From the Desk of the Chief Economist  A year of Keir brings little cheer

After the IoD’s confidence measure rose sharply following the election, it plummeted even more sharply as rumours swirled of a Budget that would target tax rises at business. When those fears were more than met, confidence fell further. The Spring seemed to bring a bit of an improvement: members observed that some business was coming back after the shock of the budget, that consumer spending was supported by falling interest rates and strong earnings growth, and that the government was providing helpful signals of its spending priorities, e.g. defence, net zero, housing and infrastructure. May brought three trade deals in quick succession with India, the US and the EU. While the latter two only serve to undo some damage to previous trading relationships, they are viewed as signalling that the UK is open for business – a point reinforced by the latest Deloitte CFO survey which has the UK rated joint top as a location for investment, alongside India.

Unfortunately, June saw our confidence measure drop back again sharply – I would have been more surprised by this, had I not recently had the third meeting of the IoD Economic Policy and Trends group. To say the business mood was low is to put it mildly.

The damage done by the Autumn Budget

It is clear from speaking to businesses that the combination of tax rises in the Autumn Budget is having a pernicious effect on their operations.

As a reminder, the tax take was increased by £40 billion per annum in the Autumn Budget according to HM Treasury estimates, with the bulk of it from higher employer National Insurance Contributions, Capital Gains Tax and Inheritance Tax (IHT). The OBR included in its analysis of the impact of these tax measures the behavioural responses of firms and individuals – they expected £10 billion of that £40 billion to be lost through companies hiring fewer workers, pushing through lower wage rises and from having lower profits, for instance. And a further £6 billion is lost through compensating government departments for the extra cost. Evidence is now starting to emerge that in some areas, the behavioural response of firms and individuals has been greater than estimated, meaning that the measures may raise less tax as well as causing greater economic damage.

The rise in employer NIC was already expected to disincentivise work through lower wages as well as by lowering demand for workers. This was expected to reduce labour supply by 50,000 by 2026-27, reducing the expected tax take from this measure over the period by about a third relative to Treasury hopes. It is worth noting that higher government spending was supposed to take 90,000 out of unemployment over the period 2025-26, i.e. more than compensating for the loss of opportunity in the private sector. But so far, HMRC employee payrolls are down 276 thousand on October 2024 levels.

For the non-dom regime, planned reforms were expanded in the Budget to bring worldwide assets into the purview of UK inheritance tax, including some trusts as well as pensions. The OBR had expected that only 1,200 would leave in response to the reforms, and were expecting the changes to raise £12.6 billion over 2026-27 to 2029-30. But projections from the 2025 Henley Private Wealth Migration Report suggest that 16,500 high net worth individuals will leave this year, with IHT the driving force. Speculation about a wealth tax will only add impetus to that exodus.

Concerns continue to build too with respect to impacts on family firms, private schools and farms.

Looking to the Autumn Budget: another hole in the public finances

Disappointingly it seems that we’re heading towards another tax-raising Budget. The latest OBR “Fiscal Risks and Sustainability” report outlines the UK’s precarious public finances starkly. Among 36 advanced economies, we have the fifth highest borrowing, the sixth highest debt and the third highest borrowing costs (at end June). With borrowing maxed out, and limited apparent appetite to restrain public spending, we are left with tax to plug any gaps. In the above I’ve outlined some of the tax revenue already at risk from last year’s tax changes. There are a few other reasons to expect tax rises as well.

The OBR is currently forecasting GDP growth of 2.0% for 2026 against the average independent forecast of 1.0%. This is fine, if the OBR predicts that they’ll be faster growth in later years to compensate. But the OBR has recently published its “Forecast Evaluation” report, and finds itself systematically guilty of excessive optimism in its medium-term growth forecasts since 2010 – albeit no more so than anyone else. The OBR’s own sensitivity analysis finds that if nominal growth is revised down by only 0.1% points per year (driven by productivity), that would wipe out all the £9.9 billion fiscal headroom. Let’s say (perhaps optimistically) that the revision will be double that (which would be half the size of their last revision), and it’s £20 billion to find.

Fuel duty is another area of risk. The public finances are predicated on the assumption that in the Autumn, fuel duty will rise in line with RPI and the 5p cut is reversed – in fact fuel duty has been frozen since 2010-11. If fuel duty is frozen again, it’s another £3.8 billion to find.

The failure to act on welfare and pension sustainability is perhaps more concerning in what it tells us about the appetite to address unsustainable government spending and the precariousness of the fiscal rules. The numbers themselves are quite small in public finance terms. The u-turn on welfare is worth £4.8 billion while the u-turn on winter fuel payments is worth £1.2 billion.

It all adds up however: so far we’re at £29.8 billion…

Against this depressing backdrop, it might be surprising to hear that the public finances have been better than expected so far this tax year. The profile for borrowing is £2.9 billion below March forecast expectations, with receipts £0.3 billion lower and government spending £1.6 billion lower.

But this is not quite where a government on a mission to raise UK growth would like things to be. The recently announced strategies and the trade deals secured are very welcome contributions to policy stability and planning. But the risks of being blown off course continue to grow.