06 Nov 2024
Steven Bell, Chief Economist, EMEA
Key Takeaways
Although the budget was well trailed, the scale of the announced fiscal changes came as quite a surprise, with more than 70 policy notices
The Labour chancellor announced such an increase in taxes and borrowing, in order to fund public spending, that the gilt market sold off, despite a favourable initial reaction
The chancellor highlighted the £22 billion black hole in the public finances, but didn’t mention a potential £100 billion health and disability benefits bill, highlighted by the IFS, which could be this government’s biggest challenge
Fears around tax rises had seen business and consumer confidence wane in the run up to the election, and they have been realised. But the decision to hold corporation tax could see businesses respond by boosting productivity – we hope
Transcript
The first Budget by the new Labour government was subject to enormous anticipation, fuelled in part by an unprecedented degree of leaks and advance press briefings. It was nonetheless quite a surprise in terms of the sheer scale of the fiscal changes: a huge increase in tax, a big increase in borrowing and a significant rise in government spending.
There was a long list of policy measures – I counted 71 – but far and away the biggest change was the increase in employers’ National Insurance contributions (NICs). Coupled with the 6.7% increase in the minimum wage – a 16% increase for those aged 18-20 – this represents a sharp rise in the cost of employing lower paid workers. The hope is that this will encourage the shift away from a low wage, low productivity economy; the fear is that businesses will simply employ fewer people.
The extra taxes and extra borrowing will be used to fund a big increase in public spending. So big that the overall fiscal loosening is reckoned to be substantial. The Office for Budget Responsibility estimates that this will add to inflation and lead the Bank of England to slow the pace of interest rate cuts. In addition, while the gilt market initially reacted favourably to the announcements, once the scale of extra borrowing became clear the market sold off.
Indeed, although the loosening of the fiscal rules had been flagged in advance, we had been led to believe that the chancellor would not use all of it, leaving a wide margin to reduce the risk of further tax increases or borrowing in the rest of this parliament. In the event she left herself little wriggle room, and even that has been exhausted by the rise in gilt yields, according to some estimates. The Treasury has been rattled by markets’ reactions and is reported to be considering “reprofiling” the increase in spending to reduce near-term borrowing.
In her Budget speech, the chancellor made much of the so-called £22 billion “black hole” in the public finances that had apparently been hidden by the previous government. But she made no mention of an even bigger problem that had been investigated by the Institute for Fiscal Studies (IFS) well before the last election: the ballooning cost of health and disability benefits. In only the past three years the cost of this has risen by another £20+ billion. Even more worrying is the projected increase in this bill. By 2028, the IFS expect it to reach £100 billion at today’s prices, equivalent to around £4,000 for every household in the UK. The causes of this increase are many and varied, but given the problems elsewhere in the nation’s finances, tackling this problem is arguably this government’s biggest challenge.
For most of the past 12 months I have been optimistic about the prospects for UK growth and inflation – and the data had broadly supported that view, until recently. Important surveys of business and consumer confidence, which had been improving, have dipped. Some of that move had been attributed to fears of tax increases in the Budget. Those fears have certainly been realised, and more.
Before we get too pessimistic, we should consider one area that was spared in this Budget: corporation tax. By leaving the rate at 25% and retaining the policy of full expensing of investment, businesses could respond by boosting productivity. That incentive is increased by the rise in NICs and the minimum wage. It is possible that the UK shifts to a high-wage, high-productivity economy. I am sceptical that will happen, but I hope I am wrong.
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