In today’s discussion, I’ll focus on the figures 38.2 and 44.5. These are not random numbers but critical statistics related to our economic landscape revealed in recent discussions. The first represents the projected tax burden, defined as taxes as a percentage of gross domestic product (GDP), while the second signifies anticipated public spending as a share of GDP.

Before delving into their implications, it’s important to reflect on Rachel Reeves’s initial budget. Contrary to the chorus of critiques aimed at the Chancellor, one could argue that the budget displayed elements of boldness, creativity, and a transformative approach.

However, despite what Reeves and her team might hope to hear, I find the budget underwhelming when it comes to growth prospects—not solely due to a pessimistic new official forecast, but also because it further distorts the already complex tax system. It remains uncertain whether this represents a singular effort to address the pressing needs for future public spending.

The relevance of the 38.2 percent figure, indicating the anticipated tax burden for 2028-29 and 2029-30 (with a brief peak at 38.3 percent in 2027-28), is that it marks a historic high.

Historically, we often reference the tax burden as the highest since 1948, the year official records commenced. However, both the Office for Budget Responsibility (OBR) and I are inclined to believe these figures represent an all-time high. Tax revenues were notably low during World War II, contributing to the significant rise in national debt at that time. Comparatively, tax rates were much lower prior to the war.

The 38.2 percent forecast, as the OBR noted, exceeds the pre-pandemic tax burden of 33.1 percent by over five percentage points. This deviation starkly contrasts with the UK’s historical average tax burden of around 32 percent of GDP from 1948 to 2019-20. Although this period included lower rates from the mid-20th century, the average was approximately 33 percent over the first two decades of the 21st century.

Thus, we are entering a phase characterized by an unprecedentedly high tax burden, which does not, unlike in 1948, suggest a foreseeable reduction.

It’s essential to acknowledge where credit is due; a significant portion of this increased burden was left to Labour by the Conservative government. Under their plans, the tax burden was projected to rise to 37.1 percent of GDP. Reeves has added slightly more than a percentage point to this figure with approximately £40 billion in new tax increases. While other nations may maintain higher tax burdens, they typically offer better public services in return.

The method chosen by Reeves to implement these tax increases was particularly detrimental. Echoing Boris Johnson’s rhetoric on the impact of Brexit on businesses, the budget can be perceived as burdensome for enterprises. The increase in employers’ national insurance contributions is estimated by Make UK, the manufacturing organization, to impose an additional £1,000 cost per employee. Coupling this with a significant rise in the national living wage compounded the negative effects.

Research by the National Institute of Economic and Social Research indicates that the national insurance increase is likely to hamper job creation and elevate unemployment levels, while the Institute for Fiscal Studies (IFS) predicts that once broader implications—including impacts on jobs and wage levels—are factored in, the revenue from this adjustment will fall well short of the projected £26 billion. As a result, many public sector employers will be exempt from what would total a £5 billion increase in contributions.

The disparity created by the rise in national insurance is also concerning, generating a significant gap between employed individuals and the self-employed. According to the Resolution Foundation, an employee with a salary of £50,000 will pay £5,000 more per year in taxes and contributions compared to a self-employed individual earning the same amount.

The IFS expressed frustration regarding the Chancellor’s decision to refrain from reinstating fuel duty after the temporary 5p-per-litre cut initiated by Rishi Sunak. The current price of unleaded petrol is now 18p lower than this time last year and 65p below the 2022 levels when the emergency reduction was implemented. Ending the fallacy that duty increases correlate with inflation—something that hasn’t occurred since 2011—would have been a wise decision.

Fiscal policy encompasses both taxation and expenditure. The 44.5 percent figure pertains to the projected public spending relative to GDP for 2029-30, with an average of 44.9 percent anticipated in preceding years. This represents an unprecedented sustained level of public expenditure in history, rising from 39.6 percent at the onset of the pandemic, marking another five percentage point increase.

It’s important to clarify that while public spending is expected to constitute 44.5 percent of GDP, this does not translate to the state managing half the economy. Much of public expenditure consists of transfer payments—like pensions or welfare benefits—between taxpayers and recipients (with some recipients also being taxpayers). Last year, government spending and investment accounted for just under 29 percent of GDP, although this is projected to drive a significant portion of economic growth in the upcoming years.

Admittedly, some of this spending increase will fund heightened government capital investment, but not to any substantial extent. Public sector net investment is expected to be 2.4 percent of GDP in 2029-30, compared to 1.9 percent in 2019-20 and 2.6 percent in 2023-24, the last year under the Conservative government.

Reeves has managed to avert an anticipated drop in public investment, although this was hardly a budget characterized by aggressive investment initiatives, particularly when considering the expected decline in private sector investment.

The sectors emphasized in terms of investment—hospitals and schools—while necessary, are unlikely to substantially boost the economy’s growth rate when compared to other infrastructure projects. For context, in his initial budget in March 2020, just as the COVID-19 pandemic was beginning, Rishi Sunak aimed to elevate public sector net investment to 3 percent of GDP. Reeves’s targets are notably more conservative.

This caution stems from the need to account for increased day-to-day spending. Of the roughly £70 billion planned increase in expenditures, one-third is designated for capital projects, while two-thirds are aimed at ongoing operational costs.

Nonetheless, spending forecasts beyond 2026—projected to average a real increase of 1.3 percent annually, to be negotiated in next year’s three-year spending round—appear constrained. The government’s goal of enhancing public sector productivity must therefore assume a pivotal role in achieving these targets.

In summary, we recently encountered a significant budget proposal. It aimed to rectify public finances and help the UK escape a cycle characterized by underfunded public services, insufficient investment, low productivity, and an escalating tax burden that inhibits growth. Did it meet these objectives? The most charitable assessment is that it remains very much a work in progress.

PS

The market’s reaction to the budget has been somewhat volatile. The introduction of a new debt metric, known as public sector net financial liabilities (PSNFL)—rather disappointingly termed net financial debt—enables additional borrowing of around £30 billion annually.

This has led to speculation regarding how swiftly the Bank of England might lower interest rates—a consideration, along with the increased issuance of government bonds due to additional borrowing, which has contributed to a rise in government borrowing costs since the budget announcement.

The initial indicator will come this week. Before the budget, the Bank’s monetary policy committee (MPC) was largely anticipated to reduce the Bank rate from 5 to 4.75 percent on Thursday. I still believe this will occur, although the OBR’s revised inflation forecast indicates that inflation may hover slightly above the official 2 percent target until 2029.

If the Bank opts not to cut interest rates this week, and cites the inflationary consequences of the budget, it would be detrimental for the Chancellor. Market participants currently assign an 80 percent likelihood to a rate cut, a development that would be welcomed by the Treasury, although before the budget, the probability stood at 95 percent.

Shortly after the budget, I facilitated a webinar for the Mouradian Foundation featuring two former MPC members. Both experts expressed expectation for a rate cut this week.

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