The run up to the Budget next Wednesday has felt more leaky than a kitchen colander. So with little new to be said, I answer the three questions about the Budget I’ve been asked most.
How bad will the Budget be?
There’s a perception that what Rachel Reeves announces will be terrible for everyone. That seems to stem from the government’s talk of “black holes” and “funding gaps”. And it’s no secret that taxes will be raised, on my reckoning by around £25bn. So the Budget will be bad news for those households and businesses that bear the brunt of the tax rises.
But that’s not the whole story. The £25bn or so raised from higher taxes will be used to pay for £25bn or so of more government day-to-day spending. That includes the goods and services the government needs to buy and the wages it needs to pay to provide public services. That adds to economic activity.
The Budget will mean that activity is transferred from one part of the economy (households and businesses) to others (suppliers of the government and public sector workers). But the economy as a whole won’t be worse off.
In fact, a big feature of the Budget will be that public investment is increased, perhaps by around £18bn, paid for by a rise in public borrowing. That would be a new injection of money into the economy and would therefore mean the economy ends up being bigger than otherwise. The result may be that GDP growth in 2025 accelerates to nearer 2.0% than my current forecast of 1.5%.
How can we afford to borrow more?
Such concerns are valid. After all, government debt has leapt to the equivalent of 35% of GDP before the 2007/09 Global Financial Crisis to 85% before the pandemic in 2020 and to 98% now. That debt generates a lot of interest (£107bn in 2023/24) and is a lot to be paid back.
The crucial point here, though, is that all the debt doesn’t need to be paid back. It just needs to become less of a burden, or at least not become a bigger burden. Consider someone who has a mortgage of £50,000 and an annual income of £50,000. They have a similar debt burden to the government as their debt to income ratio is 100%. They could save hard to reduce their mortgage.
Or they could try to increase their income. If their income rose to £60,000, their debt to income ratio would fall to 83% and it would be easier to manage the interest due on the debt. It’s the same for the economy – the best way to ease the debt burden is to increase the size of the economy.
And that’s where the increase in public investment in the Budget comes in. Not only does public investment increase economic activity immediately (as materials are bought and wages paid to those working on the projects), but it can increase economic activity in the future. If a plumber is spending less time stuck in traffic between jobs because a wider road has been built, then there are more jobs that can be done in a day. Borrowing more to fund investment can help lower the debt burden.
How’s this different to the mini-budget of Liz Truss that crashed the gilt market?
This Budget will be very different in substance and style. The substance is that in the mini-budget, borrowing was raised to pay for one-off tax cuts, which were never going to increase the size of the economy in the future. In this Budget, borrowing more to invest could lead to a bigger economy.
The style is that Liz Truss circumvented the fiscal watchdog, the Office for Budget Responsibility (OBR), and essentially did away with the fiscal rules. In this Budget, the fiscal rules may be tweaked to allow more public borrowing, but the OBR will cast its judgement and the government appears committed to keeping a tight control over the money flowing in and out of the government’s coffers.
Admittedly, one consequence of more public investment is that over the next couple of years inflation may be a bit higher than otherwise and interest rates may not fall as far.
But that might be a price worth paying if more investment successfully boosts the size of the economy in the future. If the economic pie were bigger, then everyone’s slice would be more satisfying.
Paul Dales is Chief UK Economist of the independent global research consultancy Capital Economics