This is the final instalment of a short series previewing the Budget. It discusses how the statement might be received and what could – or should – be done differently.
The first instalment began with a primer on the fiscal framework and a guesstimate of the size of the new financial hole, which could be as large as £30 billion.
The second summarised Rachel Reeves’ options, with a plausible package comprising £10 billion of broad-based increases in income tax and another £20 billion from a dog’s breakfast of many smaller measures.
So, how might this go down? Frankly, this is still anyone’s guess. But the immediate reaction will be seen in the financial markets, and here we already have some clues.
Bond investors reacted badly on Friday 14 November when the government appeared to U-turn on the plan to raise the rates of income tax. There was a widespread perception that the government was too weak to make tough choices on tax, as well as on spending. Other ways to raise revenue are also thought to be less reliable.
Finally, there was a perception that the resulting uncertainty made a challenge to the position of the Prime Minister more likely, increasing political uncertainty.
The flipside is that if the Chancellor can somehow deliver a more credible plan on 26 November, borrowing costs could fall back again. It is possible too that the Bank of England will cut interest rates by more than previously anticipated, meaning the additional fiscal tightening from tax increases is at least partly offset by looser monetary policy.
The political fallout is also uncertain. But much could hinge on whether the freeze on personal tax allowance is indeed extended, as most now expect. If the size of the financial hole can be capped at, say, £20 billion, it may still be possible to stick to both the letter and the spirit of Labour’s Manifesto commitments.
As for the reaction in the wider economy, the impact on confidence will be key. Most households and businesses surely now expect a painfully tight Budget. The actual measures may not then be as bad as feared, especially if many taxes do not go up straightaway.
A significant increase in the planned ‘fiscal headroom’ could also reassure some people that the latest round of tax increases could really be the last for a while, especially if combined with some tweaks to the fiscal framework that reduced the pressure for more frequent policy changes.
In any event, some of the uncertainty will have been lifted, which might allow spending, hiring and investment to resume. Remarkably, some surveys suggest that households and businesses are still fairly confident about the longer-term outlook.
Nonetheless, it would be unwise to bank on this. The Chancellor faces an unenviable balancing act – only partly of this government’s making – and the risks of a fall are high.
The Budget could backfire in many ways. The bond and currency markets could be unimpressed, triggering another meltdown similar to the one in September 2022 (though the fallout then was exacerbated by the ticking timebomb in the pensions industry and by the upswing in global interest rates).
The Budget measures themselves could quickly unravel, especially if they lean heavily on a large number of smaller and complicated measures where the wider impacts and the revenue raised are highly uncertain. This could make George Osborne’s “omnishambles” Budget of 2012 look like a masterstroke in comparison.
Labour MPs could rebel against it, either in parliament or within the party. It is remarkable that this is even an issue, given the government’s large majority. But dissatisfaction with the leadership is clearly very high. The Opposition would obviously have a field day if the Chancellor does indeed break more of her promises on tax.
Finally, unlike the short-lived turbulence after the September 2022 mini-Budget, this one could really crash the economy.
So, what could – so should – the Chancellor do differently?
Obviously, no-one would want to start from here.
The root of the problem is that successive governments have failed to control public spending. However, the Chancellor might still be able to keep the size of the tax increases below £20 billion if she banked any savings from more favourable economic assumptions, rather than spent them, and found other saving from the welfare bill to replace those lost since the Spring.
As it stands, current (day-to-day) spending is forecast to rise from about £1,150 billion in 2024-25 to £1,350 billion in 2029-30 – an increase of £200 billion. Reducing the growth of this spending would save a large amount of money, without having to make outright cuts. Simply restoring productivity in public services to its pre-Covid level would be a good start and could allow the same services to be provide for 4% less money.
But if spending cuts are off the table, there are still three other steps the government could take (though these may be forlorn hopes too).
One would be to revisit some of the policy choices that are likely to make the underlying problems worse, including in the housing market (rental reforms), the labour market (the Employment Rights Bill) and energy policy (the rush to ‘net zero’).
The next step would be to undertake a fundamental reform of the tax and benefit system, with the aim of simplifying everything and reducing some of the disincentives to work, save and invest created by high marginal tax rates. Some taxes should be scrapped altogether, starting with stamp duty.
Thirdly, if it is still necessary to raise a lot more in taxes (a big ‘if’), at least it could be done in the simplest possible way. Some combination of increases in income tax rates and in VAT, perhaps including an extension of the VAT base, would be the cleanest option in economic terms and received best in the markets.
A straightforward 3p on all three income tax rates (basic, higher and additional) could raise £30 billion in a single stroke. This would also ram home the point that higher spending means higher taxes, and that voters need to be more aware of the trade-offs here. Politically, though, this may now be nigh on impossible.
Hopefully see you all on the other side!
Plain-speaking Economics 