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Chancellor Rachel Reeves is set to be hit by a bigger than expected downgrade to official UK productivity forecasts in the Budget, which analysts believe could deliver a blow to the public finances of more than £20bn.
The Office for Budget Responsibility is expected to cut its trend productivity growth forecast by about 0.3 percentage points, according to people familiar with the matter, increasing the prospect of big tax rises, including income tax.
The Institute for Fiscal Studies think-tank has said that each 0.1 percentage point downgrade in the productivity forecast would increase public sector net borrowing by £7bn in 2029-30, so a 0.3 point cut could create a £21bn hit.
Analysts had expected a downgrade of between 0.1 and 0.2 percentage points to the UK fiscal watchdog’s trend productivity outlook, meaning a lower hit of £7bn-£14bn under the IFS calculation.
Analysts have widely been predicting a total fiscal hole of £20bn to £30bn, based on those previous estimates. The larger-than-expected downgrade would on its own increase the size of that hole, but the final number could be offset by a range of other figures.
Reeves on Monday admitted that Britain’s productivity record had been “very poor”, blaming the fallout on the financial crash and Brexit. The chancellor’s allies say the previous Conservative government should be held responsible.
One Labour official said there was “fury” in Number 10 and the Treasury that the OBR has decided to deliver the downgrade now, rather than before the 2024 general election.
The absence of an earlier OBR downgrade helped former Tory chancellor Jeremy Hunt slash taxes by about £20bn in two rounds of reductions before polling day.
Reeves said on Monday: “Our independent forecaster is likely to downgrade the forecast for productivity in the UK, based not on anything this government has done but on our past productivity numbers, which, to be honest, since the financial crisis and Brexit, have been very poor.”
The downgrade increases the likelihood that the chancellor will be forced to breach Labour’s election manifesto pledge on tax, with speculation growing that an income tax increase is looming on November 26.
Reeves’ Spring Statement in March left her with just £9.9bn of headroom against her key fiscal rule, leaving her badly exposed to productivity downgrades by the OBR, which had been long expected.
Productivity has been weak since the financial crisis as a result of a range of factors including sluggish investment growth and policy uncertainty.
The OBR currently predicts that trend productivity growth will reach nearly 1.3 per cent by the final year of its forecast in 2029. The OBR has delivered two internal forecasts to the chancellor so far, with a final “pre-measures” outlook set to land on Friday.
The Treasury said: “We won’t comment on speculation ahead of the OBR’s forecast, which will be published on November 26.” The OBR was approached for comment.
The chancellor said on Monday that she wanted to increase the headroom in her Budget to “make sure we have resilience against future shocks”. Treasury officials have told City figures it could be at least doubled.
If Reeves chose to increase her headroom by £10bn and then had to find a further £25bn or so because of the productivity downgrade, that would blow a massive hole in the public finances.
The chancellor will also have to find £5bn following the abandonment of planned welfare cuts, while Labour MPs are demanding the end of the two-child benefit cap, at a cost of more than £3.5bn.
Reeves expects that the OBR will factor in good news, such as lower borrowing costs and faster than expected growth, to reduce the final fiscal gap. She also hopes that growth-friendly policies such as trade deals and planning reforms will also be “scored” positively.
The chancellor said she hoped she would be able to get agreement on a UK trade deal with the six Gulf Cooperation Council countries “very soon”. Britain has already reached agreements with the EU, US and India.
Reeves is widely expected to extend an existing freeze on personal tax thresholds in the Budget, raising close to £10bn a year, but government officials have privately admitted that a fiscal gap of £30bn or more could put an income tax rise “on the table”.
An increase to the basic rate of income tax by 1p would raise more than £8bn a year in 2028-29, according to HM Revenue & Customs. A 1p increase to the higher rate of tax would lift revenue by £2.1bn, while a 1p boost to the additional, 45p rate, would raise £230mn.
Treasury officials said no tax decisions had been taken and Reeves has previously said that Labour’s manifesto commitments “stand”.
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