The Prime Minister Andy Burnham and Chancellor John Healey have been warned by a senior economist that further tax rises in the Budget next month could stifle economic growth and that “getting lucky isn’t a plan”.
Professor David Miles, a senior economist at the Office for Budget Responsibility, also warned people were not ready for spending to be cut on public services.
The warning, a month before Healey delivers his first Budget, is all the more significant because the OBR’s forecasts underpin the Chancellor’s plans for the public finances, and will put further pressure on him to limit any increase in the tax burden.
Healey is widely expected to raise taxes – outside of Labour’s manifesto commitment not to increase income tax, national insurance and VAT – on 28 October, as he tries to meet the government’s fiscal rules to pay down debt and pay for day-to-day expenditure from tax receipts rather than borrowing.
But a gloomier economic outlook, due to the closure of the Strait of Hormuz because of the war in Iran and higher than expected borrowing costs, has cut Healey’s fiscal headroom – the amount left to cushion against future economic shocks – from £23.6bn in Rachel Reeves’ spring statement in March to around £15bn.
The Financial Times reported on Thursday that the Chancellor is considering reducing this financial buffer in order to avoid extensive tax rises.
Speaking in New York this week, where he was attending the UN general assembly, Andy Burnham said the government had to “make sure we get the balance right” on taxation adding: “We have had two budgets in 2024 and 2025, and we have to be conscious of the extent to which we have raised revenue”.
UK on an unsustainable path
At a policy conference at Imperial Business School on Thursday in comments first reported by City AM, Miles warned economic growth could be hit if the current tax burden was added to.
The OBR economist said “one of the great fiscal problems” and an “explanation” for the rise in debt was that the “public have not lowered their expectations about what the state can do for them and the level of public services in line with the reduced resources which come about as a result of productivity having been so bad”.
He also said that current tax and spending policies set the UK on an unsustainable path for debt levels.
A forecast by the OBR said current policies and welfare spending would take public debt to about 270 per cent of GDP by the mid-2070s.
Miles said: “Can we carry on in the UK setting policies in the way that it has been set and is set right now for decades to come and everything will probably be alright? To which the answer is very likely not, it would not be alright.”
He added that “getting lucky isn’t a plan” for economic growth, and the Chancellor couldn’t just wait for a productivity boom to fuel growth to ease the public finances.
(A) strategy is simply to say ‘well, let’s just hope something good turns up’, but if it doesn’t we’ll have to do something drastic maybe 25 years from now in 2051. But that would be an extraordinarily extreme tightening in fiscal policy, some combination of drastic cuts in public services and also big increases in taxes and in a sense you wouldn’t want to be around then if you could avoid it. I think I’m sure I won’t be.”
Outlining his concerns about tax rises, Miles said that a rise in the tax burden beyond the current historic high of 37 per cent of GDP could lead to additional costs on incentives in growth.
He said: “There is a question about what extra cost you pay in terms of incentive distortions and the efficiency with which people operate an economy.
“The cost of increasing taxes goes up with the square, so it’s not a straight line, it’s exponential.”
Healey, who resigned as defence secretary in June in protest at Sir Keir Starmer and Rachel Reeves’s failure to commit to 3 per cent GDP spending on defence by 2030, will also be forced to fill a £4.7bn black hole in funding the Defence Investment Plan over the next four years.
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