OBR warns higher taxes could hit growth ‘by more than expected’
Chancellor Rachel Reeves has been warned that increasing the tax burden could leave the Office for Budget Responsibility (OBR)’s key forecasts on shakier ground as it becomes harder to predict how measures hamper growth.
In the small print of its Budget report, the fiscal watchdog said increasing the tax take could lead to unforeseen consequences for the UK economy in what may be read as a warning for the Chancellor to not become over-reliant on the forecasts it produces.
The OBR said that some taxes, including those on assets such as capital gains taxes, were more difficult to measure given they were “highly sensitive” to behaviour and volatile asset prices while yields from income taxes could be easier to project.
But it warned that it may struggle to measure how raising taxes across the board could hit the UK economy while the forecast for the total tax take came with “significant uncertainty”.
“More generally, a higher level of the tax take increases the risk that incentives within the tax system distort or constrain economic activity by more than expected,” the OBR’s report said.
The comments came as Reeves took the tax burden to an all-time high, having added £26bn to government receipts through introducing new levies and extending a freeze on income tax thresholds for another two years.
Much of the Budget’s fresh welfare spending boost on areas such as child benefits and the triple lock pension depends on the success of Whitehall’s administrative efforts.
HMRC efforts to close the tax gap, which is the difference in expected tax revenue to what is actually paid, could raise an additional £2.3bn though the OBR’s report indicated that there was a possibility of the revenue forecast being changed by an £8bn margin either way.
Higher revenue from capital taxes also largely depends on “projected rises” in property prices, with Reeves introducing a new mansion tax surcharge on properties worth over £2m to raise extra funds.
The OBR’s fiscal report said the new mansion tax would lead to a further £100m borrowing in each of the next two years due to behavioural factors, including appeals from property owners against property valuations set by a government quango.
The policy is then expected to raise just £400m after 2028 though the figure could change depending on how the Valuation Office Agency targets home owners.
Questions linger over tax forecasts
Forecast risks highlighted in the report did not only emerge on the side of public sector receipts, with the OBR also highlighting “significant uncertainty” and “several risks” to spending projections.
Risks include higher welfare expenditure than expected over the next five years, added costs to the NHS budget from the Trump administration’s protectionist approach to pharmaceuticals and the ability of the Home Office to end the use of asylum hotels and save up to £1.1bn, among other factors.
A Treasury spokesperson said: “We are cutting borrowing and debt by spending wisely, reforming welfare and making fair choices on tax by asking everyone to contribute, particularly those with the broadest shoulders. This will deliver on the country’s priorities of cutting NHS waiting lists, borrowing and the cost of living.”
Questions over government policy in the report reflect the growing sense of angst among economists over the use of forecasts to keep public finances under control.
Former OBR board member Sir Charlie Bean told City PM that it was “patently absurd” to fine-tune targets on borrowing and debt to specific numbers in the report.
The series of questions posed in the report may also reflect the sense of tension between the Treasury and the fiscal watchdog after a week in which the OBR chose not to score any of the growth policies presented by the government, mistakenly released its report before Reeves’ statement and contradicted government claims that headroom figures had improved, thereby allowing plans to raise income taxes to be abandoned.