Oh – and living standards will drop
It’s been a busy 24 hours. The first female Chancellor of the Exchequer to hand down a budget has just done so, setting the biggest tax and spend budget for decades. While at first borrowing rates slipped, now they have shot up as investors have had time to digest what has actually just happened. “We have raised Bank Rate and gilt yields by a 0.25 percentage point across the forecast,” the OBR said.
It’s not just investors that aren’t giving the Chancellor top marks - the UK’s economic forecaster, the Office for Budget Responsibility (OBR), has evaluated Labour’s newly unveiled budget and concluded it is unlikely to generate substantial economic growth over the next five years. All that taxing, no growth. The OBR indicated that while the increased spending announced by Shadow Chancellor Rachel Reeves might offer a temporary boost, it will not alter the long-term growth trajectory.
In its first budget analysis for a Labour government in 15 years, the OBR highlighted that the economy’s growth would remain consistent with previous projections made in March, despite a significant increase of £70 billion in annual public expenditure. This additional spending will provide only short-lived economic benefits, the forecaster explained, without impacting the average growth rate through the remainder of the parliamentary term.
A shift in fiscal policy rules to permit higher spending will expand the size of the state to 44% of the UK’s national income—a figure that exceeds pre-pandemic levels by five percentage points. Richard Hughes, the OBR’s chair, warned that this new spending plan involves a tax increase of £40 billion, pushing the tax burden to a historic high of 38% of national income by the fiscal year 2029-30.
Hughes remarked: “Against a largely unchanged economic and fiscal backdrop since our last forecast in March, this budget delivers one of the largest increases in spending, tax, and borrowing of any single fiscal event in history.” The OBR expressed concerns that the growing state presence could hinder private sector activity by limiting resources available to businesses, a phenomenon known as "crowding out." As a result, business investment may decline, causing living standards to drop by around 1% during the final year of the forecast.
The report also noted that inflation would rise slightly higher than previously expected, while wages could decline due to increased business costs stemming from a £26 billion rise in employers’ national insurance contributions. This expanded government role in the economy would intensify competition with the private sector for limited resources, driving prices upward.
David Miles, the OBR’s chief economic adviser, cautioned: “The [fall in disposable incomes] is inevitable when the government is taking 2% of national income to spend on public services and public investment.”
Additionally, Brexit’s lingering effects are expected to hinder economic growth by reducing trade intensity with the European Union by 15%. Trade intensity measures how much trade with the EU has declined, relative to the bloc’s trade with other global partners.
The OBR estimates that Labour’s increased borrowing will lead to annual debt interest payments exceeding £100 billion throughout the parliamentary term. This reflects a sharp rise, with debt costs increasing by an average of £32 billion annually over the next five years.
Although the short-term economic outlook has improved, with growth estimates revised upward to 1.1% for 2024 (from the previous 0.8%), the forecast suggests slower growth in later years. In 2026, the OBR predicts growth will drop to 1.8%, compared to March’s 2% forecast, while in 2027 it expects a 1.5% rate, down from the previous estimate of 1.8%.
Despite the slower long-term growth, the budget's investments in public services are expected to contribute an additional 1.5% to economic expansion over time.
New budget rules will shape how the government manages taxes and expenditures. One rule mandates that day-to-day spending must remain balanced, while the other permits the inclusion of government-owned assets, such as student loans, in debt calculations.
Rachel Reeves noted that the new debt measure, called Public Sector Net Financial Liabilities (PSNFL), aligns with accounting practices used by countries like France, Germany, and Japan.
Labour’s plans are a sharp departure from the Conservatives' fiscal strategy, which had implied £19 billion in real-term spending cuts for departments such as justice and transport in 2028-29. Reeves emphasized that Labour would avoid austerity, directing much of the increased budget toward the NHS.
Although Reeves pledged to maintain defence spending above NATO’s target of 2% of national income, the OBR reported that the growth rate for defence spending would be reduced to zero next year, adjusted for inflation, following a 3% increase this year.
