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Fiscal Policy and Tax, UK Budget

Autumn Statement reaction: a “tax-cutting” statement that continues to raise taxes amid slowing growth – and what does this mean for Scotland?

Chancellor of the Exchequer Jeremy Hunt made much of his tax-cutting credentials in the Autumn Statement he delivered earlier today. The main rate of national insurance contributions (NICs) was cut for both employees (from 12% to 10%) and for the self-employed (from 9% to 8%), in addition to abolishing class 2 NICs altogether.

But looking at the tax to GDP ratio tells a different story.

The tax burden – the percentage of the nation’s income going to the government – is still on track to rise to a post-war high.

The OBR forecasts that the tax-to-GDP ratio will be at 37.7% at the forecast horizon in 2028-29. Although this is lower by 0.7 percentage points than it was forecasted before the measures were announced today (November 2023 pre-measures forecast), this is the highest level since the 1940s.

The tax burden is now expected to be 4.5 percentage points higher in 2028-29 than it was pre-pandemic, and 0.4 percentage points higher by the end of the forecast than the OBR projected in March.

One big reason for this is the freezing of most income tax thresholds, so they don’t rise with inflation. This is fiscal drag – where people are “dragged” into higher tax brackets than they otherwise would have been.

However, this is not the only reason. It also reflects underlying forecast changes, such as wider tax richness of the economy – the Treasury is getting more money in than it expected for a given level of GDP.

Chart 1: Tax as a % of GDP

Source: OBR

This increase in the tax burden comes alongside a pretty dismal set of economic forecasts. The recovery from the pandemic might have been stronger than previously thought, but the OBR now forecasts growth to be lower in every year until 2026, and inflation to stay higher for longer.

Chart 2: Real GDP growth forecasts

Source: OBR

Chart 3: CPI inflation forecasts

Source: OBR

The slowing growth and persisting inflation, together with the high tax burden, mean that living standards – measured using real household disposable income per person – is expected by the OBR to remain below pre-pandemic levels until 2027-28. This would be almost a full decade of stagnation.

Chart 4: Real household disposable income per person

Source: OBR

A big tax cut for workers through National Insurance – and it does apply in Scotland

In today’s Autumn Statement, the Chancellor announced a significant cut in rates of NICs. From 6 January 2024, while the thresholds will remain fixed, the rate of NICs on earnings in the primary threshold (£12,571 to £50,270) will decrease from 12% to 10% – a far more sizeable cut than many had anticipated.

Although income tax is partly devolved in Scotland, National Insurance is not. This means that today’s cut in NICs will impact earners in Scotland in the same way that it impacts earners in the rest of the UK. For a worker earning the median wage in Scotland of £33,332, today’s announcements mean they will experience a reduction in their marginal tax rate (income tax plus employee NICs) from 33% down to 31%.

Chart 5: Marginal tax rates in Scotland and rUK, 6th January 2024

Source: FAI Calculations

Owing to NICs status as a UK-wide tax, today’s planned changes to NICs will not generate any additional consequential for the Scottish budget by themselves. If the Chancellor had decided to cut the rate of income tax in the rUK, then through the Block Grant Adjustment, the Scottish Government would have received additional revenue to reflect any additional divergences between income tax policy in Scotland and rUK.

However, for many earners in Scotland and the rUK, today’s announcement is likely to come as welcomed news. For those in Scotland earning the median wage, today’s cut in NICs will mean they are £415 better off at the end of the year. Meanwhile, for the highest and lowest 10% earners in Scotland, we estimate today’s announcement will reduce their NICs by £754 and £146 each year, respectively.

Chart 6: Changes to annual earnings by income percentile, Scotland

Source: ASHE, FAI calculations

For the self-employed, the cut comes in two portions: the £3.95/week compulsory class 2 contributions are abolished, and there is a 1 percentage point cut in class 4 NICs, which will now be 8%. The benefit to the average self-employed person across the UK is expected to be around £350 a year – smaller than the average benefit for employees, in large part because self-employed workers are already taxed less to begin with.

Full expensing made permanent – value for money?

The Chancellor has announced the permanent extension of their ‘full expensing’ (FE) policy, temporarily introduced for three years in March 2023. This policy allows companies (not including unincorporated businesses such as self-employed, sole traders and partnerships) to immediately write off the full cost of investment in new plant and machinery, classified as a ‘main rate’ asset, against taxable profit in the year that the investment cost incurred. ‘Special rate’ assets receive a first-year allowance of 50% of investment expenditure. Prior to the permanent extension, these rates would have returned to the 18% and 6% ‘writing-down allowance’ from April 2026. Under FE, the value of investment that can be written off is uncapped. Prior to the introduction of the temporary FE policy, a temporary 130% super deduction was in place between April 2021 and March 2023.

Under temporary FE, businesses were incentivised to bring forward investment into the 2023-26 window, but investment was expected to fall again once the measure expired, resulting in no effect on long-run level of capital stock. The introduction of the permanent measure is expected smooth out this investment curve, lowering investment in the short-term by £11bn, but raising investment in the medium term by £25bn (Chart [x]). This additional £14bn in total business investment by 2029 averages to a £3bn increase per year.

Chart 7: Quarterly business investment forecast

Source: OBR

Implementing a permanent extension to FE is expected to lower corporation tax receipts by £10.9bn by 2028-29, while only raising capital stock by 0.2%. This is forecast to increase potential output by 0.1% in 2028-29 and just under 0.2% in the long run. The real terms cost of permanent FE will fall over time, however, as the higher corporation tax deductions firms experience in the short run will result in lower tax deductions later. As a share of GDP, the real terms cost of permanent FE is forecast to fall from 0.35% of GDP at the outset in 2027-28 (when the temporary measure was due to finish), to 0.15% of GDP after 10 years, and approximately 0.12% of GDP in the long run.

Overall, business investment requires certainty, and the introduction of permanent FE measure provides some improvement here, following three years of major changes in the corporation tax base and rates. However, the investment requirements in place under the temporary policy remain the same, so an incentive remains towards certain types of investments. For example, FE is only available for investments in plant and machinery and excludes investments in assets such as cars, buildings, intangible assets and assets used for research and development (R&D). Additionally, the FE policy increases the incentive for marginal debt-financed investment, over equity-financed investment. This is driven by the ability to deduct debt interest payments from taxable income and may potentially making more unprofitable projects viable. Therefore, while the move to a permanent measure is expected to increase business investment in medium to long run, there is no guarantee of the quality or productivity of these investments, which is required to boost output and economic growth.

Debt interest spending at record highs

Debt interest spending is expected to peak at £122.5 billion in 2028-2029 owing to higher levels of debt and the cost of servicing that debt.

The largest share of debt interest spending goes towards paying interest on bonds issued by the government – known as ‘gilts’. Some ‘gilts’ are index-linked and therefore spending on debt interest is impacted by changes in the retail price index (RPI).

Chart 8: Debt interest spending forecast

Source: OBR

This year’s debt interest spending, net of asset purchase facility (APF), has been revised upwards by £22.2 billion relative to the OBR’s March forecast, and so have future years.

Table 1: Central government debt interest, net of APF

Outturn Forecast 
 £ billion 2022-23 2023-24 2024-25 2025-26 2026-27 2027-28 2028-29
March 2023 forecast 115 94 77 77 89 96
November 2023 forecast 111 116 106 102 109 115 122
Difference -3 22 29 25 20 19

Source: OBR

Debt interest spending as a share of GDP is forecast to fall from 4.4% in 2022-23 to a low of 3.5% in 2025-26 before climbing back to 3.8% in 2028-29. Despite a lower debt-to-GDP ratio than in the OBR’s March forecast, higher Bank Rate, long-term rates and RPI all lead to higher debt interest spending.

Table 2: Change in debt-relevant market determinants and inflation since March

Bank Rate Long-term interest rates RPI
Mar-23 Nov-23 Change Mar-23 Nov-23 Change Mar-23 Nov-23 Change
2022-23 2.3 2.3 0.0 3.2 3.2 0.0 12.7 12.9 0.2
2023-24 4.1 5.1 0.9 3.7 4.6 0.9 6.4 8.3 1.9
2024-25 3.5 5.0 1.5 3.8 4.9 1.1 1.2 4.3 3.1
2025-26 3.2 4.4 1.3 3.9 5.0 1.1 1.0 2.4 1.4
2026-27 3.1 4.2 1.1 3.9 5.0 1.1 2.1 2.6 0.5
2027-28 3.0 4.0 1.1 4.0 5.1 1.1 2.9 2.8 -0.1
2028-29 4.0 5.2 2.9

Source: OBR

In 2027-28, public sector net debt is forecast to be £94 billion higher relative to March. This increase is met with a higher forecast of the bank rate and long-term interest rate.

Departmental and devolved spending is getting squeezed

One of the main unspoken bits of the forecast has been the slow and prolonged squeeze on departmental and devolved spending pencilled in by the Chancellor. Of course, the Spending Review period ends next year and settlements aren’t yet determined, but the Treasury does tell the OBR what they should use as a holding assumption.

Spending on public services across departments and the devolved administrations is not expected to keep pace with GDP – which the OBR usually view as a neutral assumption – and instead is projected to fall across the forecast horizon relative to GDP. By 2028-29, resource and capital spending are forecast to be 0.6 and 0.5 per cent of GDP lower than in 2023-24, respectively, putting further pressure on frontline delivery.

Chart 9: Departmental and devolved spending

Source: OBR

Second round effects of policy measures

The indirect effects of the policies announced today will likely lead to a boost in demand in the short-term and permanent increase to potential output, albeit a small increase.

Table 3: Total effect of government decisions since March

  2023-24 2024-25 2025-26 2026-27 2027-28 2028-29
Total effect of Government decisions 8.1 13.7 14.3 22.1 26.6 19.5
Direct effect of tax decisions 1.8 10.7 9.8 15.1 17.7 18.2
Direct effect of spending decisions 6.8 5.6 7.2 8.0 7.4 -0.9
Indirect effects of Government decisions -0.5 -2.6 -2.7 -0.9 1.5 2.2
Direct effect of Government decisions 8.7 16.3 17.0 23.0 25.1 17.3

Source: OBR

Cut in NICs

The biggest increase in potential output comes from the cut in National Insurance Contribution NIC.

This is projected to raise employment by 28,000 or 14,000 in full-time equivalent (FTE) terms. The entrants of these 28,000 employees is assumed to be at lower-than-average hours. This explains the difference between the total and the FTE figure.

There is also projected to be an increase in hours from existing workers, by 79,000 on a FTE basis.

These two effects taken together will offset a £0.6bn of the cost of the measure in 2028-29.

As well as these behavioural affects, there is estimated to be a reduction in tax motivated incorporations (labelled as direct effect). This generates an additional £0.4 billion in receipts

Table 4: Cost of reducing rates of employee and self-employed NICs, £ billion

  23/24 24/25 25/26 26/27 27/28 28/29
Costing (static) 2.4 9.9 10.1 10.4 10.7 11.1
DIRECT: Reduced incentive to incorporate 0.0 0.1 0.0 -0.2 -0.3 -0.4
Post-direct-behavioural costing 2.4 10.0 10.1 10.2 10.4 10.7
INDIRECT: Increase in employment and hours worked -0.1 -0.5 -0.6 -0.6 -0.6 -0.7
Post-indirect-behavioural costing 2.2 9.4 9.5 9.5 9.8 10.0

Source: OBR

Making full expensing permanent

Business investment in the UK has been a long-standing weakness. In 2021, UK business investment accounted for 10% of GDP compared to the OECD average of 12.5%.

Back in March, the Chancellor introduced full expensing permitting businesses to write off the full cost of qualifying plant and machinery investment against taxable profit in the year that the cost is incurred.

Initially due to expire in 2026, in today’s Autumn Statement, the government made full expensing a permanent promise. The move makes the UK’s capital allowances regime one of the most generous in the world, with no cap on the amount of investment that can benefit from full expensing.

Capital allowances are a form of tax relief for firms that allow them to deduct some or all of the cost of an item before paying tax.

Ultimately, full expensing (FE) should incentivise investment and help boost productivity. The move from temporary to permanent FE, however, raises uncertainty in relation to how it affects the path of business investment.

Assumptions in March, under temporary FE, were that any planned investment by businesses would be brought forward to take advantage of the policy within the three-year window.

Now permanent, the incentive for firms to bring investment forward to the near term is gone, leading to a negative but temporary demand effect which reduces real GDP by 0.1% in 2024-25.

The announcement also means that in the first half of the forecast period, real investment is around £11 billion lower than what was previously assumed in March. Of this cost in 2028-29, just over three-fifths derives from the static costing – the impact of the more generous tax treatment on pre-planned investment – with the remainder from the dynamic impact of additional investment.

Table 5: Cost of capital allowances, making FE permanent, £ billion

2023-24 2024-25 2025-26 2026-27 2027-28 2028-29
Static costing 0.0 0.0 2.0 6.9 9.1 9.2
Behavioural response -0.3 -0.7 -0.5 0.7 1.7 1.8
Post-behavioural costing -0.3 -0.7 1.4 7.5 10.7 10.9

Source: OBR

Labour Supply Measures

The government also announced today its plans to spend £3.2bn on five different measures to increase employment by around 50,000.

The first of these measures is the change to the Work Capability Assessment. This assessment is a medical process and is designed to determine an individuals capacity to work and ultimately their eligibility for health-related benefits.

The changes announced today relate to changes in the mobility and risk factors of the assessment. As well as this, these assessments will also now take place every 12 months for new claimants.

The OBR estimates that this policy will generate savings to £1bn each year between 26/27 and 28/29, resultant from a lower spend on the health measure of Universal Credit.

The overall aim therefore is that this policy change will help to reduce the overall caseload for those deemed to have severe incapacities and increase it for those with less severe incapacities.

These estimates suggest that those with the most severe incapacities claiming UC should fall by 371,000 by 28/29, with an increase of 342,000 for those with less severe incapacities.

The table below sets out the associated cost to these labour supplies policy changes, with the alterations to the WCA expected to reduce spend by £1.3bn in 28/19.

The other policies announced, such as the expansion of Universal Credit for disabled individuals in work, the expansion of the Individual Placement and Support scheme and the Restart Scheme, to get people back into the labour force, are expected to increase spend by £0.3bn in 28/29.

Table 6: Cost of labour supply measures, £ billion

2023-24 2024-25 2025-26 2026-27 2027-28 2028-29
Work capability assessment reforms 0.0 0.0 -0.1 -0.5 -0.9 -1.3
Other labour supply measures 0.0 0.4 0.8 0.6 0.3 0.3

Source: OBR

What does this mean for Scotland?

The two main tax measures – lower NICs and making full expensing permanent – are UK-wide, and apply automatically in Scotland.

Some other measures announced are England-only, and therefore bring with them additional funding for the Scottish Government through the Barnett formula, totalling £233m in this financial year and £281m in the next. The main measures generating consequentials are:

  • The funding of the pay award for the NHS in England in 2023-24, which generates £235m;
  • The 75% relief on business rates in England for the retail, hospitality and leisure sectors in 2024-25, up to a £110,000 cash cap, which generates £232m;
  • Freezing the small business multiplier in England in 2024-25, which generates £32m.

As these are devolved matters, the Scottish Government receives this funding but is under no obligation to match the policies announced by Westminster. For example, the retail, hospitality and leisure relief is a repeat of the measure for 2023-24, which the Scottish Government decided not to pass on and spent elsewhere. So this is one to watch out for at next month’s Scottish Budget.

Settlements with the Treasury are only fully determined until 2024-25, when the current spending review period finishes. Nevertheless, the UK Government budgets on a 5-year basis, and has to give the OBR an indicative assumption for departmental and devolved spending. This is a technical detail, and is only indicative at this time, but the OBR’s forecast incorporates a slightly higher spending assumption than it did in March, whose consequences are buried deep in our favourite supplementary table 3.11. If this did come to pass, it would mean Scottish Government spending power being higher in each year by between £1.1bn and £1.4bn from 2025-26 onwards.

We have also summarised which measures apply directly to Scotland or are devolved in the table below.

Table 7: Summary of whether measures are reserved or devolved

Announcement Reserved Devolved
National Insurance contributions (NICs): 2p cut to the main rate of Class 1 employee NICs from January 2024 Applies in Scotland
 National Insurance contributions (NICs): 1p cut to the main rate of Class 4 self-employed NICs from April 2024 Applies in Scotland
 National Insurance contributions (NICs): abolish Class 2 selfemployed NICs liability from April 2024 Applies in Scotland
Business Rates: 75% relief for Retail, Hospitality and Leisure sectors in 2024-25, up to £110,000 cash cap Consequentials 2024/25: £232m
Business Rates: freeze the small business multiplier in 2024-25 Consequentials 2024/25: £32m
 Local Housing Allowance (LHA): set to the 30th percentile from April 2024 Applies in Scotland
 Universal Credit: extend the £2,500 surplus earnings threshold for one year from April 2024 Applies in Scotland
 Universal Credit: increase the Minimum Income Floor by up to a max. of £1,250 a month for lead carers from April 2024 Applies in Scotland
 Alcohol duty: freeze rates until 1 August 2024 Applies in Scotland
 Tobacco duty: increase duty on Hand Rolling Tobacco by RPI+12% from 6pm on 22 November 2023 Applies in Scotland
 Individual Savings Accounts: maintain subscription limits at current levels for 2024-25 for Adult, Junior, Lifetime ISAs and Child Trust Fund Applies in Scotland
 VAT: extend the zero rate on Women’s Sanitary Products to include period underwear from January 2024 Applies in Scotland
 Universal Credit: Severe Disability Premium transitional protection Applies in Scotland
 Restart: expand eligibility and extend the scheme for two years Consequentials:
2024/25: £27m
 Mandatory Work Placements: phased rollout Consequentials:
2024/25: £3m
 Talking Therapies: expand access and increase provision Consequentials:
2024/25: £2m
 Individual Placement and Support (IPS): expand access Consequentials:
2024/25: £1m
Fit Note Reform trial Consequentials:
2024/25: £1m
 NHS: funding for Agenda for Change pay awards (consolidated and non-consolidated) and winter planning Consequentials:
2023/24: £235m
Apprenticeship Growth Sector Pilot Consequentials:
2024/25: £2m
Local Authority Housing Fund, housing supply and planning Consequentials:
2024/25: £10m

Source: OBR, FAI calculations

We’ll continue to trawl through the documents and conduct analysis, especially regarding some of the more detailed areas that are impossible to cover on the day. So look out for additional analysis on our website and social media.

Authors

João is Deputy Director and Senior Knowledge Exchange Fellow at the Fraser of Allander Institute. Previously, he was a Senior Fiscal Analyst at the Office for Budget Responsibility, where he led on analysis of long-term sustainability of the UK's public finances and on the effect of economic developments and fiscal policy on the UK's medium-term outlook.

Emma is Deputy Director and Senior Knowledge Exchange Fellow at the Fraser of Allander Institute

Mairi is the Director of the Fraser of Allander Institute. Previously, she was the Deputy Chief Executive of the Scottish Fiscal Commission and the Head of National Accounts at the Scottish Government and has over a decade of experience working in different areas of statistics and analysis.

Brodie is a Knowledge Exchange Assistant at the Fraser of Allander Institute. She has recently completed an MSc in Applied Economics at the University of Strathclyde and has a first-class Honour’s degree in Economics and Politics from the University of Glasgow

Ciara is an Associate Economist at the Fraser of Allander Institute.

Calum is an Associate Economist at the Fraser of Allander Institute (FAI) and a Researcher at the Centre for Inclusive Trade Policy (CITP). He specialises in economic modelling and trade, and holds an MSc in Economics from the University of Edinburgh.

Allison is an Associate Economist at the Fraser of Allander Institute.

Jack is an economist at the Fraser of Allander Institute.

Ben is an economist at the Fraser of Allander Institute working across a number of projects areas. He has a Masters in Economics from the University of Edinburgh, and a degree in Economics from the University of Strathclyde.

His main areas of focus are economic policy, social care and criminal justice in Scotland. Ben also co-edits the quarter Economic Commentary and has experience in business survey design and dissemination.

Kate is a Knowledge Exchange Assistant at the FAI working across a number of project areas. She is currently studying for her MSc in Economics at the University of Edinburgh and has a bachelor’s degree in Economics from the University of Strathclyde. Kate is also the Outreach Coordinator at the Women in Economics Initiative which aims to encourage equal opportunity and improve representation in the field.