FTI Consulting UK Public Affairs Snapshot: Autumn Budget – Reeves rolls the dice

The first Labour Budget since 2010 was always going to be a big political – and economic – moment, one that would see Chancellor Rachel Reeves simultaneously try to put the public finances on an even keel, implement policies that would create growth, maintain fiscal credibility, stick to manifesto commitments, and keep the back benches happy. That is quite the challenge.

To frame the task, Labour leader Keir Starmer argued earlier this week that if in 1997 the country had relatively healthy public finances but broken public services, and in 2010 it had healthy public services but broken public finances, then the situation in 2024 sees both public services and public finances on their knees. Therefore, tough action needed to be taken.

That tough action came in the form of £40 billion of tax rises – in real terms, the biggest ever of modern times. The country had been primed for both the concept of tax rises, and the order of magnitude; and many of the areas in which the Chancellor chose to increase taxes – capital gains, stamp duty, carried interest, reform of the non dom regime – had either had the pitch rolled by the Government, or were obvious targets for action.

But the reality is that trying to get a sum that large means either lots of increases across the board, which is complicated as well as being difficult politically, or one big increase. The Chancellor chose the latter: an increase in employers’ National Insurance contributions to 15%, coupled with a the decrease in the per-employee threshold at which employers are liable to make the payment to £5,000. This policy alone will account for £25 billion of that £40 billion – and Reeves will have judged that the inevitable debate about whether this is within the letter of the manifesto commitment is a price worth paying.

That was the stick. But there were carrots. The freeze in fuel duty will continue, much to the Treasury’s chagrin. The freeze on Income Tax and National Insurance thresholds – much criticised for causing “fiscal drag” – will be lifted in 2028. Pensions, too, largely escaped unscathed, aside from unused pension funds and death benefits payable from a pension being included in the value of estates, for inheritance tax purposes, from 2027.

Other tax rises paint a picture of a Chancellor that – having been caught off guard by the backlash to cuts to the Winter Fuel Payment – has engaged with industry and exercised caution. Thus, increases to capital gains tax are graduated, and carried interest will only go up to 32% pending further reforms. Business asset disposal relief, meanwhile, has not been abolished but merely decreased. (Agricultural relief on inheritance tax – a totemic issue for farmers – might probe more difficult, however.)

This was, of course, not just a Budget of tax rises, but of spending increases too. Moving the fiscal rules away from public sector net debt to public sector net financial liabilities is more than an accounting sleight of hand in that it gives Reeves approximatively £50bn of fiscal headroom, albeit for capital spending only. Reflecting some of that headroom as well as the wider growth ambition, the Office for Budget Responsibility (OBR) sets out that cumulatively, the policies in the Budget increase spending by almost £70 billion (a little over 2 per cent of GDP) a year over the next five years, of which two-thirds goes on current and one-third on capital spending.

Most of the real term increases in spending are over the next two years. They then settle down, leaving the size of the state settling down at around 44 per cent of GDP by the end of the decade, almost 5 percentage points higher than before the pandemic. The tax rises help meet around half of this sum, but, as the OBR sets out, “the other half of the increase in spending is funded by a £32 billion (1 per cent of GDP) a year increase in borrowing, one of the largest fiscal loosenings of any fiscal event in recent decades”.

The political narrative here is all about rebuilding after years of, as the new Government sees it,  Conservative neglect – £1.4 billion for rebuilding more than 500 schools in the greatest need, and, to roars from the Labour back benches, a huge boost to the NHS in the form of £22.6 billion extra money in day-to-day spending, plus £3.1 billion for capital spending. Importantly, it also means that departmental capital spending remains largely unchanged, and most government departments see a degree of real-terms growth in their budgets. Less than their Secretaries of State would like, but not as bad as many had feared.

The question is whether this additional government spending will lead to growth. Here the OBR is cautious, projecting real GDP of growth will be 1.1% in 2024, 2.0% in 2025, 1.8% in 2026, 1.5% in 2027, 1.5% in 2028 and 1.6% in 2029. In addition, the OBR warns of private investment being crowded out by fiscal loosening, and a reduction in labour supply stemming from the rise in employer National Insurance. Reeves will hope that these growth figures are on the cautious side, and that – as she put it – “investment, investment, investment” will deliver additional growth. Ensuring businesses are fully bought in to this ambition is likely to require many further months of painstaking work.

Making fiscal changes of this order of magnitude was always going to be a gamble. But this is a government with a commanding majority and time on its hands, and so in its view it is a gamble well worth making. Only time will tell. But, if the gamble pays off, and the economy starts growing again, this could be one of the defining Budgets of modern times.