(Bloomberg) -- Chancellor of the Exchequer Rachel Reeves may have to raise taxes again next year if growth fails to pick up because her spending plans are based on “fictions” much like those she inherited from the Tories, according to the Institute for Fiscal Studies.
In her budget on Wednesday, Reeves increased taxes by £40 billion ($51.6 billion) in the biggest single hike for 31 years and the second largest since at least 1970, taking the overall tax burden to a record high as a share of GDP.
Despite the increase, Reeves will meet her main fiscal rule by just a “razor thin” £9.9 billion, the IFS said. She will lose half of that if she continues to freeze fuel duty, as she did at the budget. Small changes in interest rates could eradicate the rest. On top of which, her current plans assume £9 billion of real-term cuts for unprotected departments that the IFS does not expect to be delivered.
“If they don’t get lucky on growth, it brings tax rises back into play,” said Ben Zaranko, IFS senior research economist.
On Wednesday, Reeves unveiled one of the most consequential budgets of modern times. Public spending will rise on average over the parliament by £70 billion a year, paid for from tax rises and a big increase in borrowing, as Labour looked to deliver on its manifesto promise to “rebuild Britain” by ending austerity in public services and invest for growth.
“The state has been growing and seems unlikely to shrink any time soon,” said IFS director Paul Johnson. Resolution Foundation research director, James Smith, said the record tax burden showed “the UK is pulling away from the anglosphere - Canada, Australia - and is now moving towards Europe.”
Both research firms questioned whether the implied cuts to unprotected departments beyond next year are realistic after years of austerity that has brought services from prisons to local government to crisis point. Similar criticism was leveled against the last Conservative government after it penciled in “impossible” savings amounting to £19 billion in order to meet its fiscal rules.
Despite the scale of the budget, living standards will stagnate as employers pass much of a £24 billion payroll-tax hike on to staff in lower wages. At the same time, households will be hit by higher inflation and interest rates than had been expected. “It would be the worst term for living standards under a Labour government,” the Resolution Foundation said in its budget analysis. Real weekly wages are projected to be just £13 higher by 2028 compared with two decades ago.
Warnings that some public services face more real terms cuts may ignite criticism that Reeves is ushering in another period of austerity. She will hope the economic outlook improves before she delivers a multi-year spending review next spring, allowing her to ease the pressure on government departments.
If growth does accelerate, Reeves will have to choose between pressing ahead with planned spending cuts, finding welfare savings or raising taxes. Johnson said the chancellor’s plans were an extension of the “spending fiction” of her Tory predecessors, using the “same silly maneuvers.”
“Let’s pretend we’ll increase fuel duties next time, but not do it this year. Let’s pretend that we’ll really rein in spending in a couple of years after splurging this year. That’s not going to happen. The spending plans will not survive contact with her cabinet colleagues,” he said. “There will be more to come from this chancellor.”
Speaking at a Resolution event, Richard Hughes, chair of the Office for Budget Responsibility, also suggested Reeves will need to find more savings to end the squeeze on unprotected departments. “There are a lot of unanswered questions about what happens in the rest of the parliament,” he said.
The Resolution Foundation said real household disposable incomes per person are set to grow by an average of just half a percent a year over the next five years, only slightly stronger than the increase in living standards during the last parliamentary term.
Prolonging a stagnation in real wages is fraught with political danger for Prime Minister Keir Starmer. The Labour leader was elected in July on a promise to revive the economy and improve struggling public services after 14 years of Tory rule, a period that included the country’s exit from the European Union, the pandemic and an energy-price shock driven by Russia’s invasion of Ukraine.
“With Britain finally turning the page on its longstanding failure to invest thanks to a £100 billion boost to public capital spending, the hope is that this short-term pain will eventually turn into a long-term living standards gain,” said Mike Brewer, interim chief executive of the Resolution Foundation. “But if it doesn’t, future Budgets won’t be any easier to deliver, especially if further tax rises are needed.”
--With assistance from Irina Anghel.
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