The UK government put a political twist into its autumn statement on Wednesday, promising to cut employees’ National Insurance bills and boost business investment. But after Brexit, the UK’s growth remains sluggish and its public finances are under pressure.
The reality is that, despite the National Insurance cut, the tax burden is expected to rise to its highest level in many years, while public spending forecasts point to real spending cuts at departmental level – which seems almost impossible to achieve on the projected scale – and lower State investment.
The next UK government, which is likely to be Labour, will have some difficult decisions to make. The difference between Britain and the Republic – where state investment and spending is increasing – will be emphasized. The UK could change course under Labour, of course, but the promise of more spending also means higher taxes – the political trap created by the Conservatives.
Numbers
UK public finances were slightly better than expected before the autumn statement, but remained under long-term pressure due to low growth and a relatively high national debt.
The impact of inflation, which pushes tax revenues higher as prices and wages increase, has given the Chancellor of the Exchequer, Jeremy Hunt, some room to manoeuvre.
He chose to direct this almost exclusively to cutting taxes, which meant that he had little extra money to give to government departments. Borrowing is expected to fall from 5 percent of GDP this year to 1.1 percent by 2028-29.
The United Kingdom spends more than 10 percent of its tax revenues on debt repayment, while the Republic spends less than 3 percent.
However, the Office for Budget Responsibility (OBR) – Britain’s budget watchdog – points out that this is based on a £19bn reduction in the real value of government spending by 2027-28. The report says that in the past, spending tended to add to daily spending as pressures emerged. If this happens, future borrowing levels will rise, unless taxes rise to compensate.
Comparison with Ireland: Strong growth and higher corporate finance revenues have helped push Irish public finances into surplus. Ireland’s national debt is also less vulnerable to rising interest rates because the bulk of outstanding debt is at fixed interest rates, unlike the UK where a quarter of the national debt is in index-linked bonds, so premiums have risen due to higher inflation.
The United Kingdom spends more than 10 percent of its tax revenues on debt repayment, while the Republic spends less than 3 percent.
The state budget surplus in the last budget is expected to reach 2.7 percent of gross national income* (the total that excluded distortions caused by multinational companies) and 4.4 percent in 2025 and 2026.
However, recent shortfalls in corporation tax and pressures on health spending are likely to dampen these expectations – and it is worth noting that the Treasury estimates that if all “excess” corporation taxes disappeared, the Treasury would be in deficit.
tax
The headline-grabbing part of the Autumn Statement for the public was the reduction of the main national insurance rate by two percentage points from January to 10 per cent.
This will benefit taxpayers. However, this will be offset by the traditional hidden tax effect in the budget – the effect of non-indexation of tax bands and credits that will increase the tax burden on working people.
If not adjusted for inflation, the tax rises as wages increase in response to inflation. Economists call this “financial drag.” The effect varies with income levels.
But income taxes are set to rise, with an additional 4 million workers paying income tax by 2028/29 and a further 3 million moving to the higher rate. Despite the National Insurance cut, the tax burden is expected to rise to a post-war high of 37.7 percent of GDP by 2029-29.
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The Decision Foundation, a think-tank, found that because of the interplay between social insurance and tax systems, the only groups that would be better off are those earning between £11,000 and £13,000, and between £42,000 and £52,000.
Comparison with the Republic: The Irish income tax system is not automatically adjusted for inflation either, so taxpayers are reliant on finance ministers increasing these taxes every year if they do not want to move into higher tax brackets and erode the real value of the credits. The credits and standard range were increased this year and USC was cut.
But this hidden tax has been a quiet collection tool for Ireland over the years, and a key question for the parties in the next general election campaign is whether they will benchmark the income tax system according to inflation each year. At the same time, some modest increases in the Poverty Reduction Index are marked here to maintain the Social Insurance Fund surplus.
The Office for Budget Responsibility estimates that the UK’s tax burden will rise to around 37.7 per cent of GDP over the coming years. With a significantly lower tax burden over the years, this would push it towards comprehensive Irish-style tax levels. However, bodies such as the Fiscal Council have warned that Irish taxes will have to rise in the coming years to pay for the costs of aging and climate transition.
The interesting point is that tax collection in Ireland is boosted by corporate tax, most of which is based on offshore activity. Excluding corporation tax, the UK’s overall tax burden has now, by some accounts, exceeded Ireland’s level.
Spending
UK spending as a share of the economy is expected to fall from 44.8 per cent to 42.7 per cent of GDP, but will still be around 3 per cent of GDP above its pre-pandemic level.
Whatever serious questions have been raised about the prospect of achieving planned spending cuts by government departments and local authorities, many of them are already under financial pressure.
The Office for Budget Responsibility says that if levels of service to the public do not decline, large – and unlikely – increases in public sector productivity will be needed. Services are likely to remain under pressure.
On the other hand, capital spending is set to remain at cash levels, which implies a real decline. Instead, the government is trying to encourage private sector investment by extending the tax break for investment spending beyond its previous expiry date of 2026 – another costly measure in addition to the National Insurance cut.
The key question for Irish policymakers is whether spending can continue to rise if tax revenue growth slows.
This will have some impact on investment and growth – and on the economy’s long-term expansion potential – but the Office for Budget Responsibility believes it will be marginal enough.
Comparison with the Republic: Government spending is expected to continue to rise in Ireland – and forecasts for this year and next are already under pressure from rising health spending.
Government capital spending is also set to continue to rise – from €17 billion this year to more than €23 billion by 2026. A key question for Irish policymakers is whether spending can continue to rise if tax revenue growth slows.
Bottom line
One figure stands out in the Office for Budget Responsibility’s assessment. Living standards, measured by real disposable household income per capita, are expected to be 3.5 percent lower in 2024-25 than before the pandemic. This would be the largest decline since records began in the 1950s.
It will be 2027/2028 when per capita living standards return to the pre-pandemic level. Despite key measures in the Autumn Statement, slow growth and a rising tax burden will lead to lower living standards in Britain. The next government will also face an almost immediate choice between cutting spending or raising taxes, given the unrealistic spending figures in the latest document. This could be a more difficult task if corporate taxes stop growing.
Overall growth in the UK is slow, with the Office for Budget Responsibility forecasting that GDP will rise by just 0.7 per cent next year and 1.4 per cent in 2025. The Irish domestic economy is expected to grow by 2.2 per cent next year, according to To the Ministry of Finance.
Here, household living standards have been rising, but mainly due to the fact that more people are working, as inflation has eroded workers’ purchasing power.
The outlook for the next Irish government looks better than its UK counterparts, but it could see a sharp decline in budget surpluses expected from 2025 if the apparent decline in corporation tax in recent months continues. The UK experience shows how difficult it is to break the negative fiscal cycle.
A key objective of Irish policymakers is to ensure that the current positive fiscal position is maintained.