Of fiscal gaps and geese

Of fiscal gaps and geese

A year ago Britain’s chancellor, Rachel Reeves, said that the £40bn of tax rises announced in her October budget, the largest in 30 years, were needed, “to wipe the slate clean and put our public finances on a firm footing”. The following month, Ms Reeves told the CBI that she would not be “coming back with more borrowing or taxes”.

Things have not turned out as the chancellor had hoped.

• Government borrowing is running well ahead of Ms Reeves’s plan. In the first five months of 2025-26 the government borrowed £83.8bn, £16.2bn more than in the same period last year and £11.4bn more than planned. Without higher taxes or cuts to public spending the chancellor is likely to miss her own rule for reducing debt which she has repeatedly described as being “non-negotiable”.

• The true scale of the problem is greater than these numbers imply. Higher government borrowing costs, government U-turns on cuts to winter fuel payments and sickness and disability benefits and an expected downgrade to the Office for Budget Responsibility’s estimate for UK productivity growth have created a hole in the public finances. Estimates of the size of the ‘fiscal gap’ vary, but a figure of around £30bn seems plausible. To this it would be prudent to add a margin of error of at least £10bn to avoid being blown off target by future shocks and surprises. That would leave the chancellor needing to find around £40bn in her budget on 26 November, an amount similar to the scale of last October’s tax rises.

• The obvious solution would be to change the fiscal rules to allow more borrowing. That would be risky. High inflation and government borrowing, and a falling away of demand for gilts from a shrinking pool of UK defined benefit schemes, mean that the UK government already faces interest rates that are higher than its European or North American peers. To overturn what the chancellor has described as ‘ironclad’ fiscal rules – in what would be the eleventh change to the rules in 18 years – to fill a hole in the UK public finances could test the patience of the gilt market.    

• That leaves the chancellor facing a choice between reducing public expenditure and raising taxes.

• The government’s inability to win the support of its backbenchers for relatively modest welfare cuts earlier this year suggests significant reductions in public spending are not on the cards. In any case, the existing plans for departmental spending for the next four years, which were unveiled in July, already look tight and public satisfaction with services is low. The government could kick the can down the road, pencilling in an even tougher spending settlement towards the end of the forecast period, but given the slippage on spending in recent years such a commitment might not be credible.

• This leaves taxes. The Party’s  manifesto stated that, “Labour will not increase taxes on working people, which is why we will not increase National Insurance, the basic, higher, or additional rates of Income Tax, or VAT.”  The chancellor said last month that the manifesto pledge stands but other comments seemed designed to create more room for manoeuvre on tax. Before her speech to the Labour Party conference Ms Reeves said that “world had changed” since last year’s budget due to a combination of conflicts, US tariffs and higher borrowing costs. The chancellor’s comments have been widely construed in the media as meaning that she no longer stands by last year’s pledge not to raise taxes.

• Chancellors occasionally raise significant revenues through a single tax change – as with George Osborne’s increase in VAT to 20% in 2010, Rishi Sunak’s introduction of the Health and Social Care levy in 2021 and Ms Reeves’s increase in employers’ NICs last year. These are the exceptions. Chancellors tend to favour a mix of smaller tax-raising measures, sometimes stealthy, such as through freezing income tax allowances.

• The media have speculated about the possibility of a wide range of tax-raising measures in recent weeks.  Some of the larger revenue-raising measures that have attracted discussion include extending the freeze in income tax allowances, reducing pension reliefs, increasing Council Tax and extending the VAT base. What is clear is that the chancellor could raise £40bn or even more through a series of smaller tax measures and without increasing rates of income tax, VAT or national insurance.

• Implementing a host of tax-raising measures may seem like the least risky course of action. But, as the Institute for Government (Ifg) has observed, “small isolated [tax] changes can create a concentrated group of losers and attract outsized bad press”. More fundamentally, the Ifg also cautions that, “an eclectic grab bag of tax raisers that complicate an already inefficient tax system would hamper, not promote” the government’s key aim of supporting growth.

• Louis XIV’s finance minister, Jean-Baptiste Colbert, famously declared that “the art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.”  £40bn of tax rises would occasion a good deal of hissing. With the tax burden already at the highest level in more than 70 years perhaps the more pertinent question is what £40bn of additional tax increases might do to the health of the goose.

PS: Last week’s Briefing examined the so far limited impact of AI on the US and UK jobs markets. A report from the Yale Budget Lab and the Brookings Institution think tank released later in the week came to a similar conclusion, noting that since the introduction of Chat-GPT in November 2022, the US labour market has not "experienced a discernible disruption" from AI. Moreover, fears of the destructive force of AI in relation to jobs, seem, at least so far, wide of the mark. The report found that the occupational mix of the US job market is not changing at a markedly different pace today than during the personal computer revolution of 1980s and the rollout of the internet in the 1990s.

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week up 2.2% at an all-time high of 9,49.

Economics

• Gold prices surpassed $3,800 per troy ounce, a new record, as investors increased demand for gold-backed exchange-traded funds amid concern over levels of government debt and inflation
• The US federal government shut down for the first time in seven years as Democrat and Republican lawmakers failed to reach an agreement on government funding. The Congressional Budget Office has estimated that the previous shutdown in 2018-19 resulted in a minimal economic impact. Donald Trump has threatened to use this shutdown to permanently close agencies and “clear out dead wood, waste and fraud” 
• The shutdown means that key US non-farm payroll data will not be released as had been planned this Friday
• The US Supreme Court ruled that Federal Reserve governor Lisa Cook could remain on the Fed board until it takes up her case in January, following previous attempts by Mr Trump to fire her
• Mr Trump withdrew his nominations for the heads of the US Bureau of Labour Statistics and the Commodity Futures Trading Commission, increasing uncertainty over the future leadership of the agencies
• The US economy lost 32,000 jobs in September, according to payrolls processor ADP, indicating a softening of the labour market
• The UK Purchasing Managers reported a marked softening of the pace of UK services activity in September, commenting that, “Many survey respondents suggested that corporate clients had deferred spending decisions until after the Autumn Budget, while households were also hesitant about major purchases”
• Tesco CEO Ken Murphy said his “one ask” for the UK chancellor’s November budget was, “Don’t make it harder for the industry to deliver great value for customers… In the last budget, the industry and the sector incurred substantial additional operating costs. We’re doing our best to deal with them, but enough is enough.”
• The Bank of England’s Decision Makers Panel found that higher employer NICs have contributed to weakening of businesses’ hiring intentions
• The UK government banned ‘buy one, get one free’ deals and other price promotions on unhealthy food and drink in a bid to tackle obesity
• Euro area inflation increased to 2.2% in the year to September, up from 2% in August, while the unemployment rate increased marginally to 6.3% in August

Business

• In a blow to the UK equity market pharmaceutical company AstraZeneca announced plans to elevate its listing in New York, as it seeks to attract US and global investors. The FT reports government estimates that show the move will cost the exchequer up to £200m a year in lost stamp duty on share trading
• Energy producer Diversified Energy announced plans to switch its primary listing from London to New York
• The UK government is expected to give a stamp duty holiday on shares of newly UK-listed companies amid rising concerns over the international competitiveness of the London Stock Exchange
• Global Tesla sales rose to a record high in the third quarter this year, as US consumers rushed to take advantage of tax credits on electric vehicles before their September expiry deadline
• The US government asked US universities to sign a set of operating principles, which include freezing tuition fees for five years and limiting the share of international undergraduate students to 15%, in return for access to federal funding
• US food delivery company DoorDash’s £2.9bn acquisition of UK rival Deliveroo was approved by the UK High Court
• The UK government approved a £1.5bn loan guarantee for Jaguar Land Rover following a cyber-attack that halted production
• European carmakers warned that Europe will lose out to China in the production of electric lorries unless the European Commission takes urgent action to support the energy transition

Global and political developments

• In a sign that president Trump may be losing patience with Russia the US announced that it will share intelligence with Ukraine to support its long-range missile strikes on Russia’s energy infrastructure
• Danish prime minister Mette Frederiksen said Russia’s hybrid war was “only the beginning” as European leaders met in Denmark to discuss European security and support for Ukraine
• Munich’s airport shut for several hours following drone sightings in the area, only a week after a series of similar incidents in Denmark
• Israeli prime minister Benjamin Netanyahu agreed to the US administration’s proposed peace plan for Gaza, which includes an immediate cessation of military operations. Hamas said it accepts parts of the plan, but seeks further negotiation on other issues
• Mr Trump signed an executive order providing security guarantees to Qatar. The order regards any armed attack on Qatar as a “threat to the peace and security of the US”
• Mr Trump said that “America is under invasion from within” and pledged to continue deploying the military across US cities that could be used as military “training grounds”
• Keir Starmer pledged to remove the right for refugees to apply for permanent residency after five years or gain an automatic right to family unification amid efforts to tackle rising irregular migration to the UK
• Conservative Party leader Kemi Badenoch pledged to scrap the UK’s Climate Change Act. Former UK prime minister Theresa May said the decision would be a “catastrophic mistake”

And finally… AI research company Google DeepMind unveiled an AI model with advanced reasoning that enables robots to perform household chores including recycling rubbish and sorting laundry – domestic-AI-ted