Rachel Reeves will have to account for a bigger-than-expected £20bn hit to the UK public finances in next month’s budget, increasing the likelihood that the chancellor will breach a key Labour’s manifesto pledge not to raise income tax.
The Treasury’s forecaster is preparing a steeper than anticipated cut to UK productivity for the next five years, the Guardian understands.
The Office for Budget Responsibility (OBR) is planning to cut its trend productivity growth prediction by 0.3 percentage points after a downgrade of the UK’s economic momentum since the 2008 financial crash.
Reeves is understood to be furious that the OBR has chosen her second budget to downgrade the figure, which indicates how effectively workers can do their jobs and underpins forecasts of economic growth.
Labour said in its election manifesto that it would not increase income tax, VAT or national insurance, but Reeves could say that the revisions by the OBR upend her calculations, forcing the government to renege on earlier commitments.
Reeves is now in Saudi Arabia, where she told the Fortune Global Forum in Riyadh: “Our independent forecaster is likely to downgrade the forecast for productivity in the UK based not on anything this government has done, but on our past productivity numbers, which, to be honest, since the financial crisis and Brexit have been very poor, and that just shows how essential growth is.
“So I’m not going to do anything in the budget that reduces our opportunities to grow the economy. That’s very important.”
The estimated impact is based on calculations by the Institute for Fiscal Studies (IFS) thinktank, first reported in the Financial Times, which has said that each 0.1-percentage-point downgrade to productivity would increase public sector net borrowing by £7bn in 2029-30. That suggests that a 0.3-point reduction could result in a £21bn hit to the public finances.
Some analysts had been forecasting a 0.1 to 0.2-point downgrade in the OBR’s productivity outlook, resulting in smaller hit to the public finances of between £7bn and £14bn, based on IFS calculations. This would result in a total fiscal hole of £20bn to £30bn, according to some estimates.
A larger downgrade to productivity by the OBR would increase that shortfall. However, the final number could be offset by other factors including lower borrowing costs and faster-than-expected growth.
Allan Monks, an economist at JP Morgan, said the productivity downgrade could reach almost £27bn, but a fall in debt financing costs or more people coming into the jobs market may help limit the damage.
“For now, we are still assuming a £20bn-£30bn range, but with the risk that this could be exceeded to some degree,” Monks said.
The Guardian reported last week that the chancellor was already in active discussions over an income tax rise to help reduce a multibillion-pound shortfall in the public finances. Reeves is understood to be nervous about the political consequences of such a major abandonment of the party’s previous pledges.
However, comments in recent weeks appear to be opening the door to a possible U-turn since news of the likely productivity hit emerged in the September. Last week, the chancellor said a heavier-than-anticipated blow from Brexit and austerity meant she was braced for a sharp downgrade from the OBR.
The watchdog is due to present its outlook to the Treasury on Friday.
Reeves is facing one of the most difficult budgets any chancellor has contemplated in recent years. As speculation over income tax rises swirl, Reeves is also planning to raise an additional £2bn by increasing national insurance for doctors, lawyers and accountants who are employed through partnerships.
A Treasury spokesperson said: “We won’t comment on speculation ahead of the OBR’s forecast, which will be published on 26 November.”
