The Treasury’s working assumption, ahead of receiving the first official set of forecasts from the Office of Budget Responsibility (OBR), is that taxes will have to be increased by £30 billion in the budget on November 26.
A full two-thirds or £20 billion of those rises can perhaps be viewed as bad luck for the government and for taxpayers, because they stem from a summer review by the OBR of the supply-side of the economy, or the UK’s potential to grow.
The official forecaster has been conducting an evaluation of productivity growth during the Tory years of government and has concluded that its assumptions about future productivity growth – that is output per hour worked – are too optimistic.
The working assumption in the Treasury is that the OBR will lower its forecast of future potential productivity growth so that it would be more in line with the Bank of England’s more pessimistic outlook.
Each 0.1 of a percentage point reduction in future annual productivity growth reduces the so-called headroom in the chancellor’s fiscal rules, such that she would need to raise taxes or cut spending by just under £10 billion a year.
The OBR’s downgrade is expected to be around 0.2 of a percentage point. That requires £20 billion of tax rises.
On top of that, another £5 billion needs to be found to compensate for the revenues lost when Labour MPs rebelled against proposed cuts to disability benefits, and a further £5 billion is required to cover interest costs that are higher than predicted.
There is zero chance of spending reductions being found to cover the shortfall so a very significant £30 billion of tax increases are needed.
The nightmare for the chancellor and prime minister is they will be blamed for the inevitable tax rises. However they are victims of the OBR’s decision to reassess past productivity performance over the summer.
Within government, there is deep – and many would say understandable – frustration that the OBR didn’t conduct this productivity reassessment straight after the general election of July 2024, more than a year ago.
That would have allowed the consequential revenue losses to have been factored into the last budget.
Reform and the Tories will attack the Labour government for not doing more to revive growth, such that revenues from existing taxes would be more buoyant.
And it is true that employment reforms and the employers’ national insurance increase represent cost increases for businesses that are antithetical to growth.
But the sluggish growth of productive potential captured in the OBR’s new evaluation largely reflects the Tories 14 years in office, rather than measures taken by Labour.
Per contra, the big question is whether the government’s push to build more housing, transport links and infrastructure, coupled with planning reforms that may shortly become more ambitious, will ultimately lead to growth that exceeds the OBR’s expected new forecast.
One consequence of the £30 billion public finance hole is that the chancellor and Treasury are not yet in a position to commit to end the two child limit on universal credit payments – the anti poverty measure most wanted by Labour MPs – because it would require Rachel Reeves to find another £3.5 billion.
There will be no announcement about the two-child limit at Labour conference next week, though it may yet be abolished later in the autumn.
As government sources said to me, it will be hard enough identifying £30 billion of tax rises that don’t weigh too heavily on growth, without breaching manifesto pledges not to increase income tax, national insurance, VAT or corporation tax.
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