Chancellor Rachel Reeves’ attempts to put the public finances on firmer ground through tax hikes are “unlikely to succeed,” according to analysts at Oxford Economics.
Collecting evidence from a range of ‘fiscal adjustments’ – attempts by governments to balance their budget deficits – Edward Allenby and Adam Slater said attempts to balance the budget through higher taxes were likely to end in failure.
“A number of studies suggest that fiscal adjustments centred on expenditure reductions, rather than revenue increases, have a better chance of success,” the pair wrote in a note published today.
“The failure rate for adjustments based on revenue raising is high, given the risk of dampening growth prospects without yielding material improvements to the public finances,” they added.
“We think prospects for the success of the UK’s fiscal adjustment programme look unpromising.”
The research will raise further questions about the government’s fiscal plans, soon after new figures confirmed that the economy slowed significantly in the second half of last year.
Reeves announced tax rises worth £40bn in the Budget, on top of the revenue raising measures which were already incorporated into government plans, such as frozen tax thresholds.
This means that although Reeves increased spending significantly compared to previous proposals, her plans still represent a substantial ‘fiscal tightening’.
Fiscal tightening refers to the combination of tax hikes and spending cuts, which typically weighs on growth in the economy but should help to balance the budget.
Oxford Economics estimated that the value of fiscal tightening over the parliament will be 2.8 per cent of GDP, which would be more restrictive than during the 2010-15 austerity years.
This is more restrictive than the Office for Budget Responsibility’s (OBR) forecasts because Oxford Economics has a more pessimistic forecast for the UK’s potential growth rate.
Source: Oxford Economics, Haver Analytics
About 80 per cent of the planned reduction in the deficit comes from higher taxes, particularly the frozen tax thresholds and the increase in employers’ national insurance.
Allenby and Slater warned that the split between spending cuts and higher taxes was “similar to that seen in unsuccessful adjustments,” where countries failed to narrow their budget deficits.
“Our analysis above suggests the UK’s current fiscal adjustment plans are unlikely to succeed,” they said.
And while some countries were able to reduce the budget deficit through higher taxes, this often relied on external factors which the analysts warned were unlikely to come to Reeves’ rescue.
“Accompanying policies don’t appear particularly supportive of successful adjustment either – growth-boosting structural reforms look minor, monetary policy conditions are likely to remain restrictive for a prolonged period, and trade policy uncertainty is set to rise,” they wrote.
But the analysts also noted that it would be “difficult” to cut spending, given the fact that some departments are already facing real terms cuts.
“This serves to highlight the importance of the current government making tangible progress towards improving public sector productivity – this would be the key to reducing future current spending requirements and lessen the need for tax rises,” they concluded.
The Treasury was contacted for comment.