Thomas Pope,
Deputy Chief Economist, Institute for Government
The first budget from a Labour chancellor in a decade and a half
was characterised by record tax hikes, substantially increased
borrowing and a generous envelope for public services – but the
effects may take more than one electoral cycle to be felt, says
Thomas Pope.
The Labour manifesto implicitly signed up to most of the previous
Conservative government's spending plans, which would have
required cuts to many public services and a sharp fall in
investment – but doing so meant it did not need to commit to
large tax rises at the election either. Many, including the
Institute for Government, pointed out that this did not look
consistent with their commitments to a decade of renewal, better
public services and more investment.
Rachel Reeves' first budget resolved that particular puzzle: this
is to be a government that taxes, spends and borrows
significantly more than the previous government claimed it
would.
Day-to-day spending on public services will now be much higher
than previously planned, by around £20bn this year and over £40bn
each year thereafter. It should be enough to deal with acute
crises this year and to ensure that almost all departments see
real terms spending increases next year – including the
predictable large increase for the NHS but also, less
predictably, generous settlements for local government and
justice, two areas under serious strain.
That increase is mostly funded by what amounts to one of the
largest tax increasing budgets of the last 50 years. It is as
large as Norman Lamont's 1993 budget, and comfortably surpasses
Gordon Brown's and George Osborne's first budgets. The bulk of
the increase comes from increasing employer national insurance.
The rest comes from a combination of a crackdown on tax avoidance
and increasing taxes on those with higher incomes and wealth who
benefit from various favourable tax regimes, including non-doms
and those who receive their income through capital gains.
The third prong of the budget was a big increase in borrowing to
fund capital investment. Under previous plans, public sector net
investment would have fallen by almost one-third as a share of
national income. It will now stay broadly flat, allowing around
£25bn a year of additional investment.
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For all the emphasis on investment, the OBR anticipates
only a modest lift in GDP
This was Reeves' first big opportunity to show some action on the
government's mission to increase economic growth. However,
overall the OBR judges that this budget will do little for growth
by the end of the five-year forecast. This is because, it says,
the positive effects of higher investment are more or less offset
by the economic drag from higher employers' national insurance
contributions, which will feed through into wages, and a view
that higher borrowing will likely push up interest rates and so
‘crowd out' some private sector investment, at least
initially.
But there is better news for Labour's ambitions for a ‘decade of
renewal'. The OBR has also published a longer-term assessment in
which it judges that over 10 years higher public investment will
encourage more private investment and increase growth.
Either way, the official forecasts imply that households will
continue to feel the squeeze over the next few years. As a result
of tax increases, real household disposable income is expected to
fall next year and only reach its pre-pandemic level in 2026/27.
This suggests that things might get harder before they get easier
and, with the next general election likely to be in 2028, the
chancellor and prime minister will be watching the forecasts
closely.
But what these numbers do not account for is the effect that
higher public spending might have on public services, which could
both support growth and improve people's lives. A
well-functioning health and education system should help to
improve participation in the workforce, while improvements to the
health and justice systems should also improve broader wellbeing.
Getting the multi-year spending review in the spring right will
be critical to ensure that higher spending does feed through into
better results.
There were welcome signs of a coherent strategy, but the
plans could still be shaken off course
Looking at the budget as a whole, there were welcome signs of
some coherent strategy. The new fiscal rules and wider changes to
the fiscal framework, which implement many of the recommendations
we have made, should support more stable, sustainable fiscal
policy. The new corporate tax ‘roadmap' is a useful start to
providing greater certainty about the taxes and clarity about the
areas the government expects to reform. And a commitment to more
stable, higher levels of investment – accompanied by five-year
capital spending plans – should also help ensure that projects
can address the most important gaps and be delivered effectively.
But there are still question marks over the government's
strategy. Day-to-day public service spending is set to grow quite
slowly beyond next year, which the government may find frustrates
progress on its missions. And given the small headroom against
the fiscal targets even a modest revision to the forecasts would
see them breached: it is not clear from today's announcements how
Reeves' would respond to this.
