Rachel Reeves will find out this week just how big a black hole she has to fill in her Budget when the official forecaster’s initial estimates for economic growth land on her desk.
The Chancellor is braced for the Office for Budget Responsibility to cut its key productivity forecast, leaving Reeves on track to break her fiscal rules and making big tax rises inevitable.
The OBR has consistently overestimated long-term growth in productivity – the amount of output per hour worked – which has remained stubbornly low despite advances in technology.
Experts says even a tiny reduction in the OBR’s forecast would have a big impact on the public finances.
It currently assumes productivity growth of 1.1 per cent a year over the medium term.
But slicing just 0.1 of a percentage point from that forecast would mean Reeves would have to find £9 billion to make her numbers add up, according to Allan Monks, UK economist at JPMorgan investment bank.
Shockwaves: Chancellor Rachel Reeves in Downing Street last October
The Chancellor promised after her first Budget last year that she would not come back with more tax increases or extra borrowing.
But she is likely to have to find anywhere between £20 billion and £50 billion to balance the books in November’s Budget.
The Government already faces a £6 billion shortfall after back-tracking on welfare cuts and winter fuel payments. Economic growth has also stalled, partly because of the £25 billion of employer National Insurance taxes that Reeves heaped on business in her last Budget.
And the recent rise in Government borrowing costs will add several billion pounds to the debt interest bill.
Reeves is also under pressure to give herself more than the historically low headroom of just £9.9 billion against her key fiscal rule, which is to fund day-to-day spending on the likes of health, education and defence entirely from taxes by the end of the decade.
But the sheer size of the gap in the public finances has led to growing calls for the Chancellor to abandon her manifesto pledge of not raising income tax, VAT or employee National Insurance – the three biggest revenue raisers for the Treasury, making up more than half of all receipts. Experts warn that targeting pensioners, landlords and certain self-employed people by making them pay National Insurance will not raise enough money to plug the hole.
In July, the OBR admitted it had been too optimistic in its past growth forecasts, leaving Treasury officials reportedly resigned to a significant productivity downgrade.
But they are frustrated that the OBR has not acted sooner given its poor forecasting record since the watchdog was created in 2010 to give an independent assessment of the public finances.
Reeves is expected to challenge any downward revision to the OBR’s forecasts.
She will argue that a series of ‘pro-growth’ measures such as easing planning restrictions to allow more airport runways and data centres to be built will boost growth.
The OBR will give its final verdict on the public finances after Reeves reveals her tax and spend plans to the watchdog shortly before the Budget.
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