In light of the Labour Party’s leadership and the country’s poor public finances, the United Kingdom’s annual budget is scheduled to be released on Wednesday.
Despite keeping a number of pledges, UK Chancellor Rachel Reeves has the difficult task of keeping the public finances in order while maintaining a number of them, leaving her with little room for discretion in terms of taxes and spending.
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Reeves will face what a leading think tank has called an “impossible trilemma,” leaving her with no choice but to compromise on her plans.
Why is the UK government facing such a challenge with this budget?
Years of struggle have been a result of the UK’s slow economic growth, high inflation, and national debt that is rapidly rising.
The Group of Seven (G7) nations’ economies have had the worst economic performance since COVID, with the UK having the worst performance after Germany.
According to government data, GDP increased by just 1.7 percent between the end of 2019 and the start of 2024, compared to 8.7 percent in the US, 5.1 percent in Canada, and 4.6 percent in Italy.
Even though Labour won the election in July last year with a landslide victory, economic conditions still remain challenging.
The UK is on track to become the G7’s best performer after the US, but growth slowed to a meager 0.1% in the quarter that ended in September despite a strong start to the year.
The interest rate on long-term government bonds increased in the UK, reaching its highest level in nearly 30 years in September, leading to a rise in borrowing costs.
To bridge the gap between tax revenues and spending, the UK government took out 17.4 billion pounds ($1 billion) in October alone.
Reeves’ self-imposed pledges have made the already challenging task of drafting her budget more challenging, as her Labour Party campaigned against spending cuts after years of austerity policies under the Conservatives.
Reeves’ “fiscal rules” require that the exchequer maintain a balance between daily spending and the reduction of the country’s debt by 2029-30, without increasing income taxes, VAT, or national insurance.
Reeves casts her budget as a one-time injection of pain needed to keep the government’s finances on an even keel, raising taxes by about 40 billion pounds ($52.66 billion) in the most recent year’s budget.
Reeves has once more found herself with a significant deficit between spending and revenues as a result of the rising cost of government borrowing.
Reeves would need to find another 41.2 billion pounds to meet her goals, according to a top think tank called the National Institute of Economic and Social Research, which estimated earlier this year. This would leave her with the “impossible trilemma” of higher taxes, decreased spending, or changed fiscal rules.
The fiscal “black hole” is estimated to be closer to 20 billion pounds ($26. 3 billion), including more recent assessments based on improved economic data.
According to Jasper Kenter, an economics professor at Aberystwyth University in Wales, “I do think it is a particularly challenging budget because the government is caught between their commitments to avoid severe cuts to public services, not raising taxes on working people, and self-imposed fiscal rules and a jittery bond market.”
They also have significant hangovers from the previous government, which abruptly cut national insurance taxes just before they left as a failed electoral stunt.
Reeves is expected to announce other revenue-raising measures, including a tax on properties worth more than $2. 6 million ($2.6 million) and a freeze on adjustments to the income tax thresholds, after backtracking on a tax increase that would have violated Labour’s manifesto pledge.
Labour’s popularity in the weeks leading up to the budget has fallen far behind the right-wing populist Reform UK.
Reeves, an economics professor at the University of Liverpool, claimed that the budget’s conflicting signals contributed to the UK’s economic problems.
According to Milas, “investors are unwilling to invest in the economy until they see what economic measures she will actually put in place.”
Consumers are concerned about what additional taxes they will have to pay, at least until they see what that means.
Why has the UK economy recently experienced a slump?
Some of the issues with the UK are caused by factors like falling birth rates and rising welfare costs, which are common in almost all developed economies.
The UK has a long history of low labor productivity growth, which is more significant than many of its peers.
The UK ranked fourth among the G7 countries in terms of labor productivity (GDP per hour worked) in 2023.
However, productivity has fallen in recent years, leaving it trailing behind its peers.
According to OECD data, the UK’s GDP per hour increased by only about 6% between 2007 and 2022, compared to 17% in the US, 12 percent in Japan, and 11 percent in Germany.
According to economists, austerity measures introduced in the wake of the global financial crisis in 2007-2008 led to years of persistent underinvestment.
In contrast to the 23% of GDP in Japan, 23% in France, and 21% in the US, PwC’s analysis of World Bank data shows that the UK invested in the country between 2017 and 2021, compared to 23% of GDP in Japan, and 21% in France.
The post-financial crisis trend has been largely caused by Brexit, which has been blamed on.
According to the UK’s Office for Budget Responsibility, its exit from the bloc will result in a 4 percent drop in long-term productivity.
The UK must address long-term structural issues, according to Jonathan Daniel Portes, an economist at King’s College London, by implementing “pro-growth tax reform” and “reversing anti-growth policies on immigration and universities.”
No significant tax reform is anticipated, despite my expectation of significant tax increases. Portes described his expectations for the budget as “I don’t think it will make a big difference.”
The UK could benefit from experimenting with the tax system, according to Michael Ben-Gad, a professor of economics at City St George’s University of London. However, it won’t be able to avoid long-term welfare state reforms.
According to Ben-Gad, “Pay-as-you-go national pension plans were created to accommodate a growing population or at least one that was stable.”
