the OBR (rightly!) does not buy the idea that the government has been improving long-term growth prospects. Thus, it concludes that “the central estimate of the level of potential output in 2029 is broadly unchanged from March, as weaker growth over the forecast is offset by a higher starting point”. The latter is principally due to a higher estimate of the trend employment rate. The OBR is also more bearish on inflation in 2026. If it is correct on this, the Bank of England might also stay higher for longer on interest rates.
What then has Reeves done about the overall fiscal position? The answer is that she has worked to meet the letter of her fiscal targets, but failed to implement their spirit. In my view, this would require her to lower public sector indebtedness from today’s high levels before the very last year of the forecast. In fact, the OBR shows a flat profile for public sector net financial liabilities over GDP (the government’s target measure) at 81 per cent this year and 82 per cent in 2030-31, even though it forecasts economic growth at its long-term potential rate. Yes, the latter is awful. But it is a realistic best estimate. Ideally, the OBR would be able to show a decline in the ratio of PSNFL to GDP throughout its forecast. This is particularly true when the yield on UK government bonds is one of the highest among all advanced economies — an extremely uncomfortable position.
Strikingly, as the OBR notes, the forecast for public sector net borrowing is also worse now than it was in March for every year, apart from 2030 — not surprisingly, the year when targets bite. As the OBR also notes, the Budget delivers a frontloaded increase in spending of £9bn and a backloaded increase in taxes of £26bn. This is sweetness today and sourness tomorrow. That must reflect panic over the unhappiness of the Parliamentary Labour party. Will Reeves’ measures at least be enough to avoid any possibility of further need to raise taxes or slash spending? Possibly not. The OBR concludes that “the probability of meeting the fiscal mandate is 59 per cent, up from 54 per cent in March” — safer, but hardly safe.
What about the measures themselves? They are exactly as expected. Out of a net fiscal adjustment of £22.9bn for 2030-31, £12.7bn comes from freezes in personal tax thresholds, £2.6bn from national insurance contributions on salary-sacrifice schemes, £2.2bn from increases in income taxes on property, savings and dividends and so on and so forth. This sort of scattershot approach is what chancellors do who have no sense of what a good tax system would look like, or lack the courage to attempt radical reforms but desperately need to raise revenue. It was entirely predictable. But how ministers can say with a straight face that using inflation to raise effective tax rates in an arbitrary way is protecting “working people” from higher tax is beyond me.
What is depressing is that a government with a huge majority dares to do so little to transform economic prospects. It is easy to imagine far more irresponsible budgets than this. But the OBR is right that it will not have any positive effect on growth or the efficiency of the tax system. Moreover, it leaves a risky fiscal position, with persistently high debt and already high interest rates. The government could have done better. Indeed, it should have done better.
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