OBR forecasts slower growth and rising tax burden amid fiscal headroom expansion

“The OBR’s downgrade to productivity was less severe than some had feared. Although productivity is weaker, this was offset by expectations of tax-rich growth in the future, meaning higher wage growth is expected to generate greater revenues for the exchequer. The OBR now forecasts only a £6bn deterioration against the Government’s fiscal targets in 2029/30, however, the newly announced tax measures have expanded the Government’s fiscal headroom to £22bn, up from £10bn at the time of the Spring Statement.

“The OBR now expect the UK economy to grow by an average 1.5% per year from 2027 onwards, down from an average of 1.8% at the time of the March Spring Statement. This revision reflects an acceptance of recent productivity underperformance, even as the OBR continue to paint a more optimistic future in its alternative scenario, which sees a faster pace of AI adoption in the UK. While the Government places growth at the heart of its ambitions, the factors driving that growth may be out of the Government’s control, decided by the, largely unknowable, impact of new technologies.

“Sticking to the letter of manifesto commitments, the Chancellor opted to avoid increasing the rates of income tax and instead chose to once again extend the freeze on income tax thresholds. Under current plans, these would stay fixed until at least April 2031, bringing an additional 4.8 million into paying the higher rate of tax and 600,000 more onto the additional rate. 

“Households bear the brunt of the planned tax hikes, which take UK tax revenues to a new historic high of 38% of GDP by 2029/30. However, this historic increase is only just enough to match the commitments to spending increases in health and defence, with funding for other public services staying flat in real terms until 2028/29 and potentially facing cuts in 2029/30. 

“These spending cuts were largely relegated to the final year of the forecast, with 0.2% of real terms cuts planned between 2028/29 and 2029/30, before rising again by 1.3% in 2030/31, after the next election and an expected spending review. Given that NHS, Defence and overseas aid budgets are projected to rise in line with previous plans or linked to overall GDP, this leaves remaining departments having to find a 3.3% of budget savings per year from 2029/30, a commitment which may not be feasible without jeopardising the level of public services. 

“The Chancellor once again opted to freeze fuel duty and extend the 5p duty cut, first announced by Rishi Sunak in March 2022 for another five months. This measure added a further £2.4bn to projected deficits in 2026/27 and could wipe out more than £3.9bn from the headroom against fiscal target, if as widely expected, fuel duty remains frozen to the end of the decade.

“Overall, the markets reacted positively to the Budget as 10-year gilt yields saw a modest fall after the initial volatility caused by the early publication of the OBR report, while the value of the Sterling rose against the US Dollar.”