Podcast: Fiscal policy under pressure ahead of the Autumn Budget statement

In this episode, FAI Deputy Director João Sousa joins economist Hannah Randolph to talk through some of the economic pressures facing the chancellor as she prepares her autumn budget statement, as well as what a delayed timeline and the potential announcements could mean for the Scottish budget.

Episode notes

Participants

Dr Hannah Randolph – Fellow at the Fraser of Allander Institute

Dr João Sousa – Deputy Director at the Fraser of Allander Institute

Time stamps

(0:40) What pressures does the chancellor face ahead of the autumn budget statement?

(8:30) Prospects for improved economic conditions

(11:00) Potential policy changes in the Autumn Budget statement

(17:00) Impact on the Scottish budget process

Transcript

00:00:07 Hannah Randolph

Hello and welcome back to our latest Fraser of Allander podcast. I’m Hannah Randolph, an economist here at the Institute, and today I’m joined by my colleague João Sousa, who is a deputy director here at the FAI.

So the UK and Scottish Parliaments returned from recess last week, as did some of the cooler weather. And so now we can return to our favourite autumn sport here at the Fraser, which is speculating about upcoming fiscal events. Or maybe it’s our second favourite, after commenting on fiscal events once they’ve already happened.

00:00:37 João Sousa

I don’t know. The rugby season is starting, so maybe second and third.

00:00:41 Hannah Randolph

Second and third, okay. But first up this autumn is the UK budget which is set for November 26^th, and last year Rachel Reeves announced tax rises that raised an additional £40 billion which included a rise in the rate of National Insurance paid by employers.

Since then, she’s been under a lot of very public pressure from poor economic conditions, so things like slower growth and the recent US tariffs, and that’s put her under a lot of pressure to meet her fiscal rules. So João, can you start with what pressures are at play here and what is the Chancellor trying to balance in the budget?

00:01:20 João Sousa

Yeah. So, as you said, Hannah, the chancellor last year announced pretty big increases in tax, but on top of those increases in tax she also announced pretty hefty increases in borrowing because spending also went up significantly.

So it was, it was a pretty large fiscal loosening last year, and so, on top of of that, she also announced some changes to the main targets that she was going to try and hit, also known as the fiscal rules. So the fiscal rules are that no borrowing should happen by 2029/30 for day-to-day purposes, and that an easier to hit measure of financial liabilities, public sector net financial liabilities, as opposed to net debt, should be falling by 2029/30.

She loosened the fiscal rules and then made sure to hit them with a very thin sliver of, of margin. That means that given that the economy wasn’t doing too well and still isn’t doing too well, and borrowing costs have gone up relative to where they were in the autumn last year. She then had a choice in in the March statement that she made to the House of Commons, which was to either to accept she’s going to break her fiscal rules, which she said were non negotiable, or tighten fiscal policy to make sure that that was hit.

So that’s what she did. Uh, she announced, amongst other things, £5 billion a year worth of cuts to welfare, mostly on on disability, but also in its incapacity benefits.

And that was really to to try and and hit the OBR target. There seemed to be no particular reason why that was picked other than this is a relatively large and growing line of the budget that we need to to to do something about, and and that obviously didn’t get down so well. So at the beginning of July we had a big revolt within the the Parliamentary Labour Party in Westminster. Which ended up with with the Work and Pensions ministers having to essentially turn at the dispatch box, which is far from ideal in terms of party management. Certainly when you have a majority of 100, well not 180 anymore because some people have have lost the whip or or or resigned the party, but still, you know, about 160, I think 160-odd MPs. So you have, you know a big majority in you know situation where you can’t really get big reforms through, well, relatively big but not massive, massive reforms through.

So since then things have slightly worsened, I would say. There was also the the, the, the U-turn over Winter Fuel [Payment], all these things kind of like, aren’t massive in the grand scheme of things. But remember that the room against meeting the fiscal rules was very, very small by historical standards, which means that, buffeted by one or two things the path for net debt in particular could be veered off course.

And that’s what’s kind of happened so far. So gilt rates are still higher than they were 12 months ago. They’re particularly higher at the long end, which matters less than it might appear at first.

But there’s also the prospect of, of the OBR doing a review of their productivity assumption, which has been discussed somewhat in the press, and in the more specialist end of the press, I would say. Probably the sort of things that we read, but we wouldn’t recommend the, the average person spend too much time doing. But the thing is the productivity in the long run is is the main driver of improvements, living standards, and therefore it’s really important when we’re looking 5 to 10 years down the line, because that kind of drives where we think things are headed. The OBR has been perennially over-optimistic about productivity. Now it’s less bad than it seems at first. The reason is that when they were founded in 2010, we were just coming off the back of, you know, 7 decades nearly of continual productivity growth that was relatively high. It had tapered out somewhat, but you you’d expect that. So after the Second World War, it hit as high as 5% a year. That is not sustainable. Part of it was kind of the, the, the rebuilding after the war, which which was huge and and obviously it only had to happen because there was so much destruction before that.

But it had averaged since the 1980s about two and a half percent a year, which is pretty good by certain standards, and meant that the things were improving significantly year on.

Now when the crisis happened in 2008, the expectation was that there would be a drop off immediately. In fact, that’s what we saw. But we expected that there would be a rebound towards the long-term trend, which was two and a half percent. Now the OBR even at that time thought maybe there’s been some kind of mismatch of, or misallocation of capital that’s lost forever, so we’ll take that up to 2%.

They’ve since taken it down to one and a half percent in the long run, 1.25 in the, in the medium term because they assume that there’s some Brexit effects. All of these numbers that I’ve thrown at you are way, way higher than what’s actually happened, which is that productivity labour productivity is averaging about 0.5% a year.

So that’s, well, just just under half of what the OBR assumes will happen in five years into the future. Obviously, this matters a lot, like when we think about like what drives tax basis five years into the future, it’s this productivity growth assumption that that is anchoring them onto a higher level. So if, if we don’t, if we shouldn’t be assuming 1.25, we should be assuming maybe 0.7 or 0.5. It means that the government is in a real bind and could be facing, you know, tens of billions of pounds of of basically unfunded pledges because the spending side is pretty much fixed. So now the tax side.

If we think that tax bases are going to underperform, that means that the government has to do something. Now, what could that something be? It could be that they decide to revisit spending plans. That could be one thing, but it will look pretty silly after after they they they did a spending review three months ago, not even three months ago. So it’s, that is probably not something that’s going to get reopened now. So that leaves us back onto what can they do on the tax side or on the welfare side. But none of these are particularly palatable things for the government to do.

00:08:31 Hannah Randolph

Yeah, it does feel like the approach to the Autumn Budget is coming with a certain sense of dread of what’s going to happen next. And this year, the budget is at the end of November, last year it was late October. So I, I know that the productivity stuff that you’re talking about is really a long term thing. But is there any chance that we get slightly better economic news before the Autumn Budget and is that maybe what Rachel Reeves is hoping for before she delivers the budget?

00:09:00 João Sousa

I think so. I think that there’s there’s definitely, you know, my, my experience having been at the OBR for, for a few years before working here at the FAI was that there was always kind of a temptation. It certainly seemed that way anyway by chancellors, to kind of do these events as late as possible, but especially when things weren’t doing too well, which, which was actually quite often over that period. So the idea would be like, maybe the next data release will prove that things are coming back towards us. It’s very understandable.

And I can see the, the attraction of that. As you said, the productivity upgrades, if they do happen and and I think we have argued that that it’s pretty much inevitable they will happen at some point because the outturn data is just so out of kilter with, with the assumptions, the question is, will they happen now? We think that that would be pretty remarkable if the OBR put out another forecast with those assumptions built in. Even if the, the timing, you know, will make it things harder for the government. But it’s not the OBR’s job to necessarily make it things easy for the government.

But the, the other economic data, I mean short-term indicators can have some effect and, and particularly like the OBR takes market-derived assumptions on interest rates for example. So if they do come down somewhat, that would be helpful for, for the government, I guess, but ultimately the, I think the overarching narrative here is pretty clear, even if quite unpleasant, but, but it is what it is, and I don’t know that another GDP release or another inflation release will necessarily change things very much.

00:11:04 Hannah Randolph

Hm. Yeah. With those conditions in mind, the sense going into the budget seems to be that we’ll be seeing more tax rises. So last year the biggest one was the rise to National Insurance paid by employers, but we talked about, you know, that typically over time will just get passed on to employees regardless through what salaries they’re offered.

What do you think we might see in the autumn budget, or at least, what are some of the options?

00:11:31 João Sousa

It’s very hard to to see a way out that that means hitting the fiscal rules and not, not raising taxes. And and I should say that part of it is not just you know, a lot of people, even, even very recently and we, we saw an article by former Transport Secretary Louise Haigh saying you need to rid ourselves of this fiscal straitjacket that we’ve got ourselves into, and all of that. But the problem is that, as some of the turmoil in the gilt market has shown, the problem isn’t necessarily that fiscal rule is XYZ, it’s that the UK Government needs people to be willing to buy their bonds at a price that is reasonable, and that’s that’s partly why some of the, the narrative about, you know, these auctions are over-subscribed. Yes, they are. But that doesn’t necessarily mean that that you’re getting the interest rate that you want to get because people have to bid for what interest rate they’re going to, to lend you at. So just being over-subscribed doesn’t, doesn’t tell you as much as you might think.

And really – the market gets very jittery, and when, when you issue more borrowing when you already have such a high debt stock. So then then that leaves you with either cutting back on spending, as I said, doesn’t seem that likely, it it looks like the government might try and go again on on welfare although that seems rather risky in terms of of getting you through the Commons.  on the tax side, they’ve really.

On the tax side, they’ve really hamstrung themselves on this, in a pledge that income tax, National Insurance contributions on the employee side and VAT will not be raised. So that ,that means, I mean, these three taxes kind of raise about 2/3 of all revenue and they’re also the broades-paying taxes which means that you can raise a lot more money from, by raising each person’s liability a little bit, which kind of diffuses the pain.

Whereas what we saw last year with the for example, the changes to inheritance tax on on farmland was that yes, there might not be very many people, but for those people, the changes to the liabilities are huge and therefore they have a very strong incentive to, to protest and really make their case to government.

Whereas if you raise everyone’s income tax by £20 a year, you’re going to find much less resistance in that regard because the the amount that each person pays just, just is much less and therefore it has much less effect on their personal circumstances than those few people who get affected by by this.

And that’s that’s why broad-based taxes tend to be the easiest way to raise large amounts of revenue and, and why we end up relying on, on this, this small number of taxes.

I mean, I think one of the things that will happen inevitably is that the, the thresholds will be frozen again for, for income tax, National Insurance and because that’s that’s an easy way of, of changing policy without having to pass anything, so it’s kind of like, you know, changing your policy, but ultimately you don’t have to pass any legislation for this to be in place. So that’s, that’s pretty standard. I mean you have to pass a resolution, but that’s very easy and it just goes through.

That’s probably what’s going to happen, and in fact that will be almost a full decade of an indexed threshold. But ultimately I don’t, I don’t see some of the – it might be there’s some, that there’s some attempt at introducing some narrow taxes that, that take a lot of money from some people, but I just can’t see how that’s going to raise the amount of money that would be required.

00:15:59 Hannah Randolph

Yeah, some people talked about things like inheritance tax, but that’s paid by a relatively small part of the population and might be like as you said about the farmland from last year. It’s maybe relatively few people and it makes a big difference to them, but overall you’re not raising a huge amount that way.

00:16:17 João Sousa

Yeah, the, the total amounts that you raise from inheritance tax today, even if you doubled it, that would not be enough to to get rid of all the the fiscal problems.

And that would be a huge change. Either by, you know, you’d have to more than double the rate, or you’d have to, to reduce the threshold from, from £1 million. Yeah, it would be a big, big change that – and I think it’s just, it’s just infeasible to get through, but also it just doesn’t give you that much money.

00:16:53 Hannah Randolph

Yeah, it’s a huge political fight for something that’s not going to solve your problem.

00:16:55 João Sousa

Exactly.

00:16:58 Hannah Randolph

And so, this is all, we’ve all been talking the entire time about the UK budget. We are also, of course, looking forward to the Scottish budget, which usually happens in December and now the Finance Secretary has said that, because the UK budget is delayed, likely the Scottish budget will not be until January. And so right now the Scottish system works a little bit differently and so they have a lot of pre budget scrutiny and so that has been, is going on right now.

How do you think the delayed UK budget might affect the pre budget scrutiny here in Scotland?

00:17:32 João Sousa

Yeah, I think the, as you said, the pre-budget scrutiny is is pretty well along the way now, I think it’s been relatively tight in terms of time frames this year, it has felt, so maybe it will mean that it can go on for a bit longer in terms of the the write up, because each committee does a write up of of the different inquiries that they’ve, that they’ve done. So some of it that could be positive. However the, I think ultimately the, the Scottish Parliament has a relatively restricted timetable to get everything done.

So usually there would be about 3 weeks after the, the UK budget that there, there would be a Scottish budget. That gets very, very close to the end of of the parliamentary to of the parliamentary term before recess at Christmas, which then means that either there is something that we had a couple of years ago, where like everything has to be crammed into the final days of sitting.

And to be frank, not as many people are paying attention as as would otherwise be the case, or it gets punted into January. I think it’s possible that that will, that’s what will happen now. Now, it’s not, it’s not unreasonable that that happens, doesn’t mean that there’s a, a compressed timetable for for the the different stages of the Scottish budget because again, the Scottish budget, because the system is designed for a Parliament, as happens at the, at the moment, where there isn’t a majority, and that means that the different legislative stages actually matter more than for the UK budget, where things tend to be assumed to get through unless there’s a surprise, when, say, the welfare cuts don’t go through.

So, so that that might get compressed, the Scottish Government does have to pass a budget of some kind before the before the end of the financial year. But more importantly – so you have to get royal assent before the end of the financial year. That’s not, royal assent could be attained in just a matter of days. That’s not a problem really. The biggest problem is the fact that they also have to dissolve the Scottish Parliament towards the end of March, because there’s an election on the 6th, I think it’s the 6th of, of May. So the first week of May. And that means that everything needs to be wrapped up by then. And the other thing is that the, the Scottish Government doesn’t, or Scottish Parliament rather does not have something that that happens at UK level, which is called the Provisional Collection of Taxes Act, which allows you to retrospectively change the law.

So you, you, all you do is pass a resolution saying we’ll pass this, an act at a later date which will confirm that these are the rates and thresholds of income tax. And you can collect it on a provisional basis. That’s not available for Scotland. So they need to pass a rates resolution before the Parliament gets dissolved.

So that that will tighten things a little bit. My impression is that the budget will go through. It might be a bit less scrutinised than, than otherwise be the case, but on the other hand, we do have a a pre election period to scrutinise all this as well. So maybe some of that will will turn out to be part of the campaigns and I think that that is okay.

But I think it’s, it’s not ideal that the things get shoved so late in in the day, but but I think that this, the process should survive this test.

00:21:34 Hannah Randolph

Well, thanks for joining me today, João! You can follow our commentary leading up to the UK and Scottish budgets on our website, fraserofallander.org, which is also where you will find our Scottish budget report when it’s available.

If you were intrigued by some of the references that João made to fiscal policy history, you should also make sure that you are signed up for our conference on September 18th and 19^th where João is chairing a session on exactly that topic. Until next time on the Fraser of Allander podcast, we’ll see you then.

00:22:10 Ben Cooper

Hello, 2025 marks a significant year for the Fraser of Allander Institute. Founded in 1975, the Institute celebrates 50 years of leading economic research in Scotland. Given this, we have a series of exciting events and content planned for the remainder of this year to mark this milestone.

This includes our anniversary conference on the 18th and 19th of September this year at the University of Strathclyde’s Technology and Innovation Centre. We have a number of speakers and themed sessions planned for the day in order to highlight the breadth and importance of the Economic Research being conducted across Scotland.

As well as this we have a number of other events planned, including our reception at the Scottish Parliament in December and one at the Scotland Office in London in October.

You’ll also see some unique content published in the coming months, including a podcast series with past institute directors and some articles on the history of the Institute, as well as some other eye-catching covers from some of our reports from over the years in the coming months.

In order to be kept up to date with any of these events and to be the first to know about our 50th anniversary publications, visit our website, fraserofallander.org and you can join our mailing list.

If you are interested in engaging with us also, whether you previously work for or with the institute, why not get in touch? We have a designated 50th anniversary e-mail fraser50@strath.ac.uk. We hope you’re as excited as we are and look forward to celebrating this exciting milestone with as many of you as possible.