Heading in to this week’s Labour party conference in Liverpool, the Chancellor admitted that the economic outlook is “very uncertain” ahead of the Budget in November.
On Friday the official watchdog, the Office for Budget Responsibility (OBR), will submit its first estimates of the trajectory for the UK economy and public finances over the next five years.
At the Spring Statement in March, the Chancellor had £9.9bn of “headroom” against these rules – low by historical standards – and is likely to seek to retain a cushion at least that large in this Budget.
Ruth Gregory of Capital Economics estimated that the public finances had deteriorated by up to £38bn in total – which would force Reeves into a tax-raising Budget as big as last year’s if she wanted to keep the same headroom.
Rachel Reeves with Sir Keir Starmer in May (Photo: Justin Tallis/Reuters/Getty)
The OBR has been working on a review of how it forecasts future growth in productivity – the amount of economic output from each worker – after several years in which its estimates proved repeatedly too optimistic.
“The biggest one is what is going to happen to GDP growth over the next few years,” Gregory Thwaites of the Resolution Foundation said. “The OBR is pencilling in a much stronger recovery over the next few years, and you don’t need a big change to that to see a big downgrade in the public finances.”
Cuts to immigration could also drag down growth projections – Capital Economics estimated that if the UK receives fewer migrants as Sir Keir Starmer has promised, the public finances will suffer to the tune of £6bn.
Efforts to curb migration to the UK could drag down growth projections (Photo: Sameer Al-DOUMY/Getty)More expensive borrowing
The precise dent in the public finances created by more expensive borrowing costs is uncertain, as there are likely to be several more weeks before the OBR takes its final reading of the markets to determine the assumptions it will use in its forecasts.
Ben Caswell of the National Institute of Economic and Social Research (Niesr) said: “Markets think that the UK’s economic and fiscal outlook is a little bit less certain than it was in the past, so they are charging a bit more to lend.”
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The combined cost of restoring winter fuel payments to most pensioners and scrapping planned cuts to disability benefits is around £6bn a year.
Caswell pointed out that ramping up GDP growth would be the least painful way of resolving issues such as these, saying: “If you had really, really strong growth of 2 per cent, then a lot of these conversations about borrowing costs or welfare would go away.”
Extra spending plans – fuel duty to two-child cap
One of these is ending the two-child benefits cap, which would cost around £3bn a year – although a compromise, which could see the cap ended only for families with a parent in work, would be cheaper.
Allowing the levy to rise by 7p per litre of petrol or diesel would be highly politically controversial but would avoid the need for Reeves to find savings adding up to nearly £5bn over the next five years.
The Government has also committed to raising defence and security spending to 5 per cent of GDP by the middle of the next decade, but has not explained how this will happen. Adding this spending to the upcoming Budget would cost £36bn a year, according to the IFS.
How to limit the tax hit
One factor is that the Chancellor may be able to promise lower growth in Government spending from 2029 onwards, which would help the public finances but would not require her to explain how it would be achieved until a spending review takes place at a later date.
Reeves told The Times that a “reset” of relations with the EU should help the economy. She said: “We also want the OBR to score that because when we left the European Union, the OBR said that our economy would be 4 per cent smaller as a result. As a result of that reset in May, we think the economy will be stronger.”
A Treasury spokesman said: “We do not comment on speculation on the budget or around the OBR forecasts. The OBR will publish its independent assessment alongside the Chancellor’s statement in November.”
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