Chancellor Rachel Reeves is bracing for a significant fiscal challenge ahead of her upcoming Autumn Budget, as the Office for Budget Responsibility (OBR) is set to downgrade its productivity forecasts. This anticipated revision threatens to deepen the gap in public finances and makes substantial tax increases almost unavoidable.

The OBR, the UK’s independent fiscal watchdog, has a history of overestimating productivity growth—defined as output per hour worked—even though it has remained persistently low despite technological advances. Currently, it forecasts a 1.1 per cent annual growth in productivity over the medium term. However, a mere 0.1 percentage point reduction in that forecast could widen the fiscal shortfall by around £9 billion, according to Allan Monks, a UK economist at JPMorgan. Some experts suggest the required fiscal tightening to balance the books could be as high as £50 billion, or at least between £20 billion and £50 billion, putting Reeves in a precarious position given her prior pledge not to raise income tax, VAT, or employee National Insurance contributions.

The Chancellor’s fiscal rules demand that day-to-day government spending on essential public services like health, education, and defence must be fully funded by tax revenues by the end of the decade. Presently, Reeves has only £9.9 billion in headroom against this rule, a modest buffer that is now under serious threat as borrowing costs rise and economic growth stalls. This stall in growth has been partly attributed to higher employer National Insurance taxes introduced in her last Budget, as well as the government backing down on planned welfare cuts and winter fuel payments, which collectively have added pressure on public finances.

Treasury officials reportedly expect the OBR’s downgrade to significantly erode this already tight cushion, with some insiders blaming the worsening fiscal outlook on the legacy of Conservative fiscal policies. A government source conveyed to the Financial Times that the downgrade could account for half to three-quarters of the fiscal hole, with the full gap potentially running into tens of billions of pounds.

Economic think tanks and independent forecasters, including those from the National Institute of Economic and Social Research and Oxford Economics, have echoed these concerns. They highlight that aligning productivity forecasts with broader, more cautious economic consensus could reduce GDP forecasts by around 1.4 per cent over the forecast horizon, necessitating immediate fiscal consolidation measures. This adjustment might be equivalent to a 2p increase in both the main and higher income tax rates, inflation-matching tax rises that could recalibrate the Chancellor’s budget constraints.

The fiscal consequences of downgraded productivity forecasts extend beyond tax revenues. Lower productivity implies slower wage growth, resulting in weaker income tax and National Insurance contributions, diminished corporate profits leading to reduced corporation tax receipts, and constrained household spending impacting VAT revenue. Additionally, social security benefits may take up a larger share of GDP if growth falters, exacerbating the budget gap. In a more extreme scenario, where productivity growth drops by 0.7 percentage points on average over the forecast period, the fiscal deterioration could exceed £60 billion by 2029/30.

Despite mounting pressure, Reeves has indicated that her fiscal rules are “non-negotiable,” constraining her manoeuvrability. This inflexibility underscores the challenge she faces in meeting the government's fiscal targets amid an uncertain economic outlook. The UK's debt trajectory also adds urgency to the situation. The OBR warns that if productivity growth remains weak, public debt could skyrocket to unprecedented levels within decades, severely limiting the government’s ability to respond to future economic shocks.

Against this backdrop, Reeves is expected to contest the downward revision by highlighting 'pro-growth' measures announced in recent budgets. These include easing planning restrictions to encourage infrastructure development, such as new airport runways and data centres, which she hopes will boost productivity and economic output in the medium term. However, economic experts caution that the OBR’s decision to revise its productivity forecast should be based on a robust evidence base, especially given the volatility and ongoing revisions in productivity data. Some argue the OBR should maintain its current forecast until more conclusive data emerges, to avoid prematurely triggering tax hikes or spending cuts that could, paradoxically, dampen growth further.

The fiscal tightrope Reeves walks highlights the broader challenge facing the UK economy: balancing short-term fiscal responsibility with long-term economic growth ambitions. As the Autumn Budget approaches, the Chancellor’s capacity to navigate these intersecting pressures will be closely scrutinised, with the OBR’s updated economic assessments likely to be the decisive factor in shaping the government’s path forward.

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Source: Noah Wire Services