Autumn budget preview

Autumn budget preview

On Wednesday the UK chancellor, Rachel Reeves, will unveil her second budget. This week’s briefing examines the challenges facing the chancellor.

• After implementing £40bn of tax rises in last October’s budget, the largest tax-raising budget in more than 30 years, the chancellor told the CBI that she would not be “coming back” with more tax rises.

• Much has changed in the last year and the chancellor is widely expected to raise taxes by about £20bn this week. The deterioration in the public finances since last year’s budget is due to government U-turns on cuts to winter fuel and disability benefits, higher-than-expected government borrowing costs and downgrades to the Office for Budget Responsibility’s (OBR) estimate of UK productivity growth.

• Fiscal forecasts are prone to large errors and the state of the public finances can shift quickly. At the start of this month the government was generally thought to be facing a fiscal gap of £30bn-£40bn. In response, the chancellor signalled that she was likely to raise rates of income tax in the budget. On 13 November, the Financial Times reported that these plans had been ditched in the light of improved fiscal forecasts from the OBR. Overnight, expectations for the scale of tax rises in the budget dropped from £30bn-£40bn to around £20bn and the government let it be known that it was no longer planning to raise rates of income tax.

• I do not recall a UK budget that has been preceded by such extensive speculation about which taxes will be increased, much of it seemingly fuelled by briefings from sources close to the government (often cloaked in phrases such as, “according to people familiar with the matter”).

• Of the tax-raising measures available to the chancellor, perhaps the most politically palatable would be to extend the current freeze on income tax thresholds. This would be a deferred tax rise, stealthier than simply raising tax rates, but could be seen as breaching Labour’s manifesto pledge not to raise income tax for “working people.” Extending the freeze in thresholds by another two years, until the end of the parliament, would raise around £10bn with no immediate effect on taxpayers – but a growing impact from 2030. Other tax-raising measures that have won significant media coverage include raising council tax on top-band properties and reducing the tax benefits of salary sacrifice pension contributions.

• Avoiding broad based increases in personal tax, such as VAT, national insurance and income tax, may be politically attractive. But shifting the burden of tax increases to a series of smaller tax changes is not without risk. They can create large losses for small groups of taxpayers, adding complexity and inefficiencies to the tax system and attracting high-profile opposition. Time and again chancellors have had to reverse course on proposed tax rises due to opposition, perhaps most famously in 2012 when George Osborne had to backtrack on a plan to charge 20% VAT on hot takeaway food, including pasties. The same problem applies to planned reductions in welfare spending, as demonstrated by Ms Reeves having to back down on proposed cuts in winter fuel payments for pensioners and disability benefits in response to opposition from her own party. Whatever measures the chancellor announces this Wednesday will need to win the support, or at least acquiescence, of her own party and of parliament.

• Tax rises will be necessary for Ms Reeves to meet one of her stated aims for this budget, to reduce public debt. The greater question is whether she can convince markets that the UK public finances are on the mend. We expect the chancellor will pencil in a margin of error to meet her debt target of about £15bn. This is minimal by the standards of budgets in the last 15 years. With public spending running at around £1,335bn a year it wouldn’t take much to go wrong for a reserve of £15bn to be swallowed up by events.

• Without a larger fiscal reserve, or an improvement in growth prospects, markets will remain sensitive to the risk of further slippage in the UK public finances and more tax rises. That, in turn, could weigh on business sentiment, just as it has in recent months (as the headline for the latest Chambers of Commerce business survey put it, “Bruised firms not ready for another budget battering”). 

• This year’s budget seems likely to lay out a fiscal consolidation programme relying almost entirely on tax rises. With the tax burden already at the highest level since the 1940s, further tax rises will weigh on growth and, more worryingly, risk blunting incentives. Moreover, relying solely on tax rises to right the public finances looks risky. Numerous academic studies show that successful fiscal consolidations place more weight on reductions in public expenditure than on raising taxes. A 2018 study by Harvard economist Alberto Alesina and his co-authors, looking at 16 OECD countries over a 30-year period, found that tax rises tend to have a greater dampening effect on growth than spending cuts.

• Alongside debt reduction, the chancellor says she wants to reduce NHS waiting lists and reduce the cost of living. The government has already announced that it will leave prescription charges unchanged next year and has announced the first freeze in rail fares in 30 years. The chancellor is widely expected to reduce VAT on energy bills and lift the two-child benefit cap in the budget.

• In terms of her objective of bringing down inflation the chancellor has chosen an easy target. Inflation has already peaked and, with or without any new measures from the government, is likely to fall substantially by the middle of next year. Any ‘cost of living’ measures announced by the chancellor would help this process along.

• This week’s budget will no more solve the UK’s fiscal problems than last year’s budget. Righting Britain’s finances will take years. Levels of public debt have roughly tripled since the turn of the century. The burden of tax is higher than it has been in more than 70 years. Public spending is running way above post-war averages. The state is spending, taxing and borrowing on a grand scale, yet public satisfaction with key services, such as health and social care, is low. Most fundamentally, growth today is running around half the rate that was seen before the financial crisis. 

• This budget, like last year’s, seems likely to lean heavily on tax rises. Big questions on the size and role of the state will have to wait.

 

OUR REVIEW OF LAST WEEK’S NEWS

The UK FTSE 100 equity index ended the week down 1.6% at 9,540 after a volatile week as investors became more wary about US tech valuations.

 

Economics

• Activity in the US unexpectedly accelerated in November but fell in the UK and euro area, according to initial estimates from surveys of purchasing managers 
• Delayed US labour market statistics showed payrolled employment rose by more than expected in September, while unemployment also increased to a four-year high of 4.4%, highlighting mixed signals in the US labour market
• UK inflation fell to 3.6% in the year to October, down from 3.8% in September. Investors now expect the Bank of England to cut interest rates in December
• UK retail sales unexpectedly fell in October, the first monthly fall since May this year, with some retailers reporting that consumers were delaying spending prior to Black Friday sales
• Consumer confidence remained stable in the euro area in November, while confidence fell in the UK ahead of the Autumn Budget
• London house prices fell in September to their lowest level since December 2023, according to official statistics, amid higher mortgage costs and high property prices in relation to earnings compared with the rest of the UK
• European Central Bank chief Christine Lagarde warned that Europe’s economic prosperity is “geared towards a world that is gradually disappearing” and called for policymakers to strengthen the EU’s domestic economy
• Japanese GDP fell 0.4% in the third quarter due to a fall in exports amid higher US import tariffs
• New Japanese prime minister Sanae Takaichi announced a $135bn stimulus package, including electricity subsidies and food coupons, in a bid to kickstart economic growth and support households from rising costs. Speculation about the announcement has increased Japanese long-term borrowing costs to their highest level since 2008 
• Taiwan’s National Science and Technology Council minister Wu Cheng-wen said that the US would not “punish” Taiwan’s semiconductor industry and would lower tariffs in return for supporting the development of US chip industry

 

Business

• A US judge ruled that Facebook owner Meta does not hold an illegal social media monopoly due to its previous acquisitions of Instagram and WhatsApp
• UK-owned TV programme exports surpassed £2bn for the first time, according to industry body Pact, highlighting strong demand for British content
• UK chancellor Rachel Reeves asked the Competition and Markets Authority to investigate the cost of private dental treatments due to rapidly rising prices
• The UK’s Financial Conduct Authority launched investigations into eight companies, including ticketing website Viagogo, over their online pricing practices 
• Bond Street in London was named as the most expensive location for retailers, beating international shopping destinations like Milan and New York, due to strong demand for premium retail space
• The Greater Manchester Authority announced a £1bn public investment fund to capitalise on strong growth in the city
• University regulator the Office for Students said that despite announcements of higher tuition fees, 41% of higher education institutions are expected to report deficits in 2026-27
• Channel Tunnel owner Eurotunnel cancelled future UK rail investments, including reopening a freight terminal, due to an alleged tripling of business rates
• US pharmaceutical company Eli Lilly became the first pharmaceutical group with a $1tn stock market valuation

 

Global and political developments

• A 28-point peace plan to end the war in Ukraine, drafted by the US and Russia without the involvement of Kyiv, was presented to Ukrainian president Volodymyr Zelenskyy. The plan includes demands that Ukraine cede territory it currently controls. Mr Zelenskyy said Ukraine faces a choice of “loss of dignity, or the risk of losing a key partner”
• The FT reports that the status of the plan was thrown into doubt when president Donald Trump said over the weekend that it was not America’s “final offer” and US secretary of state Marco Rubio reportedly sought to distance Washington from it, before saying the US had produced it
• The UN security council approved the US-backed proposal for Gaza, which includes deploying an international stabilisation force and creating a transitional administration
• US president Donald Trump said he would approve Saudi Arabia’s request to purchase US F-35 fighter jets during a visit by Crown-Prince Mohammed bin Salman. Currently Israel is the only Middle Eastern country with F-35 jets
• The UK government announced reforms to its migration policy and asylum seekers system, including changing the eligibility period for UK settlement, in an attempt to lower net migration to the UK
• The UK’s official COVID-19 inquiry found that the UK government’s response was “too little, too late”, with delayed action causing an estimated 23,000 extra deaths
• UK defence secretary John Healey warned Russia that the UK has eased the rules of engagement in the North Sea after a Russian spy ship sailed near British waters and shone lasers at a UK aircraft that was monitoring its movements
• The UK’s domestic intelligence service, MI5, warned MPs that Chinese intelligence services are actively attempting to recruit people with access to the UK government
• The UK government is planning to approve a controversial new Chinese ‘mega-embassy’ in London, The Times reports
• The European Commission cut its demanded fee for the UK to join the EU’s rearmament programme to €2bn, down from €6.7bn, amid ongoing disagreements among the UK and EU members over the price for UK access to the scheme, the FT reports
• Relations between Japan and China deteriorated following Japanese prime minister Ms Takaichi’s comments that a Chinese attack against Taiwan could be considered a “situation threatening the survival (of Japan)” that could trigger a Japanese military response 

And finally… researchers in British Columbia used hidden cameras to find out who had been damaging lobster traps. A pack of wolves had been swimming out to retrieve the traps, dragging them to shore and stealing the bait – lobster thermi-paw