Labor could cut taxes by £16 billion, economists say

Economists at Capital Economics predict Labor could benefit from a £16 billion spending boost if it wins the upcoming general election, thanks to updated forecasts from the Office for Budget Responsibility (OBR).

This potential fiscal space is almost double the £8.9 billion announced in the March Budget.

Rachel Reeves, Labour’s shadow chancellor, could use this revised forecast to either undo some planned spending cuts or tackle the freeze on personal tax thresholds, but probably not both at the same time.

The OBR’s improved borrowing forecast, which is being revised downwards by around £5 billion per year over the next five years, is attributed to higher tax revenues due to recent wage growth. This shift offers the next administration an opportunity to reassess its fiscal strategies.

If Capital Economics’ forecasts hold, the next Chancellor could have fiscal space of as much as £27 billion, assuming wider-than-expected interest rate cuts and higher-than-expected tax revenues from higher house and share prices. However, the OBR’s forecast could vary significantly, with a range of scenarios presented from a deficit of £13 billion to a surplus of £38 billion, equivalent to 1.4% of GDP.

The UK’s deputy chief economist, Ruth Gregory, commented: “As things stand, we suspect that the next government may get some more fiscal space from the OBR. But the country will probably not have enough fiscal space to do everything it wants at once.”

Gregory emphasized that economic developments and the OBR’s forecasts will significantly impact the available fiscal space, in addition to the new government’s willingness to increase taxes to finance additional expenditure beyond what the fiscal space allows.

The potential fiscal flexibility comes from discussions about how best to use the projected surplus to balance spending and tax cuts, reflecting the broader economic conditions and strategic priorities of the next administration.