Budget analysis: Much Ado About… Not Much

As ever, the budget speech was long on politics, but, as I will show below and as I suspected, broadly irrelevant to the medium-term outlook for the UK economy. The Chancellor has announced a long list of revenue-raising measures, most of which are narrowly targeted at small sections of society (Private education, people who pay capital gains and inheritance taxes and the private equity industry, for example) but which are not meaningful at a macro economy level.

The most significant measure which I believe will have an important impact on the labour market is the decision, which was flagged ahead of today’s speech, to raise a significant sum (£25bn) from employers’ national insurance contributions. This effectively completely reverses the previous administration’s £20bn cut to employees’ NI.

This is effectively a tax on jobs levied on employers, and I expect that as a result of this measure, employers will probably adjust two things. They will either look to recoup this additional cost by contributing less to their pensions, and/or adjusting their pay, or by employing fewer people. Ultimately, a tax on jobs will result in lower demand for labour.

When planning this note, I had expected it to be long and detailed and address and comment on a number of important measures that would have longer-term impacts on the economy. As it is, this note, which is not about politics but about the economic impact of the budget’s measures, can be mercifully short.

Ultimately, for all the politics, the budget is broadly irrelevant for the economy’s medium-term outlook. In the short term, I suspect that the labour market will cool, but that aside, and as I wrote yesterday, the budget will not change my views about the broad outlook for the economy. And it would appear that the OBR agrees with me. Its updated forecasts for the five-year period from 2025 through to 2029 are almost identical to the numbers the organisation published last spring (according to the latest numbers, growth will average 1.75% pa over that period).

So, in summary, we have a budget with at least 60 different individual measures, many of which I acknowledge are controversial and have important political ramifications but ultimately have no impact on the overall trajectory of the UK economy. Nevertheless, we will end up with more public sector debt than was forecast in the spring, higher taxes, and higher government spending.

Albeit that the OBR’s medium-term growth forecasts have not moved from the Spring, my guess is that growth in the short term (2025 and 2026), and as I have written in previous blogs, will be stronger than the OBR is forecasting. Specifically, it is forecasting 2% growth in 25 and 1.8% in 26. My guess is that growth will be better in both these years. As an aside, and for reasons I find very difficult to explain, the OBR’s inflation forecast for 2025 has gone from 1.5% to an extraordinary 2.6%. Inflation forecasts for subsequent years have also gone up. This looks especially odd in the context, for example, of the most recent inflation data, which came in significantly below the MPC’s target and the recent collapse in oil prices. I suspect that this odd inflation forecast will be revised down significantly, and soon, not least because it is based on out-of-date assumptions.

One other noteworthy event that the OBR has slipped under the radar is the upgrade to this year’s growth forecast, which, at 1.1%, is now 0.5% higher than was forecast in the spring, which I said at the time was significantly too low.

Summary

In summary, a budget that was heralded as one that would rebuild Britain and, by implication, raise the economy's growth rate appears to be doing no such thing. The OBR, in which so much political faith is invested, has not moved its five-year growth forecast at all. Indeed, at the margin, in the short term, the forecast is slightly lower.

Perhaps unsurprisingly, the budget will result in higher taxes (the tax share of GDP rises to 42.5% of GDP), higher government spending (45.25% of GDP), and a larger deficit (£127bn in the current financial year, £50bn higher than was forecast in the Spring). Over time, as the economy grows and as the tax increases take effect, the deficit falls from 4.5% of GDP in 24/5, eventually to 2% in 29/30.

The political implications of these changes are, in my judgement, more significant than the economic ones. I do not believe that higher spending, taxes and debt will have a material impact on what I think the UK economy can deliver in terms of growth in the short and medium term. That is not to say, however, that a smaller public sector coincident with significant deregulation wouldn’t liberate the economy's growth potential. I believe that it would. However, this is something that will require a significant shift in the leadership of this country away from a post-pandemic political and institutional consensus.