All Budgets are balancing acts: Chancellors balance what they want to spend with what they raise in taxation (and borrow). We need only look to Kwasi Kwarteng and Liz Truss’s disastrous so-called ‘Mini Budget’ to see what happens when Chancellors get that wrong. But rarely has a Budget been as difficult to balance as this one. Rachel Reeves found herself in the unenviable position of having ambitions to fund public services and articulate a vision for this new government, but amid the tightest of public finances in a generation. For Reeves, that balancing act isn’t simply one of making the income v expenditure sums add up. There is a more fundamental challenge in that Britain has suffered an utterly anaemic economy for 15 years now. It has never recovered the rates of economic growth experienced before the economic crisis. Indeed, the economy in the 15 years before the credit crunch grew 10 times as fast as the last 15 years.
Whatever the ambitions of this government, little of substance will be achieved unless it tackles this dire situation. And herein is the problem with which the Treasury has been grappling. With tax as a proportion of GDP at historic highs, and wage and productivity growth slow, the scope for raising income is limited — though Reeves managed to increase taxation by a substantial £40bn in her debut. There is a further risk, which is that increasing taxation removes spending power from the economy. That in turn has an impact on demand and consequently growth. The increases in employer National Insurance, for instance, represent something of a gamble since it disincentivises private sector employment and pay rises. And it’s worth considering the scale here — employers are being asked to stump up a whopping £25bn to pay for this Budget and that is not a risk-free measure. Squeezing business also risks reducing the incentives to invest in R&D which is a key route to improved productivity. The Office for Budget Responsibility (OBR), confirmed that the burden will be felt by employees through lower pay, and consumers through price increases.
In the run up to the Budget there was also considerable speculation that Britain could be in line for what was being described as Austerity 2.0. The emphasis on core public services, notably the NHS, in the measures announced by the Chancellor, mitigate against this and more importantly Reeves has been careful to avoid one of the potential errors of the coalition after 2010. Maybe the boldest move, is the plan to revise the Treasury’s Fiscal Rules, something trailed well ahead of the official announcement so as not to frighten the markets. The consequence is that the Chancellor has far greater scope for capital spending over the Parliament. The announced £100bn of spending over 5 years are important since they create demand in the economy beyond where geographically the market determines and potentially throughout the country. According to OBR calculations, this spend will lead to an increase in GDP of 1.4% over the period.
Having got the bad news out of the way, Reeves is gambling on a future growth dividend as tough decisions today pave the way for easier ones in the future. It will be needed given the OBR now forecasts the tax burden will hit an historic high of 38% of GDP by 2029/30 accompanied by inflation and interest rate rises.