Chancellor raises taxes again as growth takes policy backseat

After 14 years out of office, last year’s Autumn Budget was largely met with an understanding that tax rises were necessary. Labour had been dealt a poor hand by its predecessors, with borrowing elevated and debt rising. The Chancellor, Rachel Reeves, announced tax rises to steady the ship and expressed hope that such an action would be a one-off. Yet, one year later, the Chancellor has reneged, announcing a further package of £26 billion worth of tax hikes. Though this has built up a significant buffer of fiscal headroom, such policy changes could well be to her detriment, by undermining the simultaneous commitment to supporting growth.  

The Chancellor was quick to emphasise the government’s role in supporting the economy since taking office. She highlighted the OBR’s upgrade to its forecast for 2025 to 1.5%, which brought it into line with Cebr’s own projection. This is a low bar for suggesting success. Indeed, stronger growth has been recorded in 25 of the last 35 years. Over the rest of the forecast horizon, both the OBR and Cebr’s projections show average growth sustaining at this 1.5% value, a modest outcome for an administration committed to economic growth.

The OBR’s downward adjustment to medium-term growth was driven by a long-overdue revision to its productivity forecast. In the years since the financial crisis, output per hour worked has grown at an average annual rate of just 0.6%, compared to 2.1% in the 15 years pre-2008. In the last two years, there have been consecutive declines. Yet, at each forecast round, the OBR has tended to show a turning point towards improved growth. Its revision brings it closer in line with Cebr and, indeed, many other forecasters. 

In terms of revenue raising measures, the extension of the freeze on income tax bands is most significant. As a policy decision, it also came as little surprise. During a period of strong earnings growth, this has proven to be an easy, albeit somewhat untransparent, way of raising revenue for successive governments, by bringing more individuals into higher brackets and into the taxpayer base altogether through the maligned phenomenon of fiscal drag. All the while, this conveniently upholds Labour’s manifesto commitment to not raise income tax rates. Under Cebr’s forecasts for earnings growth, this policy is expected to raise revenue of £15.9 billion by 2031, outweighing the OBR’s projection. This measure also carries little distortive impact, with the impact on employment decisions on the margin likely being negligible.

The same cannot be said for several of the Chancellor’s other announcements. A key example is the ‘mansion tax’, a series of annual charges to be levied on homes of a certain valuation. This will likely cause disruption to property valuations and curtail rental supply. There is an argument that the threshold has been placed at too low a level, covering smaller properties in urban locations carrying high real estate value. At the top end, this could also act as a further incentive for internationally mobile, high-net-worth individuals to leave the UK in favour of other jurisdictions, adding to changes outlined at previous fiscal events, such as to the non-domiciled regime and inheritance tax.

There also appear to be inconsistencies in her messaging. The change to rules on Individual Savings Accounts (ISAs), capping annual contributions to cash ISAs at £12,000 per year to encourage retail investing is a welcome one, and would help to plug some of the underinvestment gap experienced in the UK as a standalone policy, albeit subject to significant behavioural uncertainty. Yet, the Chancellor simultaneously announced policies that will disincentivise personal investment, notably the expansion of the scope of dividend taxes and the near decimation of the ability to sacrifice salary in favour of pension contributions. Meanwhile, the announcement of a ‘pay-per-mile’ charge on electric vehicles does not particularly align with previous policy encouraging their sale and the continued goal of phasing out internal combustion engine vehicles.

Being far out from an election period, the second year in office is often a time when governments tend to make unpopular decisions. Yet, it was striking that growth did not seem to be prioritised at today’s fiscal event, despite being a key component of Labour’s manifesto and messaging throughout its period of government. The OBR suggested that there would be no significant growth boosting effect from the announced policies. We at Cebr would be inclined to agree. Overall, under the current policy path, the UK appears to be tending towards a high-tax, middle-of-the-road growth, economy.

Cebr’s Forecasting and Thought Leadership Team
Email: forecasting@cebr.com, Phone: 020 7324 2850