Macro moments: UK budget preview

Key takeaways

• The Government faces a near-impossible balancing act: raising taxes without stifling growth or driving away top earners, while keeping markets and voters onside.
• The budget’s success will hinge on whether it can lay credible foundations for growth—especially in housing and productivity—without fuelling inflation or breaching fiscal rules.
• The ultimate test: will the bond markets and the Bank of England be convinced, or will political and economic pressures force a rethink?
   

The upcoming budget is of huge significance for the UK, for the Labour party and for the future of the Prime Minister and his Chancellor, Rachel Reeves. Get it wrong and they will be pilloried in the run up to Christmas. The markets do not expect another Truss moment, as they have faith in Reeves. Should they?

This year’s budget has been delayed by almost a month to allow the Government to assess the Office for Budget Responsibility (OBR) report and determine the level of tax rises needed to maintain their public spending plans.

It is clear that cuts in expenditure are politically impossible. This leaves the Government with no choice but to raise taxes, if it is to keep within its own fiscal rules. It must do that to keep the cost of UK debt down, which is already taking £1 in every £10 of tax raised.

Any higher and the Chancellor risks a collapse in Gilts, a run on the UK pound, falling stock markets, collapse of business and consumer confidence and in that political chaos, a general election. The stakes could not be higher.

Economic context

The Government must address the level of debt, which (broadly) they need to keep flat during this Parliament and is currently running at 94% of GDP. This is their fiscal rule.

With pressure from their supporters for more money for the NHS, housing, pensioners, child benefits and a range of other causes, this will not be easy. They have made a commitment to raise defence spending too. So, how to balance the books? And, who pays?

Last year, they raised taxes in such a way that they stoked inflation, creating further expenditure problems where benefits and pension rises are indexed. Also, latest figures show that public sector wages are rising much faster than those in the private sector, providing further pressure in the competition for labour. Is it possible to cut spending anywhere at all?

How much further can you ‘tax the rich’ before they leave? According to the Taxpayers Alliance, the top 1% of income earners in 2024-25 earned 13.3% of total income and paid 28.2% of all income tax. The top 10% paid 60% of all income tax.

Most worryingly the top 0.1% of taxpayers – just 31,000 people, half of whom live in London – contribute 14% of all tax. That is £42bn per year.

Four fiscal conundrums

1. High level of government debt: Liz Truss’s traumatic tenure as Prime Minister has left an indelible restriction on all future governments – you  have to placate the bond markets before you can please the voters. Will this budget do that?
2. Cost of government debt: the more debt issued means the higher the cost. The higher the cost, the higher the cost of a mortgage for voters and lower demand for both new houses and old. The central plank of the Government’s growth strategy is to double the number of houses built every year to 300,000. Does this budget lay the foundations for that?
3. Inflation: having been the principal cause of the inflationary boost that occurred in the UK and did not occur elsewhere in the world, will this budget add to inflation or (through rising taxes) could it be deflationary?
4. Fiscal rules: will the rules set by the Government be met or will they be missed? The OBR’s lowering of the productivity target has widened the fiscal deficit. Productivity is a mix of rising supply of labour and lower investment. What (if any) measures in the budget will improve productivity and raise investment?
    

Four focus areas

1. Taxation: adjustments to personal tax allowances and thresholds may feature, as well as measures to address tax avoidance. Will the rise in the tax burden be via income tax, or a variety of taxes aimed at the better off. We expect a rise in the basic rate and the higher rate of income tax, supplemented by other measures around housing and pensions.
2. Infrastructure and ‘Levelling Up’: continued investment in infrastructure projects – such as transport, housing, and broadband – will be a priority, particularly in regions targeted for economic levelling up. How will these projects – rail, road, renewables and airports – be incentivised to be built? How will the Government attract private sector to fund them?
3. Savings and investments: will the Government reduce the incentives for cash savings in ISAs or lower the amount you can save in a tax-free ISA? Will there be any incentive to invest specifically in the UK or a cost to invest outside it? Will the treatment of pensions change, lowering the tax relief and or the amount allowed to be held. What will this mean for the savings industry?
4. Build houses: the key plank of government policy. Will they alter stamp duty, or introduce a wealth tax or a seller’s tax in the shape of CGT for sellers? Will they incentivise first time buyers? What does this mean for the housebuilding industry?
    

Fiscal outlook

The Chancellor is expected to reaffirm the Government’s commitment to prudent fiscal management, aiming to reduce borrowing as a percentage of GDP while maintaining room for strategic investment. The fiscal rules may need to be updated to reflect current economic realities, balancing the need for growth with debt sustainability. Let’s see if the bond markets believe in the commitment or the rules!

And, if the Bank of England sees a significant rise in taxation (that lowers demand) will the MPC be persuaded to cut interest rates?