Labour has embarked on a “large, sustained increase in spending, tax and borrowing”, according to the government’s economic forecaster, as it judged that Labour’s first budget for 15 years is unlikely to increase economic growth over the next five years.
Assessing Rachel Reeves’s policies, the Office for Budget Responsibility (OBR) said the economy would expand at the same rate as predicted in March by the end of the parliament, despite a £70bn-a-year rise in spending.
The extra spending revealed by Reeves would give a short-term lift to economic output, it said, but leave the average rate of growth over the next five years unchanged.
A change in the budget rules that allows for a spending increase will swell the size of the state to 44% of annual national income, five percentage points higher than before the pandemic.Richard Hughes, the head of the OBR, said the effect of an increase in taxes of £40bn would take the tax take each year as a proportion of national income to a historic high of 38% by 2029-30.
Hughes said: “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 larger state will “crowd out” business activity and business investment, the OBR said, pushing living standards down by about 1% in the last year of its five-year forecast.
Inflation will be slightly higher than previously estimated and wages slightly lower than previously forecast after a £26bn hit to business costs from the chancellor’s decision to raise employers’ national insurance. The expanded state will be competing with the private sector for the same scarce resources, pushing up prices.
David Miles, the chief economic adviser to the OBR, said: “The [fall in disposable incomes] is inevitable when the government is taking 2% of national income to spend on public services and public investment.”
Brexit will also hurt the UK’s growth prospects by lowering trade intensity with the EU by 15%. Trade intensity measures a drop in trade with the EU relative to the bloc’s trade with the rest of the world.
Hughes said the increase in borrowing would cost the government more than £100bn in debt payments in each year of the parliament for the first time following an average annual rise of £32bn over the next five years.
There was a better outlook for the economy over the next two years, compared with a revised outlook since March, but a weaker rate of expansion in the second half of the parliament, the OBR added.
A prediction in March that the economy would grow by 0.8% this year was revised up to 1.1%, in line with the outlook by the International Monetary Fund and just below the 1.2% forecast by the Bank of England.
Next year the economy is expected to expand by 2%, compared with the 1.8% expected in March. However, the growth rate will slow in subsequent years compared with the forecast in March. In 2026, the OBR said growth would be 1.8%, down from 2% in March and 1.5% in 2027, down from the 1.8% prediction in March.
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Over the longer term, the improvements in public services expected to be funded by the budget will add 1.5% to economic growth.
Hughes said two new budget rules would govern how the government taxes and spends. One rule forces the chancellor to keep day-to-day spending in balance. The other allows the Treasury to include government assets in its calculation of the national debt.
Reeves said she had adopted a new measure of national debt to align with the way it is calculated in France, Germany and Japan.
The switch to public sector net financial liabilities (PSNFL) will capture assets such as student loans and investments made through government agencies.
Conservative spending plans implied £19bn of real-terms cuts in 2028-29 for unprotected departments such as justice and transport.
Reeves, who vowed there would be no austerity under Labour, pumped most of her extra spending into the NHS.
She said defence spending would remain above the commitment made to Nato of 2% of national income. However, the OBR said this had been achieved after reducing a growth rate of 3% in defence spending this year to zero next year, once adjusted for inflation.