First, let’s take the economy. It has stagnated since spring 2022. There was some good news from the Office for Budget Responsibility (OBR) who predicted growth of 0.8% this year and 1.9% next. These forecasts look credible. As inflation falls, real incomes will rise. The OBR sees consumption growing by around 2% per year between 2025-28. After the sharp fall in living standards in 2022-23, real household disposable income per person is set to return to pre-pandemic levels by 2025/26, two years sooner than the OBR was forecasting last autumn.
Yet quite correctly, the OBR calls the medium-term outlook challenging. They see trend growth at around 1.75% and while this is far less than the 2.25% enjoyed by the economy before the 2008 financial crisis, it may still be too optimistic. Notably, in reaching their views the OBR notes that the impact of higher immigration in boosting GDP is offset by “higher and rising levels of inactivity.”
In his speech the Chancellor stressed that the UK has outgrown Germany, Italy and France over the last decade. The Leader of the Opposition challenged this, based on GDP per person. The key point, though, is that the challenges the UK faces are not unique to us, but are faced collectively by western Europe. We see the underperformance of the UK market and resulting cheap valuations as clear symptoms of the known challenges. Effective policy action could be one of the catalysts to unlock that value.
We have to contend with a changing and growing global economy where more of global growth is emanating from the Indo Pacific region. We need to become competitive against countries like the US and those across east Asia, many of which invest more and have more competitive taxes.
Admittedly the UK (like other countries in western Europe) has faced a succession of shocks. The Chancellor also announced a plethora of measures to help specific sectors, such as life sciences, the creative industries and the City, and he was right to highlight the continued high rates of overseas investment into the UK.
This reinforces the importance of a sustainable, pro-growth strategy. There is a consensus emerging that the UK is a low growth economy and that there is little that can be done to address this, but this is clearly wrong. There are policy levers that can be pulled, but it is not always possible politically to pursue them, as is evident with the resistance to necessary planning reform.
Second, were the Chancellor’s measures themselves. Economically there was a case for a boost, with domestic demand sluggish and inflation falling. The politics were in line with this, but the budgetary sums limited the room for manoeuvre.
The Chancellor unveiled a fiscal boost, reaching £13.9 billion in 2024/25 and totalling £47.21 billion over the next five fiscal years. There were 40 fiscal measures, the main ones being a two pence cut in employee and self-employed national insurance. Many of the measures were small and a number aimed at raising taxes, enabling the Chancellor to just meet his fiscal rules in five years by £8.9 billion – a “modest margin” according to the OBR.
Yesterday’s Budget continued a well-trodden path. Last year the Chancellor’s fiscal boost was £91.3 billion in the March 2023 Budget and £93.7 billion in the Autumn Statement. That was accompanied by 84 specific measures last March and 67 in the autumn. So, in the space of the last 13 months, there have been close on 200 specific tax measures, some new and many making changes to existing taxes or spending.
It’s little wonder the UK’s tax code is now so complex. So, when people argue for tax cuts, perhaps they should also couch their demands in the context of tax simplification and reform.
The most dramatic claim in the Red Book was that, “The personal taxes paid by a median earner (with no children and no interaction with the benefits system) as a proportion of their income in 2024-25, are the lowest they have been since 1975” when the modern structure of National Insurance came into effect. There is little doubt that there have been significant targeted tax cuts in recent years, including to those on low income.
Yet despite that, as the OBR’s Economic and Fiscal Outlook makes clear, “Tax as a share of GDP is forecast to rise to 37.1 per cent of GDP in 2028-29, 4.0 per cent of GDP higher than the pre-pandemic level. Of this rise, we estimate 2.9 per cent will have taken place by the end of 2023-24, with the remaining 1.1 per cent forecast to take place thereafter to 2028-29.” This rising trend is despite the cuts in national insurance last autumn and today, which are “major tax cuts (that) … account for 0.7 per cent of GDP.”
Third, is the public spending challenge. In terms of controlling the public finances there are five main options: boost economic growth; borrow; control public spending; tax; and reform of the public sector aimed at boosting productivity.
These are not mutually inconsistent and may occur simultaneously. Of these, the two that should warrant most attention are growth and reform, both because of the present high level of debt and because of the longer-term trajectory outlined by the OBR. Reform in terms of boosting public sector productivity was highlighted yesterday by the Chancellor, as indeed it has been many times before, most notably by Gordon Brown.
It could also include the efficiency of public spending, thus allowing spending to be kept under control. Yet the challenge is clear: based on current public spending plans, non-ringfenced departments look set to face a squeeze in coming years. We need to avoid a return to the austerity of a decade ago, which I publicly opposed at the time, as it had no long-term strategic thought behind it and was arbitrary, hitting non-ringfenced departments hard.
Moreover, at that time it was unnecessary given the borrowing environment and the outcome made the economic situation worse. Now, even though interest rates need to fall, they are likely to settle at a higher level and suggests the future pressures on public spending may be acute.
The immediate impact of the Budget on UK financial markets has been limited. Perhaps this is largely because all the key aspects of the Budget were well trailed in advance, and there were no subsequent surprises in the speech.
The Red Book confirmed that total gilt sales for debt financing remains sizeable, at £237.3 billion in 2023/24 and £265.3 billion in 2024/25. The Budget is unlikely to change the outlook for interest rates, with gradual cuts beginning in the second quarter remaining our expectation. Our conviction that the UK remains an appealing place for investors also remains unchallenged, largely through attractive valuations.
Positively, following the Edinburgh and Mansion House reforms, it was welcome to see the Budget announce further measures to improve the competitiveness of the UK’s capital markets, including the launch of a UK ISA and unlocking more private capital for the UK’s growth industries.
Please note, the value of your investments can go down as well as up.
