Rachel Reeves’ first budget is a clear break from the recent past

The Labour manifesto implicitly signed up to most of the previous Conservative government’s spending plans, which would have required cuts to many public services and a sharp fall in investment – but doing so meant it did not need to commit to large tax rises at the election either. Many, including the Institute for Government, pointed out that this did not look consistent with their commitments to a decade of renewal, better public services and more investment. 

Rachel Reeves’ first budget resolved that particular puzzle: this is to be a government that taxes, spends and borrows significantly more than the previous government claimed it would. 

Day-to-day spending on public services will now be much higher than previously planned, by around £20bn this year and over £40bn each year thereafter. It should be enough to deal with acute crises this year and to ensure that almost all departments see real terms spending increases next year – including the predictable large increase for the NHS but also, less predictably, generous settlements for local government and justice, two areas under serious strain.

That increase is mostly funded by what amounts to one of the largest tax increasing budgets of the last 50 years. It is as large as Norman Lamont’s 1993 budget, and comfortably surpasses Gordon Brown’s and George Osborne’s first budgets. The bulk of the increase comes from increasing employer national insurance. The rest comes from a combination of a crackdown on tax avoidance and increasing taxes on those with higher incomes and wealth who benefit from various favourable tax regimes, including non-doms and those who receive their income through capital gains. 

The third prong of the budget was a big increase in borrowing to fund capital investment. Under previous plans, public sector net investment would have fallen by almost one-third as a share of national income. It will now stay broadly flat, allowing around £25bn a year of additional investment. 

For all the emphasis on investment, the OBR anticipates only a modest lift in GDP

This was Reeves’ first big opportunity to show some action on the government’s mission to increase economic growth. However, overall the OBR judges that this budget will do little for growth by the end of the five-year forecast. This is because, it says, the positive effects of higher investment are more or less offset by the economic drag from higher employers’ national insurance contributions, which will feed through into wages, and a view that higher borrowing will likely push up interest rates and so ‘crowd out’ some private sector investment, at least initially. 

But there is better news for Labour’s ambitions for a ‘decade of renewal’. The OBR has also published a longer-term assessment in which it judges that over 10 years higher public investment will encourage more private investment and increase growth.

Either way, the official forecasts imply that households will continue to feel the squeeze over the next few years. As a result of tax increases, real household disposable income is expected to fall next year and only reach its pre-pandemic level in 2026/27. This suggests that things might get harder before they get easier and, with the next general election likely to be in 2028, the chancellor and prime minister will be watching the forecasts closely.

But what these numbers do not account for is the effect that higher public spending might have on public services, which could both support growth and improve people’s lives. A well-functioning health and education system should help to improve participation in the workforce, while improvements to the health and justice systems should also improve broader wellbeing. Getting the multi-year spending review in the spring right will be critical to ensure that higher spending does feed through into better results. 

There were welcome signs of a coherent strategy, but the plans could still be shaken off course

Looking at the budget as a whole, there were welcome signs of some coherent strategy. The new fiscal rules and wider changes to the fiscal framework, which implement many of the recommendations we have made, should support more stable, sustainable fiscal policy. The new corporate tax ‘roadmap’ is a useful start to providing greater certainty about the taxes and clarity about the areas the government expects to reform. And a commitment to more stable, higher levels of investment – accompanied by five-year capital spending plans – should also help ensure that projects can address the most important gaps and be delivered effectively.

But there are still question marks over the government’s strategy. Day-to-day public service spending is set to grow quite slowly beyond next year, which the government may find frustrates progress on its missions. And given the small headroom against the fiscal targets even a modest revision to the forecasts would see them breached: it is not clear from today’s announcements how Reeves’ would respond to this.

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