All eyes are on Rachel Reeves this week, as she responds to updated fiscal and economic forecasts from the Office for Budget Responsibility (OBR) in her Spring Statement. Her range of options are unpalatable, and there is fevered speculation on whether she will miss her fiscal rules, cut spending or raise taxes. Is it possible to make any predictions?
Although the general prognosis for the OBR forecasts is gloomy, the Institute for Fiscal Studies points out that missing the fiscal rules is not inevitable: “There are a huge number of moving parts, recent economic data paint a mixed picture, and much will depend on the OBR’s judgements about future economic developments. The chancellor may yet get lucky. But she may not.”
The problem is that most economists believe she will not be lucky. It is largely accepted the OBR will halve its growth predictions for the next year from 2% to 1%. This will have a knock-on effect on the fiscal headroom of £9.9bn that Reeves had built into her previous plans.
The cost of borrowing continues to be a significant problem. Gilt yields have been edging higher, with the UK 10-year yield now 4.7%, up from 4.6% at the start of the year. There is a glut of bond issuance coming down the track. The market will need to digest £308bn in debt sales next year, according to a range of investment bankers surveyed by the Financial Times. This is about £10bn higher than the figure set out in the October Budget.
Neil Mehta, portfolio manager, RBC BlueBay AM, said: “Since the previous budget, key economic variables that form and alter the fiscal picture have moved against the government, forcing the chancellor to find savings, to the dismay to many of her colleagues and at a time when the rest of Europe is expanding its balance sheet in respect to defence and security.
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“The problem lies in that we think these key economic variables: borrowing costs, inflation, growth, will continue to work against her fiscal rules into the Autumn. This could force even more excruciating decisions, such as tax rises, as economic choices dwindle, and political uncertainty rises even further.”
That said, there are more optimistic signs: tax receipts are up, for example. HMRC’s last tax statistics before the Spring Statement showed the tax take up £11bn compared to the same time last year, according to accountancy group Blick Rothenberg.
Tom Goddard, senior associate at the group, said: “The increase is in part due to fiscal drag pushing ordinary workers into higher tax rates as a result of frozen tax bands. Total income tax receipts are actually up £1.65bn. This shows that as wages continue their upwards trend everyday workers are being subjected to higher tax rates on their employment income.”
VAT receipts have gone up by about 15% over the past two years as inflation has driven up the underlying prices on many VAT-able products and services over the past 24 months. Corporation tax receipts are also rising.
Changes afoot?
Assuming the chancellor doesn’t get lucky and needs to make changes, what are the likely targets? Freezing the tax bands beyond the current end point of 2028 is the most likely option.
The IFS said this could raise around £10bn in 2029–30: “A further threshold freeze would be a stealthy and arbitrary means of raising revenue, but it is – not unrelatedly – a tax rise that recent governments have proved willing and able to implement, and so may be judged as credible.”
Whether it fulfils the promise of ‘no tax rises’ offered by the chancellor in a recent article for The Sun is more debatable. Hargreaves Lansdown points out the impact of frozen tax bands has already been fairly nasty. In the current tax year, there are a 4.4 million extra taxpayers thanks to the freeze, and 1.88 million more higher rate taxpayers.
Welfare reforms have already been well-flagged, as have cuts to the Civil Service. There are questions over whether it will raise as much as expected, but markets are likely to welcome this as a way to halt the burgeoning benefits bill, and make government departments more agile. As it stands, the benefits cuts are likely to save £5bn, and the Civil Service cuts £1.5bn.
Boosting the stockmarket
There are also questions over whether the chancellor will announce progress on any of the schemes to boost investment into the UK stockmarket. There had been some talk of cuts to the cash Isa allowance, but research by AJ Bell suggests this might not have the desired effect. It found that more than half (51%) of cash Isa savers would simply park their money in a taxable cash savings account if they couldn’t put it in a cash Isa.
By contrast, only 20% said they would put their money into the UK stockmarket if they couldn’t put it into a cash Isa. Speculation has gone quiet in recent weeks, suggesting planned changes may have been abandoned.
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Many are hoping the chancellor will announce further details on the potential use of defined benefit surpluses. Done right, this could give the UK stockmarket a much-needed shot in the arm and help build on its momentum since the start of the year.
Tom Selby, director of policy at AJ Bell, makes the case for getting rid of stamp duty. He said: “Levying 0.5% stamp duty on UK shares is completely at odds with the government’s stated aim of encouraging greater levels of retail investing in the UK. If Reeves wants to put the country’s money where her mouth is when it comes to backing Britain, she could do away with this obvious disincentive for investors to buy UK companies.”
However, he admitted this would require the Treasury to forgo several billions pounds a year in tax revenue and “the optics of slashing welfare payments while also cutting taxes for investors may be too difficult for a Labour government to navigate”.
In the end, the chancellor may scrape through the Spring Statement without having to make too many changes, with the budget balanced through tweaking spending and freezing tax bands. However, whether this can work in the long term is debatable, and economists may be having a similar conversation in six months’ time.
