Paul Diggle

Hello and welcome to Macro Bytes the economics and politics podcast from abrdn. My name is Paul Diggle

Luke Bartholomew

And I'm Luke Bartholomew.

Paul Diggle

And today we are talking about the UK autumn budget, which was announced on the 30th of October. It's the first budget from the Labour government and from Chancellor Rachel Rees, and it was a big one. New fiscal rules, over 40 billion pounds of annual tax increases, even bigger day-to-day spending increases, a 100-billion-pound rise in public investment over the next five years, and a percentage point of GDP increase in UK government borrowing. So, it was a tax and spend Labour budget consistent with a larger state. But will it achieve Labour's political and economic goals of raising growth, alleviate pressure on public services, all while keeping voters, businesses and markets onside?

So, there's a lot to discuss. And Luke and I are joined by Lizzy Galbraith, political economist here at abrdn. Welcome, Lizzy.

Lizzy Galbraith

Thanks for having me back.

Paul Diggle

So, because we're economists, let's start by talking about the shiny new fiscal rules. Lizzy, what are the new fiscal rules?

Lizzy Galbraith

Yeah. So, as you mentioned, we have two new fiscal rules. So the first of these is a stability rule, as the government is calling it, which requires the current budget, which is day-to-day spending for the government to be balanced within three years from 2029/2030. So that's a bit of a stricter rule than the previous government used. They used a five-year horizon to balance day-to-day spending. So this is a little bit tighter than we've seen previously.

And the second bigger change is the investment rule which requires public debt as a share of GDP to be falling within three years, again, not the previous five. But more importantly than that change is that the definition of public debt has changed. So we're now using Public Sector Net Financial Liabilities - or the ‘persnuffle’ calculation - which takes into account some of the benefits of public investment as well as the costs, particularly things like student loans. So this is a more relaxed rule than the previous government used. And Rachel Reeves has used this to quite significantly increase government borrowing for capital spending.

Paul Diggle

Great Luke - economically, fiscally speaking, are these good rules? Are they improvements on what went before?

Luke Bartholomew

So, I think starting with the stability rule, it's probably fair to say that that is a sensible change. It captures the idea that you don't want to be borrowing to fund day-to-day spending. Putting it on a short horizon helps to project an image of fiscal rectitude and responsibility as well. The long run comes just that little bit sooner under the new framework, even if you know fundamentally the point at which the rule binds is forever in the future, it's rolling, so it may never actually be met in practice.

And then, as for the investment rule I mean as Lizzy says, a key feature of it I suspect as far as the government is concerned, is that it does provide significantly more headroom to investors – debt on the ‘persnuffle’ measure does fall more quickly. But I think there are also reasons to think it is better economically as well. It removes some of the incentives to game the system a little bit, in the sense that there's no longer a benefit from selling off government financial assets, such as the student loan book, and perhaps it better reflects the fact that there are benefits to be gained from investment as well. And it stops short of going all the way to a public sector net wealth rule, which would have made the UK something of an outlier compared to other countries in their fiscal rules, and perhaps quite difficult to operationalise in the short-term as well.

I mean, that being said, the thing with the ‘persnuffle’ rule is perhaps it's a little bit less useful from the perspective of capital markets, because the virtue of the old Public Sector Net Debt rule was that it measured quite directly what the government owes to investors and therefore about the ability to access capital markets and service that debt. And it was also true that ‘persnuffle’ can be impacted by big changes in discount rates as well, which would affect the value of government financial assets. So, it's not perfect, but I think on balance it is an improvement.

Paul Diggle

So the Chancellor spent a long time in this budget talking about tax increases, 40 billion pounds of tax rises annually by the fifth year of the forecast rise, and that's the largest tax rising budget in at least 30-years. And UK tax take as a share of GDP is now going to reach all-time highs of 38% five years from now. Lizzy, let's talk a little about the politics of where those taxes were directed. I mean who did they fall upon? What parts of the economy did they fall upon, and why did Labour make those sort of choices?

Lizzy Galbraith

So I think you can broadly describe the targets of these tax increases as being businesses and then to a lesser extent higher earners as well. So in the sense that, you know, people are describing this as a classically Labour budget, that's probably true to a certain extent. There’s clearly a preference Rachel Reeves has here to avoid cutting government spending too much and using borrowing and tax, particularly these targeted tax rises, to do some of the heavy lifting here.

Now the big tax increase is actually on businesses. It's the employer contributions to National Insurance. We've seen a 1.2% increase on those, but also a lowering of the threshold for eligibility to 5,000 pounds. And the OBR is projecting that that initially raises 25 billion pounds. So over half of this total tax increase is actually done by that single tax.

And I think the reason that we've seen the government go effectively all in on one very big tax increase is because prior to the election they had really boxed themselves in and ruled out the big revenue raisers for potential tax increases. So they'd already said that they were going to avoid increasing, you know, income tax, employee national insurance, VAT and corporation tax - and that takes away, you know, 70% of the total tax take, which left them in a position where, you know, we got one very big tax increase and then some of these other smaller tax increases on top to make up the difference. And those are mostly around increasing capital gains tax and increasing some eligibility for inheritance tax as well, removing some of the previous exemptions there. So for certain individuals, quite a consequential budget but avoiding middle and lower earners, at least directly.

Paul Diggle

And Luke, so the Chancellor obviously very explicitly took the decision to raise taxes, raise spending, lead to a bigger state. Was the design of the taxes good? Are these kind of optimal taxes - fiscally and economically?

Luke Bartholomew

Well, perhaps the first thing to say is whilst this is a significant tax increasing budget it's not really a significant tax reforming budget. It hasn't, you know, gone about trying to reform the tax code to sweep out inefficiencies or to boost potential growth in a more systematic way. But putting all that aside, which is perhaps too high a bar to ask for, I mean, I think from a straight, clean economics perspective, the easiest way to go about raising some revenue would have simply been to reverse the previous government's National Insurance cut. You know, in retrospect, and perhaps even at the time, that does look a little bit like fiscally salting the earth for the next government. But of course, as Lizzy described there Labour boxed themselves in on that, made it politically very difficult to do that, and hence that they raised the employer contribution of National Insurance. I mean, I think from an economics perspective, whilst that notionally falls on quote unquote ‘businesses’, what we're typically interested in is the final incidence of taxation, where it truly in the end falls. And I think there are good reasons for thinking that, where this tax is ultimately felt is probably in employees, but it's felt in the form of lower wages than they otherwise would have been, rather than directly as item on your tax bill. But that is nonetheless still very much a real cost.

I think one worry you might have about this particular tax increase is the way in which it interacts with another aspect of the budget, which was, a chunky increase once again in the minimum wage. And it is certainly true that we've gone through quite a few increases in the minimum wage up to this point, that haven't seemingly had a huge impact on employment. But there's always the concern that as you put up the minimum wage, making it more expensive to hire low wage people and then also put taxes on that as well you're doing quite a lot to damage incentives to employ this part of the wage distribution. Now, there was a positive spinning of that, I suppose, which is that it helps incentivise investment in capital formation to automate certain low wage jobs and that could boost productivity. But at the same time, it probably could close certain people out of the labour market and increase the so-called natural rate of unemployment as well.

And then finally, on capital gains tax, I mean, sometimes the concern with that is that you end up disincentivising investment and capital formation and so long-term growth. And moreover that is a tax that is quite easy to avoid. Capital tends to be extremely mobile, or you can time the disposement of assets around that in a more tax efficient way. And so, I think that's part of the reason why the increase in capital gains is a fair bit smaller than had previously been talked about, that it is quite difficult to raise much further revenue from capital gains if you push up that rate much beyond where we are at the moment.

Paul Diggle

And Luke, given the Chancellor's headroom against the stability rule, the balanced budget rule, is very tight, is there a risk of more to come on the tax front down the road?

Luke Bartholomew

I think the short answer to that is yes. In fact, the OBR go so far as to say there's a nearly 50% chance of that. I mean, that's a rather heroic quantification of the chance, given all the assumptions there have to be on that. But the broad reasons why you might expect there to be a fair degree of slippage and the need to come back for more tax increases are pretty clear. First, because the fiscal projections are extremely sensitive to gilt yields, the government borrowing cost, with debt levels so high, even relatively small changes in government borrowing costs can lead to quite significant fiscal implications. Indeed, gilt yields are already a fair bit higher than when the OBR wrote down its forecast a few weeks ago, and that's mainly due to global reasons that interest rates have sold off. But it just goes to show the sensitivity of those projections. And it's, you know, certainly plausible that interest rates are a fair bit higher than current market prices in a few years’ time.

Second, what's baked into the OBR’s numbers are an increase in the fuel duty eventually kicking in, not next year, the year after. But as the budget showed, the politics around that mean that there's a at least a pretty decent chance of that never ends up getting delivered. Another reason is that the Chancellor sort of boxed herself in again, when it comes to perhaps an easy stealth way of increasing revenue, which is to continue with fiscal drag, that is, keep the tax thresholds in place past 2028 and allow inflation to naturally increase revenue that way. She's quite explicitly gone out of her way to say that fiscal drag in that way is going to end. And so that might create some problems.

And then finally, the 1.5% real terms increase in day-to-day spending that comes through in the second half of the forecast horizon is pretty tight, especially once the protected departments are accounted for. It might be quite difficult for that, both politically and materially, to stick, that there will be a need to come back and have higher increases in spending and that will need ultimately financing with higher taxes.

Paul Diggle

And Lizzy, on the topic of spending then. So let's start with the day-to-day spending increase - the 1.5% real terms increase that the Chancellor has penciled in. Where is that going and where’s it not going?

Lizzy Galbraith

So I think first of all, it's important to say that actually if you look at the spending plans year- on-year it is a bit of a roller coaster. They're very heavily frontloaded, so it's not an evenly spaced increase across this Parliament. Real terms increase in day-to-day spending is actually 4.3% next year, but it then starts falling year on year until we get to the end of Parliament, where it's only 1.3%. So there's a very big frontloaded increase here. And the big winner, as you may have expected, is the NHS. Budgets are going to be increased there by 3.6 a year consistently over this Parliament. So they're the only budget where you've seen quite a big increase and that increase is then consistent year-on-year. Other departments have a bit of a cliff edge in 2026 where they've benefited from this initial quite big increase, but then that falls away quite significantly, particularly for those unprotected departments, as Luke mentioned, which are really everything outside of education, health and defence at the moment at least. So under current plans, Rachel Reeves actually would need 9 billion pounds of additional spending by 2028 to avoid real terms cuts to those unprotected government departments. But yes, in the short term at least, very good news all round. By the end of Parliament, it may well feel a little bit, tight again and we may need to see some top ups.

Paul Diggle

And then in addition to this day-to-day spending increase, there's also been at least 100 billion pounds of extra investment spending, which is the space freed up by the change in the investment rule towards ‘persnuffle’ giving her more space to spend to invest. So 100 billion pounds, around 25 billion per annum by the fifth year of the forecast period. What's that going to be spent on?

Lizzy Galbraith

So this we know slightly less about because the detail will be contained in the spending review that's forthcoming. That's not going to be published until next spring. And that's when the government delivers sort of detailed spending plans. Traditionally it has been held on the same day as the budget, but given the timing of the election and this fiscal event, they've been separated. So we have a bit of a delay in working out exactly what this money is going to go on, but we do have a decent idea. Rachel Reeves has given us some pretty strong indications of where that money is going to go. Some of it does go on increasing capital spending for government departments themselves. So again, the NHS is a fairly big beneficiary of an increase to its capital budget. But a lot of it is also going to go on things like transport networks. So particularly trains, improvements to the rail network and improvements to roads as well. And then we get into some of Labour's manifesto commitments. So an increase to green industrial project spending, for example, housing investment also seems to be a target for investment. And in funding some of these, capital delivery arms as well. So things like the National Wealth Fund and GB Energy. This is where that money is going to come from. So still a little bit of detail to be worked out here - and again, very front loaded. So, two years of very big increases in the capital budget before it starts tailing off again. So there are questions, I think, over whether the government can actually get this money out the door in the time frames it's given itself. But, certainly, a very significant increase going forward.

Paul Diggle

Luke, this Labour government is ultimately going to be judged on its impact on UK trend growth. I think the Chancellor, the Prime Minister, have really said that that is basically commitment number one of this Labour government. How should we think about the potential growth impacts of this budget?

Luke Bartholomew

So this does represent fiscal easing relative to the fiscal path that had previously been outlined in other budgets, written down by the OBR and indeed baked into the Bank of England's forecast as well. Even if it is true that actually fiscal policy over the next five years on net does tighten in the sense that, the change in the cyclically adjusted primary balance is actually negative, but all else equal, this adds to growth compared to the previous set of fiscal assumptions. As Lizzy has described, a lot of the rises kick in almost immediately - the biggest over the first couple of years or so. So the OBR has incorporated the biggest growth impacts in 2025 and 2026, in the order of maybe about half a percentage point or so on growth. But then over the full forecast horizon, that growth impact fades and indeed turns negative in the later years. And I think that gets at quite a fundamental point, which is that easing fiscal policy doesn't boost growth on a sustained basis in a full employment economy. All it does is changes the composition of activity. The state gets bigger and some of the private sector gets crowded out. And the mechanism by which that occurs is that the structure of interest rates has to stay higher than it otherwise would have done, which, you know, that's still probably bank rate falling, just falling less quickly, gilt yields being higher perhaps than they otherwise would have been. And that's, you know, also reflected in our own forecasts for the Bank of England as well, where it does look like a rate cut in November is pretty much nailed on, but we expect monetary policy to continue to be eased quite gradually after that, in line with that changing fiscal policy. Now looking beyond the forecast horizon, it is plausible that some of the investment spending that the Chancellor has announced has the potential to boost, growth on a more sustainable, lasting basis, although that does take some time to kick in. And the Chancellor quite explicitly asked the OBR to look into that. And, you know, whilst it's past their forecast horizon, they were able to gesture to the idea that sustained investment spending would tend to boost productivity and potential growth. But most fundamentally, you know, the way in which Labour will get to its 2.5% growth goal is not through fiscal policy. You know, you get some maybe benefits from increased investment, but really the real prize if potential growth is going to be boosted is through planning reform, other aspects of the industrial strategy, perhaps maybe closer relationships with the EU as well, but most fundamentally is on planning and energy policy. And of course, that wasn't scored in this budget, but that really is where the action has to be in terms of Labour achieving its growth objectives.

Paul Diggle

Well, after we recorded the episode on Thursday morning the UK gilt market sell-off has gathered pace somewhat. As we release the podcast today on Friday morning 10-year gilt yields are up about 25 basis points from the point the Chancellor stood up to deliver the budget and the market doesn’t like the size of tax rises, spending increases and higher borrowing – which as we discussed on the episode were all larger than expected. Crucially, market pricing is having to incorporate that the near-term growth impact may mean a slightly higher path for Bank of England interest rates and over the full 5-year forecast horizon the OBR doesn’t actually credit the budget with having particularly strong positive growth impact at all. As we said, most of the lasting growth benefits from investment spending in particular take longer to accrue and the market may be dubious they’ll ever come through. And subsequent market moves could indeed have wiped out the very narrow fiscal space the Chancellor has against the rules, making further tax increases or higher borrowing a distinct possibility. Nonetheless, the gilt market is still half the major reaction to the 2022 Truss / Kwarteng mini budget and the next week or so is going to be critical to whether the budget is remembered as a one-off set of big painful decisions with a potential long term political and economic pay-off, or as another UK fiscal policy error. And of course, in the next week we have the US election which may end up being a big driver, not just of the UK gilt market but all global markets.

And that is indeed what we're going to be speaking about on the next episode of Macro Bytes. Until then, please like and subscribe to the podcast on your platform of choice. We'll be back soon with more economic and political analysis. Until then, goodbye and good luck out there.

This podcast is provided for general information only and assumes a certain level of knowledge of financial markets. It is provided for information purposes only and should not be considered as an offer, investment, recommendation or solicitation to deal in any of the investments or products mentioned herein and does not constitute investment research. The views in this podcast are those of the contributors at the time of publication, and do not necessarily reflect those of abrdn. The value of investments in the income from them can go down as well as up and investors make it back less than the amount invested. Past performance is not a guide to future returns, return projections or estimates, and provide no guarantee of future results.

นักลงทุนทั่วไป

transcript

เรื่องราวที่เกี่ยวข้อง

บทความที่เกี่ยวข้อง

What does 2025 hold for macro and markets?

Five macro themes to watch in 2025

The Monthly Macro Outlook Video - December 2024

Global Economic Outlook: What is the impact of Trump 2.0 on the global economy?

Will the bond vigilantes return?