31 October 2024

The Chancellor’s low-growth Budget will end in tears

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Even the Chancellor’s own fan club in the Office for Budget Responsibility think Wednesday’s Budget won’t boost growth. Chart 1.3 on page 9 of its latest ‘Economic and Fiscal Outlook’ shows how a 1.4% boost to GDP from higher public spending will be more than offset by a 1.5% decline in GDP from the rest of the economy. And the positive part of this assumes that the boost to public spending isn’t frittered away in higher wages and lower productivity.

The Budget is described on the OBR’s website as increasing spending ‘by £70 billion annually, with two-thirds on current and one-third on capital spending. Half is funded through tax increases which raise £36 billion annually and push the tax take to a record 38 per cent of GDP. The rest is funded by £32 billion more borrowing annually which temporarily boosts GDP growth to 2 per cent in 2026, but leaves output unchanged in the medium term’.

This is an old-style tax and spend Budget of the kind that has done so much damage in the past. What is different now is that we have, thanks to the Growth Commission, models to estimate how much damage has been done. 

These models indicate that the Budget will reduce GDP per capita growth to 2030/31 by 3.4%. This only takes account of measures announced on Wednesday and does not include, for example, Angela Rayner’s package of additional workers’ rights or Ed Miliband’s accelerated push for Net Zero, both of which we calculate will do further serious damage to the economy.

The estimated hit to the economy in five years is shown in the second column of the table below:

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More than half the damage to the economy comes from the £25 billion rise in employers’ National Insurance contributions. Further significant damage is done by the rise in the minimum wage and the abolition of the non-dom regime, the reduction in business relief on inheritance tax and the rise in capital gains tax.

But this calculation is fairly mechanical and has been produced on a tax-by-tax basis. One suspects that the combination of the tax raids could well have a much bigger effect; the mix of the rise in inheritance tax and capital gains tax or the effects of both higher National Insurance and a higher minimum wage will produce a combined hit where the effects could be multiplicative.

What about the other side of the coin, the massive splurge in public spending?

It is worth pointing out that public sector productivity is currently falling and the latest figures show it to be 6.8% down as compared with before the Covid pandemic. In her Budget speech, Reeves claimed to be setting a 2% productivity target for the public sector for 2025/26. But this is very unlikely to happen. If the public sector has £70bn thrown at it to spend, one suspects that boosting productivity will not be at the top of its list of priorities. More likely, the huge surplus cash will be blown in pay increases and more staff.

But it gets worse.

If growth is as low as our models suggest, this will create an additional (and genuine this time) black hole. Losing 3.4% growth will hit public sector revenues by about £50bn in five years’ time.

There is already no scope for additional borrowing: the markets were spooked by Wednesday’s rise in borrowing and even the OBR has forecast that mortgage rates will rise by about 50 basis points as a result. So this additional black hole will have to be filled with spending cuts and yet higher taxes. And the latter will certainly further harm growth.

It’s hard to see how this Budget can end in anything other than tears. The loss of growth bears especially heavily on the private sector and households. Entrepreneurs will try to move money and perhaps themselves abroad to escape further vengeful tax rises. The UK has benefited from international investors coming into the country – but they will now be deterred. Government-sponsored investment has a reputation for wasting money and backing white elephant projects – ‘far from governments picking winners, losers pick governments’ – and with private investment drying up, it is unlikely that the Government will be able to fill the gap.

Because of the traditional openness of the City (and the wider UK), its economic performance is peculiarly under scrutiny and money can move fast. Even in much less capital-mobile times, Harold Wilson’s government struggled with the ‘gnomes of Zurich’ betting against his economic policy. At some point, the markets are likely to pull the plug on Reeves’ Budget. Whenever that does occur, we will all suffer – and I cannot see the Chancellor surviving it.

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Douglas McWilliams founded Cebr, the economic consultants, and was lead author of 'The Autumn 2024 Growth Budget' for the Growth Commission, of which he is former co-chairman.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.