Why does the UK's lower productivity growth forecast lead to tax increases? A closer look at the numbers and the economic landscape.
The UK's Chancellor, Rachel Reeves, is facing a challenging decision as she prepares her budget on November 26th. One of the key factors influencing her choices is the Office for Budget Responsibility's (OBR) revised forecast for UK productivity growth. But why would a lower productivity forecast trigger tax hikes?
Productivity, in simple terms, measures the output of goods and services per hour of work. It's a crucial indicator of a country's economic efficiency. When productivity grows, it often leads to higher wages and incomes. However, a slowdown in productivity growth means the UK's GDP and tax revenues might not meet initial projections.
The Institute for Fiscal Studies (IFS) highlights a significant impact: each 0.1 percentage point downgrade in the productivity forecast increases government borrowing by £7 billion in 2029-30. If the OBR lowers its forecast from 1% to 0.8%, the impact is substantial, increasing borrowing by £14 billion. This revision alone could push the government into a projected deficit, requiring Chancellor Reeves to take action.
The UK's productivity growth has been unusually weak since the financial crisis, with output per hour growing by only 0.4% annually since 2010, compared to the previous 2% average. This slowdown is not unique to the UK but has affected most advanced countries. The UK's decline has been more pronounced, with a 1.9 percentage point drop in growth rate since 2010.
Economists have struggled to pinpoint the exact cause, with various factors like the financial crisis, austerity measures, and Brexit being considered. Despite ongoing research, a clear consensus remains elusive. However, many economists believe low investment levels, both from the private sector and government, play a significant role in the productivity slowdown.
The OBR's recent forecast downgrade is not surprising. In March, they projected a higher medium-term potential supply growth than other forecasters, including the Bank of England and the IMF. This persistent optimism has now shifted, aligning with other economic predictions. Public finance experts suggest that with more headroom in March, Chancellor Reeves might have avoided tax increases if productivity had met expectations.
As the UK navigates this economic challenge, the focus on productivity and its impact on public finances remains crucial. The government's decisions will shape the economic landscape and the lives of its citizens.
