More, more, more

This has been the most anticipated Budget of modern times. It had to wrestle with profound – and sometimes conflicting – challenges: fixing strained public services; repairing failing infrastructure; and breaking with the UK’s dire record on public investment. And all of this had to be squared with pre-election pledges not to raise the rates of any of Britain’s most important taxes.

In the event, the Chancellor has sought to find a way through by, first, increasing day-today resources for public services, and roughly covering this with a £41 billion tax hike – the largest on record. At the same time, she has decided to borrow more, mostly in order to reverse planned cuts in public investment, and has rewritten one of her fiscal rules in order to give herself room to do that. This is not without risks: the already-depressed outlook for family incomes redoubles the challenge of persuading the public to support the extra tax. Equally, while the economics of extra public investment are compelling, the politics are complicated by the fact that most of the return is recouped beyond the electoral cycle.

The latest economic news provided Rachel Reeves some modestly helpful context. This year’s growth has turned out to be 1.2 per cent, twice the rate the Office for Budget Responsibility (OBR) had expected at the time of the final Conservative Budget in March. But this improvement is very short term: looking ahead, and after making allowance for the various measures within the Budget, the watchdog hasn’t made any consistent alterations to its forecasts for future years. And after the spike of 2022-23, inflation is now firmly back in the normal range. But the fact it is now expected to run just-above, rather than just-below as in March, the Bank of England’s 2 per cent target over the next couple of years means a somewhat bigger cash economy which, on balance, eases the fiscal arithmetic slightly. Altogether, changes in the economic forecast since March have reduced overall net borrowing by a projected (and decidedly modest) £5 billion a year by 2028-29.

Many warning lights have long been flashing across the public services, including: a surge in Crown court cases not being heard in six months (up from 22 to 48 per cent since 2019); dwindling parental satisfaction with local primary schools; and nine councils, including Birmingham, effectively putting themselves ‘into administration’ by issuing socalled Section 114 notices since 2020. Although the previous Chancellor, Jeremy Hunt, had pencilled in annual real growth in day-to-day public service spending of 1 per cent through till 2028-29, once allowance was made for population growth and for political commitments to protect particular departments, such as Health, this modest total expenditure growth implied substantial fresh cuts in per-head resources for services elsewhere.

In opposition, Labour accepted the baseline provide by Hunt’s plans. In Government, the Chancellor and Prime Minister vowed “no return to austerity”, and the Budget has revealed the numbers implied by those words. Over the five years from 2023-24, day-today public service spending is now set for average annual real-terms growth of nearly 2 per cent, which means £44.1 billion more in real annual day-to-day public service spending by the end of the decade in current prices. This is the sharpest absolute increase since the 2000 Spending Review. But given the frail initial condition of public services, and the way in which a within-year overspend has already overtaken the plans, this looks more like a settlement for stabilisation than for transformation.

The front-loaded profile of the extra spending is striking. As well as confirming allocations for the current year (2024-25), the Budget gave us a new settlement for next year (2025- 26), and then established the ‘envelope’ for the following four years, within which the 2025 Spending Review will then settle allocations. Assuming the Budget plans stick, day-today departmental spending now grows in real terms by 4.8 per cent this year, 3.1 per cent next year, and by an average of 1.3 per cent over the following three years. This is a very different pattern from that seen in the early days of New Labour when extra spending started slowly and then picked up.

The picture will also vary dramatically across departments. At the ‘luckier’ end of the departmental table are Education (for which another £4 billion has been found) and particularly Health (£10 billion). Health’s share of day-to-day service spending will next year rise to 42 per cent of the total, against just 32 per cent back in 2010. The rises will then continue. Despite all the real and serious challenges of the NHS’s current performance, Health is unique among the departments in this respect: its per-person spending will be far higher at the end of this decade than it was at the start of the last.

What is pencilled-in across ‘unprotected’ departments is very different. Despite emergency relief for some departments next year (the Ministry of Justice, for example, will be 7 per cent up on 2023-24) the long squeeze on day-to-day spending of others – including Environment, Food and Rural Affairs, Culture, Media and Sport and Transport – continues through the early part of this Parliament. After that, there is likely to be a fresh squeeze: the Chancellor’s ‘envelope’ implies unprotected services collectively shouldering a further cut of £8 billion over the last three years of this Parliament. If it happens, their users might not accept that there has been “no return to austerity.”

The increase in spending would, absent action, have been sufficient to leave noninvestment spending outpacing revenues by the second half of the parliament, reaching a projected £26 billion by its final year. But this couldn’t be squared with the Chancellor’s prudent commitment to a ‘current budget’ rule, under which receipts must at least cover all expenditure other than investment, a rule she needs to plan to meet with some margin for error. Action was needed. She has pencilled in £41 billion a year of tax rises by the end of the decade – the largest tax rise relative to the size of the economy in any formal fiscal event on record. And with overall taxation already historically high, this pushes the total tax take up to an all-time high of 38.3 per cent of the economy in 2027-28, smashing the record set way back in 1948. Compared with our neighbours, however, we are still not exceptional: indeed, our taxes remain lower than those in France, Germany and Italy, although this Budget might see them exceed those in Spain.

Before the election, Labour pencilled in small specific tax rises (such as imposing VAT on private school fees) and various promises to clamp down on avoidance and close loopholes. The Chancellor has now dispatched with campaign caution, but her task in raising serious money is still greatly complicated by her previous promises not to raise the rates of VAT, Income Tax or National Insurance. She has used National Insurance to raise the single biggest slice of the extra money (an annual £26 billion by the end of the decade), but through contributions that are paid by employers, rather than formally incident on ‘working people’, around whom the manifesto pledges were couched.

National Insurance rates have already oscillated wildly over the past few years – Boris Johnson announced big increases, before his Conservative successors indulged in repeated and ultimately even bigger cuts. Now the new Government is suddenly reducing the earnings threshold at which employer contributions become due (from £9,100 to just £5,000), simultaneously increasing the rate charged (up from 13.8 to 15 per cent) while softening the effect on smaller businesses, by expanding the tax-free Employment Allowance.

National Insurance is a tax whose base is uniquely restricted to earned, rather than unearned income, and as such unambiguously a tax on work. The OBR assumes threequarters of this tax increase will ultimately be funded by employers squeezing pay. This change also increases the tax advantages of self-employment status, since there is then no Employer rate: already by last financial year, the total National Insurance due on self-employment was £6 billion less than it would have been on equivalent earnings. This disparity – and perhaps the temptation for bogus and unprotected forms of freelancing – will only grow. The public services whom the National Insurance rise is designed to rescue are themselves major employers: around £5 billion of the money raised has to be handed straight back to departments to relieve them.

On the OBR assumption that three-quarters of the extra employer National Insurance is eventually passed on in lower wages, we can assess the effect of this tax rise across the income distribution. The earnings of richer households attract a higher charge in cash terms. But when we look at the picture on a proportional basis, and also factor in indirect tax changes and benefit cuts – the means-testing of the Winter Fuel Allowance, and a commitment to cut £2.0 billion by tightening the Work Capability Assessment – there is no clear distributional slant to the changes. Indeed, in proportional terms, the hit to the best-off is slightly less than it is for others.

However, a host of other tax changes in the Budget which can’t readily be analysed in the same way are squarely aimed at the rich. The rate of Capital Gains Tax for most assets steps up in the direction of parity with Income Tax rates. The extra rate of Stamp Duty charged on additional homes is up from 3 to 5 per cent. Inheritance Tax relief for business and for agricultural assets has been capped at £1 million, with a new reduced rate of 20 per cent being charged on assets above that. Inheritance Tax thresholds are being frozen, and the growing loophole created by the exemption of inherited pension pots has rightly been closed. None of these measures is huge individually, but several remove distortions. Taken together, even if this Budget has not attempted any general effort to move the tax burden from work to wealth, they look like a non-trivial effort to ensure “those with the broadest shoulders carry bear more of the burden.”

The immediate outlook for real pay is far from rosy and, after this Budget, has worsened. From 2025, the two-year projection was – before yesterday’s measures – for total growth of a mere 0.5 per cent over two years, and 1.7 per cent over four. After the Budget, and particularly the rise in employer National Insurance, this becomes a two-year shrinkage of 0.3 per cent and four-year growth of just 0.4 per cent. Average earnings (when deflated by CPI) are forecast to end up in 2029 just shy of where they were in 2008.

The picture on overall household incomes is only a little brighter. The expectation is for average annual growth of 0.5 per cent over the Parliament. This is just above the recordbreaking low of 0.3 per cent registered over the 2019-2024 Parliament, but is otherwise the joint-lowest on record (matching the 2015-17 Parliament). The contrast between this bleak outlook and life under the 1997-2010 Labour governments – during which incomes rose by an average of 1.9 per cent – is stark.

There are particular concerns about what this stagnation of average living standards could be concealing for many vulnerable families at the bottom of the scale. The twochild limit continues to operate as a poverty ratchet, affecting another 63,000 children by April next year, likely the earliest plausible date for abolishing it in the context of the Child Poverty Strategy. And a failure to repeg the Local Housing Allowance to rents next year will contribute to a widening shortfall between the benefit and the housing costs they are designed to cover. We estimate that the average shortfall between rent at the lower end (30th percentile) and the allowance in the average area is already £14 per week, but far more in some places – over £60 in Inner London – and, absent regular indexation, this gap will only rise. Ongoing freezes in the household benefit cap are yet another feature of the system that leaves poor families vulnerable to inflation.

Other developments are pushing in a more positive direction. The National Living Wage is rising, and the Government has found some money to extend the Household Support Fund. The Treasury itself points to the progressive contribution of public services. That isn’t necessarily unreasonable: the experience of using public services is one aspect of living standards, and improving them is one way to raise it. But whether voters will be content that the stabilisation of services is adequate compensation for a continuation of the two-decades long squeeze on living standards remains to be seen.

The other big Budget judgment was to cancel growth-sapping public investment cuts in the inherited plans, and to fund this with borrowing. The cumulative effect is a £100 billion boost over five years, a welcome break from the UK’s usual pattern of low and volatile public investment.

This would have been impossible under the inherited fiscal rule, which committed to get a particular measure of public debt falling within a five-year period, and which was already close to maxed out. So the Chancellor decided to replace it, switching to a wider measure of the public balance sheet, Public Sector Net Financial Liabilities. The stated aim – as voiced in the Chancellor’s conference speech – is to recognise the value of assets that investment creates as well as the cost. But in fact, this measure only captures financial assets, created when the public sector makes loans or buys equity; it doesn’t credit physical assets like school or hospital buildings. Nonetheless, in current circumstances it turns out to create significant extra scope for borrowing to invest – a total of £21 billion relative to the old rules.

Using this scope means debt is now set to rise by 4 per cent of national income from 2024-25, which obviously comes at some cost in terms of interest and exposure to financial conditions. But this is a trade worth making. So long as the extra investment is sustained, in the very long-run the OBR estimates it will add 1.4 per cent to GDP.

But the move is not without problems. For one thing, even having rewritten this rule, the Chancellor is already pushing up close to its limits. She has only a £16 billion margin for error, almost a rounding mistake in the context of the stock of public liabilities and debts. For another, the big positive payoff on productive capacity is very long term. As late as 2029-30 the OBR estimates the boost will be as low as 0.14 per cent of GDP: in other words, the real reward is badly out of kilter with the electoral cycle.

This was a Budget that dispelled the previous fiscal fictions. The response has involved more spending, more tax and, ultimately, more borrowing. But it is also a Budget that takes place when families are already squeezed. Which means that while the Chancellor has made many hard choices, many other sharp dilemmas remain. The only way to soothe the punishing arithmetic of trade-offs is, as the Chancellor has previously argued, to raise Britain’s stagnant growth rate. Public investment is one big part of the puzzle for achieving that. But it won’t be adequate on its own. After this bold Budget, the other elements of the growth strategy – on skills, on planning, on industrial policy and more – are only looking more crucial.