News in Charts: Labour’s long-game budget

Labour’s first budget in 14 years entails a significant fiscal loosening, with the direct effect of budget measures raising spending by £72 billion by the fifth year of the forecast. Around two thirds of this will come in the form of higher current spending and one third in higher capital spending, according to the OBR.

With the direct effect of higher taxes estimated to raise an additional £42 billion in revenue, the shortfall, which is estimated to be £36 billion once the indirect effects of the new measures are taken into account, will be covered by higher borrowing. As Fathom has suggested previously that she should, the Chancellor has changed the fiscal rules to give more leeway for borrowing to fund investment, by targeting public net financial liabilities rather than public sector net debt. Meanwhile balancing the current rather than the capital budget also buys additional room for investment.

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Labour announced a range of tax and spending measures, including the headline-grabbing increase in employer national insurance contributions (NICs). Some succour was offered to small businesses likely to be impacted by these changes, through a doubling of the Employment Allowance and the removal of the £100,000 threshold. Other taxes set to rise are capital gains tax, and stamp duty on second homes. On the other hand, Labour has stuck to its commitment not to raise VAT, income tax and employee NICs; and contrary to rumours published ahead of the budget it did not extend the previous government’s freezes on income tax and NICs thresholds, which will expire in 2028.

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Applying multipliers from a broad meta-analysis (Gechert and Rannenberg 2018), Fathom’s initial calculations suggest a positive impact on the level of GDP of around 1.5% over the next five years, as the increased public spending boosts demand. By itself, this would imply an upward revision to our GDP forecast, which we shall be publishing in early December. The increase in employer NICS will probably be net negative for GDP. The magnitude of the impact will depend on the extent to which higher costs for firms are counteracted by the general increase in demand, from increased public spending; as well as to what extent firms choose to shift the tax onto employees via lower wages, affecting private consumption.

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In the longer run the government is relying on increased investment to boost growth, especially if it succeeds in ‘crowding in’ private investment via the newly created National Wealth Fund. UK investment has long lagged its OECD peers. However, as with everything the devil is in the detail, and the growth-boosting effects will depend on what is invested in — with a recent study suggesting far greater multipliers for R&D than for other investment over time (Ciaffi, Deleidi and Mazzucato, 2024). While light on specific details (more information is promised next year), the budget commits £20.4 billion to R&D investment in 2025-2026, with life sciences, AI, aerospace, nuclear and carbon capture among the target industries.

Labour is playing the long game — now to see if the plan will also convince the markets.

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The views expressed in this article are the views of the author, not necessarily those of LSEG.

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