FT
Sorry about the format, but it is worth ploughing through. Sobering stuff.
Chancellor Rachel Reeves has been privately warned by the UK fiscal watchdog that its estimates for productivity are likely to be downgraded ahead of the Budget, making big tax rises more probable. Officials told the Financial Times that Reeves would blame the previous Conservative government for the expected downgrade, arguing that the Office for Budget Responsibility was giving a “historical” verdict on Tory rule from 2010 to 2024. “We don’t know precisely what they are going to say on productivity, but we have been given indications there will be a downgrade,” said one official.
People briefed on Budget preparations have warned that the total fiscal hole could amount to “tens of billions” of pounds — perhaps to £30bn. The OBR downgrade would make up a large portion of the gap. Analysts have predicted the OBR could weaken public finances by at least £9bn by downgrading its productivity estimates, which are seen as too optimistic at present. Although the Treasury insists Reeves will stick to her manifesto commitment not to increase income tax, value added tax or national insurance, the OBR downgrade could provide cover for her to change her mind. The official said: “The untold story of this Budget is the historical legacy of the Conservatives that nobody knew about. The OBR productivity downgrade could amount to half or three-quarters of the fiscal hole.” They added: “This doesn’t reflect on what’s happened since the election, but we are the ones picking up the bill.”
Sir Mel Stride, shadow chancellor, said: “Every time the numbers don’t add up, Rachel Reeves blames someone else. But the truth is the markets are losing confidence . . . Be in no doubt, any downgrade will be down to the chancellor’s economic mismanagement.” Reeves promised after her first Budget in October 2024 that she would not come back with more tax increases or extra borrowing. The OBR declined to comment. The Treasury did not immediately comment. The OBR at present assumes trend productivity growth will average 1.1 per cent over the medium term. Shaving 0.1 or 0.2 percentage points from that forecast would lead to a deterioration in the fiscal position of between £9bn and £18bn, according to Allan Monks, UK economist at JPMorgan.
The government already faced a £6bn shortfall after it retreated on cuts to welfare and winter fuel payments. If UK borrowing costs jump back to the highs reached early this month, it could knock several billion pounds more off Reeves’ fiscal room for manoeuvre. In March, Reeves left herself £9.9bn of headroom against her key fiscal rule, which requires her to fund day-to-day spending, excluding investment, entirely through tax revenues by 2029-30. Analysts expect Reeves to want to restore a buffer at least that big to mitigate the risk of future tax rises if the economy deteriorates further. That could put Labour’s manifesto tax pledges in jeopardy as income tax, VAT and employee NICs are by the far the biggest tax levers available to the chancellor. If Reeves did decide to ditch the tax pledge — currently excluded by the Treasury — one option would be to reverse twin reductions in employee national insurance made by Jeremy Hunt, chancellor under the last Conservative government, that cost the exchequer £20bn.
Another option would be to extend the freeze on personal income tax thresholds, which could deliver close to £10bn of revenue. The prospect of a productivity downgrade has been a persistent threat. Economists argue the OBR has long been too optimistic in its productivity outlook, by sticking with predictions of a rebound despite depressed growth readings. The OBR currently expects a bounceback in productivity growth to around half the pace that preceded the financial crisis. But Andrew Bailey, Bank of England governor, said in June that the central bank was “sceptical” about these predictions.