Is Rachel Reeves’ budget bad – or good – for business?

What should we make of the impact of Rachel Reeves’ budget on business? It is reasonable to question that question. There is no such thing as the archetypal business, which if it existed could have its financial situation dissected and its incentives unpacked, thereby revealing the whole economy’s response in terms of investment, growth and job-creation. Moreover, the chancellor unveiled 70 different policy measures, from a swingeing hike in employers’ national insurance contributions (NICs) and an uprating to the soft drink levy to a freeze in fuel duty. Together these are impossible to generalise about.

Another natural response is to declare this budget as obviously bad for business, because it is business that has been ‘hit’ with tax rises, notably that hike in NICs but also a slew of smaller measures. Interest rates are also higher, which raises the cost of finance. The money raised has been directed towards public services. Therefore (so goes the response) the answer is simple: this is a budget that takes from companies (the real wealth creators) and hands it over to the state. Bad for business, good for Whitehall.

But this is too simple. We should remember that legal and economic tax incidence are different; companies may pay those higher national insurance contributions, but their effect will land on consumers (through higher prices), workers (through restrained pay growth) and owners (through lower profits). Ultimately, people pay taxes. Calling it a hit to business can confuse matters.

This is why it is too simple to divide the country into blocs (business, workers, government, etc.) that wrestle for advantage from one other. Their interests ultimately merge; “business” also benefits from the provision of public services, for example. Furthermore, the higher near-terms growth that the Office for Budget Responsibility (OBR) forecasts will impact business through higher revenues; the OBR sees Nominal Gross Domestic Product – roughly the amount spent in the economy – being £80bn higher next year. That effect needs to be considered alongside the hit from taxes.

In my view, a more analytically solid way of judging the budget is to consider its effect on the incentives and investments that determine the future course of the economy. 

The budget has damaged the incentive to hire

Raising NICs increases the ‘wedge’ between what it costs an employer to hire a worker, and what that worker receives. This straightforwardly lowers demand for labour, resulting in a combination of lower employment, wages and profits. The rise in the national minimum wage will likely compound this effect.

A perverse bias towards the self-employed remains

Employer NICs are not applied to the self-employed, so the NICs rise has generated an elevated incentive for companies to organise work through this channel, rather than direct employment. This is a questionable distortion and appears at variance with Labour’s preoccupation with stable, high-quality jobs.

Adjustments within the NICs system have protected the very smallest companies

By raising the employment allowance – a sum of money rebated from the NICs bill – to £10,500 from £5000, smaller companies are protected much more from the tax rise than the large. At the same time, the government has removed an eligibility threshold when the bill hits £100,000, which introduced a sharp “kink” for companies when their wage bills went above £700,000. Overall, the point at which companies start paying employer NICs has roughly doubled to £70,000. In combination with having a VAT threshold of £90,000 (on turnover), the government needs to examine carefully whether this constitutes a meaningful discouragement to grow beyond that level.

The government has not delivered yet on its promise of a wholesale business rates review.

The government has pushed through a shift favouring retail, hospitality and leisure businesses sectors hardest-hit in the pandemic and recipients of targeted support due to be phased out. These also have a high physical footprint, pay a share of rates out of proportion with their revenues, and so are often front of mind when reform of the system is considered. From a purely economic point of view, this appears like a poor decision: they are not the most productive industries. But government has a valid concern with the social and economic costs of deserted high streets, and support here might be a smart way to target this problem.

The government has passed up the opportunity to use this budget to reform taxes in a more pro-growth way

Despite a lack of pro-growth tax reform, and even though tax rises and distortions are generally bad for growth, it is also important not to evaluate them in isolation and instead include what they pay for, which is better funded public services and capital spending.
 

The rise in capital spending ought to boost business productivity; the big question is about ‘crowding out or in’

Rachel Reeves used extra space accorded by her redefinition of debt in the fiscal rule to unveil a large rise in capital investment. It also presaged a potential argument between the OBR’s verdict on this policy, and what the Labour government might hope for. Classic, conservative economics argues that a boost in government investment will push aside capital spending by business, through higher interest rates or the state effectively competing for finite resources. But the motivation for Labour’s industrial strategy, and the set of institutions it is building (Great British Energy and the National Wealth Fund in particular) is that the opposite can happen: carefully-chosen, strategic investments from the state can ‘crowd in’ a business response. For example, public provision of transport infrastructure can help sway the case for the construction of a logistics hub. 

Overall, the OBR has concluded that the crowding-out effects will outweigh those from crowding-in, leaving business investment slightly lower as a result of this budget. It is a key challenge for the industrial strategy to try to prove the OBR wrong. Which of these two visions comes about will make a significant difference to the UK’s economic prospects in the years to come.

The government is aiming to achieve fiscal and macroeconomic stability

The intention behind Reeves’ adoption of fiscal rules with a shorter time frame is to reassure business that the fiscal situation will be kept under control. Our verdict is that they should indeed “support more stable, sustainable fiscal policy” – but current circumstances nevertheless leave the chancellor with precious little room for error, should the economy underperform or new spending pressures arise. The rise in market interest rates in the 24 hours after the budget will have unnerved some in the Treasury (particularly those with memories of those hair-rising days after the mini-budget of 2022). But rising rates are not on their own proof of the budget’s core approach being wrong-headed. Economies with improving growth prospects should also expect rising rates. 

All in all, the real question is what this budget means for growth rather than business. In my opinion, it represents a clear break from the approach of the government before: a shift from hiring incentives to public investment, a gamble that better funded public services can more than outweigh the negative effects of higher taxes, and confidence that the government can identify the right investments to ‘crowd in’ the private sector. It is far too soon to judge its success.