Budget choices

Budget choices

Rachel Reeves will deliver the budget on 30 October, the first by a female chancellor of the exchequer. After 14 years in opposition the Labour Party has to turn rhetoric and plans into an economic strategy. Next week’s budget is likely to be one of the more consequential in recent years, setting a framework for taxation, spending and public borrowing for the rest of this parliament. 

• It's hardly a secret that Ms Reeves has inherited a difficult fiscal situation. Taxes are on course to reach their highest level since 1948 and government debt has exceeded 100% of GDP, its highest level since the 1960s. Public expenditure as a share of GDP has only been higher in recessions, yet satisfaction with public services is at record lows. The country is paying – and borrowing – more for services which, on many measures, are deteriorating.  

• Ms Reeves has also inherited plans from the previous government that would mean swingeing real-term cuts to many departments, reductions in public investment as a share of GDP, further tax rises and significant public borrowing.

• The UK’s fiscal situation is difficult, but not unique. The US, Japan, France and Italy also borrowed on a vast scale to counter the impact of the financial crisis and the pandemic. Most have suffered the same combination of slowing growth trend and rising welfare and health costs as the UK. All have seen sharp increases in levels of public indebtedness.   

• The UK budget will outline departmental spending plans for the next fiscal year (2025–26) and the overall funding for subsequent years. In the spring, the government will conduct a spending review that will set out detailed departmental spending plans beyond 2025–26.

• The choices and trade-offs that Ms Reeves announces next week will set a course for Labour’s economic policy for the rest of this parliament. Three issues will define this budget.  

• The first relates to public services. Rachel Reeves has pledged no return to austerity although, perhaps helpfully, there is no agreed definition of austerity. Ms Reeves has inherited plans, laid out by her predecessor, in the March budget, for significant real-term cuts to expenditure in departments, including justice, transport, local government and the Home Office, accounting for about one-third of all public spending.

• Just to maintain real-term funding for these so-called unprotected departments – something the chancellor seems likely to want to do – would cost £23bn by 2029–30, according to the Resolution Foundation. Together with the cost of higher public sector pay, increased health and infrastructure spending and selective rises for other priorities, it seems quite plausible that Ms Reeves will announce increases in public expenditure of as much as £40bn in the budget.

• This is a significant sum and would be a marked change in the trajectory of public expenditure compared to the March budget. However, given low levels of satisfaction with public services and the scale of the squeeze on many departments (local government spending, for instance, is down by 23% per capita) even £40bn extra public spending would not transform public services. In time, the effects of public service reforms, increased investment and sustained growth should help. But peoples’ day to day experience of public services won’t change overnight. On that measure at least, austerity will not be banished.

• The second issue for the chancellor is whether to change the rules that govern public borrowing to allow for increased spending. I think this is quite likely, with the chancellor switching to a definition of debt that would create more headroom for capital investment.

• Ms Reeves will be acutely aware – especially in the light of the ill-fated Liz Truss budget of 2022 – that whatever changes are made need to command the confidence of bond investors. There is a good economic case for borrowing in order to invest, but this is still additional public borrowing. Britain has a 25-year record of frequent changes to its fiscal rules, almost always in favour of more borrowing. Resetting the fiscal rules today, in a world of high interest rates and government debt, is no free lunch. A credible focus on ensuring public investment is deployed wisely to boost growth would go some way to reassuring investors. But my guess is that any changes that allow for increased capital spending will also imply hard limits for current public spending. That would be at least as much a signal for Ms Reeves’s cabinet colleagues as for the bond market.

• The third question relates to taxes. It’s not a question of whether taxes will rise, but by how much. As a result of decisions by the previous government, the tax burden is set to rise by about £24bn by 2027, mainly due to the freezing of personal tax and national insurance allowances and increases in stamp duty and fuel duty. In addition, Labour’s manifesto outlined plans to raise a further £9bn from the imposition of VAT on independent school fees, a windfall tax on oil and gas companies and higher taxes on UK non-domiciled residents and private equity carried interest. (Press reports suggest that some planned measures may be diluted on concerns about adverse behavioural effects and/or lower-than-anticipated yields.) 

• Where else could the chancellor raise taxes? Labour has ruled out rises in income tax, national insurance, VAT or corporation tax. Recent press speculation has focussed on the possibility of increases in employers’ national insurance contributions. Estimates from HMRC suggest that raising the employer’s NI contribution by two percentage points would raise around £17bn in 2025–26. Though a charge on the employer, over time it seems likely that employees would pay in the form of lower real wages. (It is partly for this reason that the OECD scores an increase in employers’ payroll taxes, such as national insurance, as a tax on employees.) Capital gains tax, inheritance tax and pension tax reliefs also feature prominently in recent press speculation about potential tax rises. 

• Tax increases – be they inherited from the Conservatives, promised in Labour’s manifesto or likely given the scale of the pressures on public services – could add up to the £40bn level. The tax burden has risen sharply in the last 15 years, but it has further to go.

• Who is paying these taxes? Certainly, higher earners. As Paul Johnson of the Institute for Fiscal Studies noted earlier this year: “[the] top 1 per cent pay 29 per cent of all income tax now, up from 25 per cent in 2010 and 21 per cent at the turn of the century”. By contrast, taxes on average incomes in the UK are relatively low compared to other countries. OECD data shows that there is no country with higher public spending than the UK that has lower taxes on the average worker.

• Ms Reeves aims to improve public services without increasing taxes on such workers (or what Labour, more vaguely, calls “working people”). She also wants to increase public investment and raise Britain’s growth rate – all the while keeping debt under control and bond investors onside. To say this is a difficult balance to strike is an understatement. How she does it will help define this government.

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week up 1.3% at 8,358 as UK inflation fell below the 2% target, increasing expectations that the Bank of England will cut interest rates in November.

Economics

• UK inflation fell to 1.7% in the year to September, the lowest rate since April 2021. Markets now expect the Bank to announce two rate cuts before the end of the year
• UK average earnings growth slowed to 4.9% in the three months to August compared with the same period last year, the lowest growth rate since June 2022, indicating a gradual cooling of the labour market
• UK retail sales increased 0.3% in September on the month, beating expectations of a fall in sales volumes. The increase was driven by computer and telecommunications retailers
• UK prime minister Keir Starmer said that his government will “rip up bureaucracy that blocks investment” in an appeal to investors to boost private investment in the UK
• Marketing budgets failed to grow in the third quarter for the first time since the pandemic amid uncertainty ahead of the upcoming UK budget, according to a survey from the Institute of Practitioners in Advertising
• The chief executive of investment platform AJ Bell reported “a noticeable change in both customer contributions to pensions and tax-free cash withdrawals” ahead of the upcoming UK budget
• The UK government launched its consultation on regulating the “buy-now, pay-later” sector, proposing supervision by the Financial Conduct Authority and strengthened rights for consumers
• The UK government will increase the bank ringfencing threshold to £35bn, allowing banks to collect an additional £10bn in extra customer deposits before needing to separate retail and investment activities
• The European Central Bank cut interest rates by 0.25 percentage points to 3.25%, the lowest since May 2023, stating “the disinflationary process is well on track”
• Euro area inflation fell to 1.7% in the year to September, down from 2.2% in August and below the ECB’s 2% target
• German economic sentiment reflecting expectations in the next six months improved in October, offsetting the decline in September. However, the assessment of Germany’s current economic situation continued to worsen in October, with almost nine out of ten respondents assessing the current situation as negative
• The International Monetary Fund’s managing director, Kristalina Georgieva, said that IMF forecasts “point to an unforgiving combination of low growth and high debt”
• Chinese GDP growth slowed slightly to 4.6% in the third quarter compared with the same quarter last year, down from 4.7% the previous quarter
• Consumer price inflation in China fell to 0.4% on the year in September adding to concerns that the country could risk a period of deflation
• China announced a near-doubling of credit support for some housing projects to $562bn, the latest in a number of interventions by the Chinese government aiming to boost growth

Business

• Car manufacturer General Motors increased its investment in a US lithium mine by 45% to $945m as part of a joint venture with Lithium Americas in a bid to ensure future supplies used in the production of electric vehicles
• UK revenue of car manufacturer Tesla fell in 2023, the first annual fall in ten years
• Defence organisation RTX will pay more than $950m to the US government to resolve claims of bribing Qatari officials and defrauding the US Defence Department into overpaying for military weapons
• P&O Ferries owner, DP World, announced a £1bn plan to expand London’s Gateway container port
• Confidence among North Sea oil and gas operators fell to its lowest level on record, according to a survey by the Aberdeen & Grampian Chamber of Commerce
• UK transport unions ASLEF and RMT announced strike action affecting London Underground services in November in a dispute over pay
• The UK government has launched a consultation for its industrial strategy, focusing on eight sectors to drive growth and “hardwire stability for investors”
• Microsoft UK chief executive, Clare Barclay, has been appointed as chair of the UK government’s new Industrial Strategy Advisory Council
• Aerospace manufacturer Boeing announced plans to cut approximately 10% of its workforce and delay the rollout of a new plane model. Boeing also entered into a $10bn credit agreement with a consortium of banks and plans to raise up to $25bn in new capital
• Google has ordered six to seven small modular nuclear reactors from startup company Kairos Power to power its data centres       
• Industry body UK Finance reported that over £570m was stolen in payment fraud in the first half of 2024, with the majority originating from social media sites
• Competition for UK graduate jobs is the highest on record, according to the Institute of Student Employers, with an average of 140 applications per job in 2024. A slowing labour market and increased use of AI during applications were cited as key contributors
• The UK government said that it will “crack down on spiralling costs” of car insurance by creating a new cross-department taskforce

Global and political Developments

• Israeli forces killed Hamas’s leader Yahya Sinwar in Gaza
• China undertook military exercises around Taiwan, including 153 aircraft and 36 ships. The US said that it is “seriously concerned” about the exercises
• North Korea blew up roads leading to South Korea amid rising tensions between the two countries
• South Korea’s intelligence agency said that North Korea is sending troops to Russia to fight in Ukraine
• Ukrainian president Volodymyr Zelenskyy called for Ukrainian membership of NATO as part of his “victory plan” against Russia
• Canada expelled six Indian diplomats amid tensions regarding the killing of a Sikh separatist in Vancouver last year. India responded by asking six Canadian diplomats to leave the country

And finally… the World Conker Championships is investigating the winner of its men’s tournament after a steel chestnut was found in his pocket. The veteran, known as “King Conker”, dismissed claims that he cheated after winning his first men’s title since he started competing in 1977 - he came, he saw, he conkered