IN FOCUS6-8 min read

Spring Budget 2024: what it means for the UK economy – and the next government in waiting

The Budget may have disappointed many, but it is important in at least one sense: another government is likely to have to manage its policy outcomes

08/03/2024
UK budget response hero image

Authors

Azad Zangana
Senior European Economist and Strategist

With a general election expected later this year, Chancellor Jeremy Hunt’s Budget was particularly important, not only as a tool to boost his party’s dwindling support, but also in its impact on future economic and fiscal policy. Given the strong lead that the Labour Party commands in opinion polls, the management of this policy is highly likely to become the responsibility of Shadow Chancellor Rachel Reeves and her team. In what state will Labour find the economy and public finances, and how might this impact the party’s plans for fiscal policy?

The Budget’s three key policy changes

This was no ordinary budget. Hunt’s speech was lengthy relative to the number of announcements made, and it was highly political in nature, with a clear intent to draw the battle lines ahead of the general election. However, the Spring Budget can be summarised with one word – underwhelming. All the headline policy changes had been ‘strategically leaked’ to the press ahead of the announcements, meaning that the “rabbit out of the hat” moment was missing. The three most significant changes are as follow:

  1. By far the biggest policy change is the two-percentage point to cut to national insurance contributions (NICs) for employees and most of the self-employed – costing approximately £10 billion (or 0.4% of GDP) per annum from April 2024 onwards.
  2. The decision to again cancel freeze fuel duties extend the temporary five pence cut for another year are expected to be worth £3.1 billion in 2024/25, and a further £800 million per year from there on.
  3. The introduction of a less generous new tax regime for “non-doms” is expected to raise approximately £3 billion per year, but only from 2026/27.

There were other smaller tweaks and fixes, but they were fairly minor in comparison to the measures listed above.

A better outturn for tax receipts, and lower interest payments, meant that going into this fiscal event the independent Office for Budget Responsibility (OBR) would lower its forecast for annual government borrowing by a total of £30.3 billion from financial year 2024/25 to 2028/29 (chart 1). Overall, the Chancellor’s new measures not only use this additional headroom, but go further, with the cost of measures (including indirect effects) totalling £39.8 billion (1.3% of GDP). Just under a third of the fiscal stimulus is spent in the next financial year, clearly targeting the general election.

Fiscal headroom

Budget’s economic outlook and implications

Despite shouts from the opposition, the Chancellor neglected to mention the recession that the UK economy is currently experiencing, or that GDP growth for 2023 turned out to be half of what was forecast in the Autumn Statement only four months ago. The Budget is therefore starting from a weaker position, although economic growth is forecast to recover a little faster.

The OBR forecasts real GDP to grow by 0.8% in 2024 before accelerating to 1.9% in in 2025, 2% in 2026 and then moderating to 1.8% in 2027 and 1.7% in 2028. The forecast for 2024 is largely unchanged, but 2025 has been revised higher by half a percentage point. Incidentally, outer years were revised down slightly.

OBG growth and inflation forecasts

Part of the optimism in the near future is thanks to inflation falling a little faster than previously forecast (chart 3) mainly due to lower wholesale energy prices which have yet to feed through to households. The decision to freeze fuel and alcohol duties are expected to make a small negative contribution to CPI headline inflation.

The unemployment rate is still forecast to rise, but by less than in previous forecasts. Meanwhile, the level of employment is forecast to continue to grow and has been revised higher as the hope that the cut in NICs will encourage more inactive workers to return to the jobs market.

Small impact on public finances

The impact of the Budget on the public finances is small. There is a small increase in borrowing in the near future, but annual borrowing is still forecast to fall in the coming years. High indebtedness combined with higher interest rates mean that interest payments on public debt make up the largest share of annual borrowing by the government (chart 4). The good news for the government is that as interest rate expectations have fallen in recent months, this has allowed the OBR to also assume lower interest costs going forward. This helped give the Chancellor his room to manoeuvre.

The impact of the policy changes from the Budget mean that the cyclically adjusted primary deficit (annual borrowing adjusted for the economic cycle and interest payments) will now return to surplus in 2025/26 – a year later than at the time of the Autumn Statement.

Public sector net borrowing composition

Lastly, the remaining contribution to annual borrowing comes from the strength of the economy. The OBR judges that the sub-trend performance is likely to contribute to higher annual borrowing until 2026/27 – which has not materially changed since the autumn. This also indicates a lack of potency in the latest stimulus package.

Incidentally, the markets’ reaction to the Budget was largely muted. The pound was unchanged against its peers, but there was a slight fall in gilt yields, possibly suggesting that investors had anticipated a bolder budget, and therefore more borrowing and supply of bonds.

What it means for an incoming government

One of the lasting memories from the end of the previous Labour government in May 2010 was the note that then chief secretary to the Treasury, Liam Byrne, left for his successor simply saying: “I’m afraid there is no money.” It perfectly summed up the ravaged state of the nation’s public finances, having been stretched to the limit to support the economy and banking system during the global financial crisis. Today’s situation is nowhere near as dire, but it certainly presents a major challenge.

Recent opinion polls suggest that voters would currently prefer to see an increase in public spending over tax cuts. Indeed, the similar cut to NICs last November appears to have no impact on voters’ preferences. Jeremy Hunt could have attempted to win back some of the support his party has lost to the left, choosing to increase public services spending, but it appears that he chose tax cuts to re-enforce the message of his party’s political core: low taxes and small state politics. The hint in his speech that NICs may be abolished altogether had many excited, although he stopped short of stating it even as an aspiration. NICs, being a secondary form of income tax, overly complicate the system and should be merged with the main form of income tax. However, its confusing setup has also made it a popular way to raise funds in the past. Perhaps the choice to cut NICs, rather than income tax, has blunted the political impact for the Conservatives.

The OBR’s growth forecast appears somewhat optimistic, especially in the near-term. The latest Schroders forecast has the economy contracting by 0.2% in 2024, before growing by 1% in 2025. Consensus estimates are a little higher for this year, but also have growth at just 1.1% next year. If we are correct, then Labour is likely to inherit an economy with stagnant demand, being served by the supply side of the economy struggling to cope with labour shortages and growing complexity in trading with Europe. Based on current plans, apart from priority areas such as healthcare and defence, most areas of government departments will face significant real-terms cuts to their budgets for the foreseeable future.

The Labour Party is likely to favour increasing public investment (cut again in this Budget), and a general expansion of departmental and local authorities’ spending. However, it is reluctant to communicate that this would be paid for by higher taxation. This is understandable: although the Conservative Party presents itself as the champion of low taxation, the current seven-year freeze on income tax thresholds means the nation’s tax burden is expected to rise to its highest level since 1948 by the end of the OBR’s forecast.

In the past, the threshold at which workers start to pay the higher- (40%) and more recently the additional- (currently 45%) marginal rates of income tax were uprated broadly in line with inflation. The frozen thresholds have resulted in the share of workers who fall within the 40% tax band rising from 9.6% in 2010/11 to 16.6% this fiscal year. It is forecast to rise to 18.6% by the end of the thresholds freeze in 2027/28 – almost double the share of taxpayers since the Conservatives came to power (chart 5). Those falling into the highest additional-rate group is even worse, rising from 0.8% of taxpayers to 3.6% by 2027/28 – more than a four-fold increase. This phenomenon is often referred to as “fiscal drag”.

Fiscal drag

The OBR estimates that 3.3 million individuals will be pulled into the higher or additional rate tax brackets over seven-year period due the lack of indexation of thresholds. It also estimates that an additional 3.7 million workers will have been brought into paying income tax who would otherwise not have qualified, most likely because the starting threshold for the basic rate would have been higher than their earnings. This point will particularly irk left-leaning voters, as part of the argument for reducing in-work benefits for the lowest earners was that the threshold to pay the basic-rate (20% of tax) was being raised, taking many out of taxation.

For now, Labour’s election strategy seems to be to avoid talking about raising taxes. But ultimately, Reeves and her colleagues will have to find additional revenues if they are to avoid borrowing more and increasing national debt even further. With the Bank of England unwinding its asset purchase facility (APF), it is effectively raising the supply of government bonds (gilts) into financial markets, which in turn should raise the cost of borrowing for the exchequer. Increasing the amount of borrowing further in the next few years will concern investors.

Hunt also set another trap by focusing on GDP per capita, warning against increasing migration to achieve growth. The irony is that GDP per capita contracted by 0.7% in 2023, at a time when migration has been higher than expected.

Labour may find success in explaining why low tax rates have not eased the burden on workers, and why a simpler tax system could be more efficient and equitable. But for now, the strategy seems to be a focus on boosting public services, financed by higher economic growth, without really explaining how that might be achieved.

Kicking the can down the road is no longer an option

Unless the UK is about to transform itself into a leader in the use of automation, robotics and artificial intelligence, it will continue to need workers, combined with capital, and ideally an improvement in its trading relations with the rest of the world. These are areas Labour can start to focus on.

As for public services, productivity enhancing investment makes sense, as long as projects delivery genuine results. However, they should not be relied on to deliver savings when it comes to the long-term planning of public finances, as the government has done.

The UK’s long-term plan for energy supply needs urgent attention, all while making progress towards energy transition targets. Lastly, although it is unlikely to win votes, defence spending and the nation’s strategy needs to adapt to an increasingly hostile geo-political environment.

The expected change in government may not be as challenging as the previous hand-over, with the Conservatives having to cope with the aftermath of the global financial crisis. However, if the Labour Party wins the next general election, it will need to tackle many of the structural problems the economy is facing, some of which are approaching a crescendo. Kicking the can down the road is no longer an option.

Issued in the Channel Islands by Cazenove Capital which is part of the Schroders Group and is a trading name of Schroders (C.I.) Limited, licensed and regulated by the Guernsey Financial Services Commission for banking and investment business; and regulated by the Jersey Financial Services Commission. Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested. This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements. All data contained within this document is sourced from Cazenove Capital unless otherwise stated.

 

Authors

Azad Zangana
Senior European Economist and Strategist

Topics

Cazenove Capital is a trading name of Schroders (C.I.) Ltd which is licensed under the Banking Supervision (Bailiwick of Guernsey) Law 2020 and the Protection of Investors (Bailiwick of Guernsey) Law 2020, as amended in the conduct of banking and investment business. Registered address at Regency Court, Glategny Esplanade, St. Peter Port, Guernsey GY1 3UF, (No.24546) . Schroders (C.I.) Limited, Jersey Branch is regulated by the Jersey Financial Services Commission in the conduct of investment business. Registered address at IFC1, Esplanade, St Helier, Jersey, JE2 3BX, (No.31076).

The value of your investments and the income received from them can fall as well as rise. You may not get back the amount you invested.