Transcript

Mubin: Welcome to the Financial Fairness Podcast with me, Mubin Haq. It's been a long time since we had the Labour chancellor making a budget, and this was an eagerly anticipated one with many other policies trailed in advance. Today we're joined by Carl Emmerson, deputy director of the Institute for Fiscal Studies, to drill down into what was announced and what that means for people's living standards, the British economy, and whether we will see an end to stagnation.
So, Carl, welcome. Thanks for joining us today. And, great to have you here. Let's start with everyone's favourite subject, which is taxes. We'll come back to specific rises. But first, the big picture, the Chancellor raised an extra 40 billion pounds a year. Did she go far enough or did she go too far? And how coherent was it as a tax plan?
Carl: Well, it was certainly a big tax raising budget. The scorecard costing of about 40 billion makes it one of the biggest tax raising budgets in recent times. And I think it's pretty interesting. It means that taxes as a share of GDP will go faster over this Parliament than was previously expected, and that will be building on the big tax rises we had in the last Parliament.
So in terms of UK history, we've had this tax burden that was really rather flat during the 2010s, didn't change that much over the previous decade, but since 2019 has gone up a lot and it's set to go up a lot more, clearly bringing the UK up to the levels of tax that we've not experienced in this country before, about towards levels that are much more common in Western Europe and Scandinavia.
So we're becoming much more like them in terms of the role that the state is playing in society. Did the Chancellor do too much.? Well, I guess that depends on one's views about where you want the state to be doing stuff. You could say, well, no, we want the state to be earning less, but I'm not sure I see a lot of appetite for that actually in a relatively widespread way, if you look at the previous government, as I say, they were putting up taxes quite a bit and indeed adding to what the state does with Jeremy Hunt’s big expansion of childcare back in the spring budget of 2022. And if you read the words in the Labour manifesto, at least you see lots of ambitions to make public services better.
And that was always going to have a bit of a price tag. It was never going to be compatible with the kind of spending plans that the previous government had pencilled in, but, one suspects, might not have even been able to keep to themselves. So not a surprise that there was a big tax rise. 
Is it enough? I wouldn't be surprised if in a couple of years’ time she comes back and needs more. That's not definitely going to happen. She might get lucky on growth. She might find that her money that she's found for public services really does deliver a lot in terms of the quality. But I personally wouldn't be surprised if this won't be the last of the tax raising budgets of this Parliament, although I suspect it will be the biggest.
Mubin: Yeah, I mean, it would be hard to get bigger than this really, won't it? And was it coherent, you know, in terms of, various tax rises as a sort of tax plan? I mean, you know, you pride yourselves at IFS on wanting something that is coherent. So was it? 
Carl: Well, if any chancellor wants big sums of money, they're always going to have to push up the rates of income tax or VAT or national insurance.
So I don't think in that sense of surprise that she reached for National Insurance. That tends to be the one that Labour chancellors go for. Conservative chancellors either do National insurance or they do VAT. So putting up one of the big three taxes is not really a surprise. And that's where she got at least on the scorecard £25 billion.
So that was by far and away the biggest tax raising measure in the statement. I think more generally I think in some sense it was a bit disappointing that there wasn't a  oh yes, I'm going to push up taxes, which she was very honest about, but I'm also going to reform them to make them work better, make them more efficient, make them fairer.
If we're going to push up taxes, we might worry about the damage you have to do to our economy. We would clearly be more relaxed about pushing up taxes that are well-designed and then pushing up unreformed, badly designed taxes. A little bit of an exception on inheritance tax, where she did take some action to fix the tax base, which is pretty leaky and that means that very, very wealthy people can exploit loopholes. But in terms of other taxes, pretty disappointing on capital gains tax. Just pushed up the rates a bit. No attempt at serious reform. Very disappointing to see an increase in stamp duty. That's really not, it's probably the worst tax that we have in the UK, not one that should be going upwards and while landlords aren't particularly popular, if you take properties off the rental market, that's not going to be a good way to support those who end up in private rented accommodation for the entirety of their lifetimes. 
So across other taxes, I think actually a lack of reform, it's still early in the parliament. Maybe there’s time for her to come back next year and reform taxes to make them more growth friendly but that’s certainly a work in progress at best. 
And on fuel duties, I think very, very disappointing to see the charade of, oh yeah, we'll freeze, but only for one more year. Honestly, I'll increase it in line with inflation in a year's time. I don't know what the right rate of fuel duty is, but I do know that you shouldn't keep pretending you're going to put up in a year's time and then not doing it.
And surely at the start of a parliament with a new government, with a big majority with the oil price much lower than what it was before the fuel duty 5 pence  temporary cut came in. Surely this was the easiest moment in this Parliament to end that freeze? 
Mubin: Yeah on, fuel duty, it was quite a surprise not to make change there. Do you think that showed some of the risk averseness that the government has?  
Carl:  I mean, maybe it does just tell us how politically hard it is to be seen to be pushing up fuel duty in cash terms at all. And maybe we underestimate the politics of how hard that is to do. But as I say, it is disappointing because, it would be hard, I think, to think through a scenario where it would be easier for a Chancellor to do it.
I know George Osborne has said that when he froze it early in the 2010s, he felt that he had no choice, he has said. He said that he felt he wouldn't be able to carry a parliamentary vote on it, given he had a coalition government that this Labour government is not in that world. And as I say, the 5p temporary cut which Rishi Sunak introduced, as chancellor, when Russia invaded Ukraine for perhaps understandable reasons at that time well, that was when fuel prices were going up a lot. They're now well below that level, so it doesn't feel like it's going to get any easier in terms of increasing fuel duty later in this Parliament. And I guess bigger picture, we do need a strategy for how we're going to tax motorists in the longer term. We know that the, the quantity of petrol and diesel being bought is falling as more and more motorists are switching to electric vehicles.
 We know that one of the big costs that people impose on others when they drive is actually congestion. So if we stick with fuel duty, the revenue will dwindle away to nothing and we'll end up with even more congested roads, which won't be doing motorists any favour either. So we do need to come up with a strategy for how we replace fuel duty in the longer term.
Mubin: Yeah. So who knows. This could be more about road pricing going forwards, I think that's a potential, but I'm not sure that's what was in mind by the chancellor. 
Carl: Probably not. I mean, the economics would say, well, actually, fuel duty rates are set pretty high if you just look at the carbon emissions that cars do to justify the rates we have, you have to be thinking about other costs that motorists impose on others.
 Congestion is the really big one. And if you want to tax congestion, fuel duty is not a very good way of doing it because you could be driving around in a rural area, you could be driving around off peak, not imposing congestion on other people, but you could be driving around in a city in rush hour and imposing big costs. So actually a more efficient tax there would be one that taxes people according to their road use, according to how congested it is at the time they're choosing to drive and would involve redistribution away from drivers in London and the big cities towards motorists elsewhere in the country and in particular in rural areas. So there's a way of doing this that would sound positive for many drivers out there.
Mubin: Okay, so let's get back to one of other big things that happened in the budget, which was in relation to borrowing, what happened there? 
Carl: Well the Chancellor chose to set herself two new fiscal targets. One is around her day-to-day budget. And what that says is that government revenues from tax and other sources should be sufficient to cover all of day-to-day spending.
 And the idea is to be in a position where that looks like it's going to be the case. Five years out in 2029-30. But because Rachel Reeves has said she wants her plans to become a bit more credible than that, she's going to bring that forward. So in a year's time, it'll become a target for four years out, and then in two years’ time, it will become a target for three years out, and then it will remain a target for three years out, which will be aligned with how she sets spending.
 And I think that kind of fiscal target really has a lot to commend it. There's lots of reasons to think that each generation should be covering the day to day spending they get to enjoy, and looking three years out gives you a bit of time to adjust if bad shocks come along, and it should be one that attracts widespread support. It has a similar underpinning to Gordon Brown's Golden rule. It's very similar to the rule that George Osborne had when he was chancellor during the coalition. It's one that the previous shadow chancellor, John McDonnell, also signed up to. So lots to commend that. And that's the one that's really now very constraining on the Chancellor. She also signed up to a second target, which is to have a measure of debt falling again in five years’ time, but that will eventually become three years’ time.
 And she chose to target a different measure of debt to what the previous chancellor, Jeremy Hunt had. So she's targeting, not total debt net of short term financial assets, but total debt net of short and long run financial assets. So it takes into account, for example, the value of the student loan book. Now, the problem with that fiscal target is targeting the change in debt five years out is a really odd thing to say. It says it doesn't matter if debt rises for four years, come down a little bit in year five and then starts rising again. So it's a very odd target. But she's basically accepted the inheritance, albeit changing the precise measure that she's using. And that change, gave her a bit more headroom, which she used up to finance both more borrowing for day to day stuff and also more borrowing for investment. So big tax rises, but actually the increases in spending were bigger than that because the Chancellor has chosen to borrow a bit more in particular over the next couple of years. 
Mubin: So how much more is the government going to borrow as a result? 
Carl: Roughly speaking, you're talking about a £40 billion tax rise, another £30 billion a year on the deficit in the next couple of years in total financing, 70 odd billion pounds worth of spending. And I think it's noticeable that, she's borrowing more for investment, which was trailed before the budget, but she's also borrowing a bit more this year and next to pay for day to day spending too. 
Mubin: So let's talk about how we're going to be spending some of that money. The Chancellor pledged to no return to austerity. What does this extra tax and borrowing mean for public services?
Now, your boss, Paul Johnson, said this is not going to feel like Christmas has come for the public realm. So it's not Christmas. What is it? 
Carl: Well, I think it's a budget of two halves in a way. This year and next, there's a pretty big top up to day-to-day spending. Many public services will get extra money this year. That's been confirmed. And in setting their budgets for next year, most areas of government, but not all, are going to see their budget rise in real terms. The Chancellor, in her budget speech made a big play of the NHS, which is getting quite a sizable sum. But actually there's bigger increases in spending in areas like housing and areas like net zero and climate change.
So some big increases in spending this year and next. And clearly the big hope that the Chancellor has, that all of us should have, is that that spending will enable not just public services to stand still, but actually improve relative to, in many cases, the quite creaking position that they're in at the moment. So very much the hope is that the next 18 months will see a lot of money going in, and that money spent well and public services improving.
I think the big challenge with the plans is the second part of that budget of two parts, where public service spending growth thereafter is expected to slow to just 1.3% a year in real terms. In terms of the day to day budget. Now, that's a bit more generous than the 1% a year that Jeremy Hunt had pencilled in but it's still not very generous. And once the NHS, overseas aid, defence have had their share of those increases, you suspect it's going to be pretty tight for other government departments if those spending plans really are going to be kept to. And that's why I say I actually wouldn't be surprised if she gets to a couple of years’ time, decides she needs to top up the spending plans and at that point, you'll have to think about how she finances that. 
Mubin: So effectively. Some of these other departments, like the NHS and overseas aid, are going to be getting sort of 4-5% increases in spending. And that's going to mean a lot less for other departments, particularly given how much the NHS, takes up as a percentage of public spending
Carl: The NHS is a huge part of public spending now.
But not a surprise to see it getting more money. I mean, partly it's had, it's got the pressures of an aging population. Partly there has been a huge increase in waiting lists since the pandemic, which the government has clearly prioritized. So I think putting more resources in was always going to be part of, but only part of the solution to getting the NHS in a better state. And presumably the government in the next election wants part of its legacy to be able to point to an improvement in the NHS in particular. 
Mubin: Yeah, so we've got a lot more in taxes, we've got a lot more in terms of borrowing that's going to feed through into public spending. Some of that's going to go on to infrastructure and capital spending.
And the mantra of this government has been growth. In fact, the Chancellor borrowed the new Labour phrase of education, education, education quite early on in her speech. And she talks about invest, invest, invest. But this isn't going to turn into growth straight away. And in fact, the, numbers on growth, not for the first two years, but the next three years were actually downgraded.
 Could you say a bit about that? What's actually happening in terms of growth? Because for a lot of ordinary people, that would be quite unexpected. 
Carl: Saying the way to think about it is firstly, on the demand side of the economy, how much is the Chancellor putting in or taking out of the economy? What's going on there that gives you a kind of sugar rush. 
The extra spending we're doing both day to day and capital over the next two years, in part financed by borrowing, injects cash into the economy will, in part lead to more growth. In part, it's also expected to lead to more inflation. Then if you look at kind of years three, four and five, the judgment of the OBR is that, oh yes if you do the capital spending, that might help growth a bit in that in the sense of making the economy more productive and help on the supply side. But you've also got the drag of these tax rises, and in particular, that big increase in employers National Insurance expected to be a drag on the labour market. And that causes overall a downgrade in the growth forecasts.
 Now, if you look at the OBR’s longer run analysis, they're actually more optimistic there. They say, look, if we do this investment spending and we sustain it, they think that beyond the five year horizon, once you start to look out further into the 2030s, the increase in capital stock in the economy from investing more year on year on year will have a positive effect on the supply side of the of the economy,  will lead to GDP being higher than it otherwise would have done and will be more than enough to outweigh the negative effects of that employer National Insurance rise. So I guess stepping back, what it says is that really, if you want to go for growth, we should be applauding that as a strategy. But remembering it is a long-term strategy. We should also congratulate the Chancellor for the fact that she's inherited a very difficult public finance situation. And often in the past, chancellors that inherit a difficult fabric finance situation cut the capital budget straight away as perhaps the easiest thing to cut. She's very much chosen not to do that. But we should also remember that even if this capital spending happens, even if it's spent really well, we shouldn't expect to have big effects until, say, year ten, 11 and beyond. We have to be patient as well. 
Mubin: So you are saying it's going to take about a decade for us to see some of these results?
Carl: Yes. And the way to think about it is if you invest more for one, two, three, four years, that's all well and good. But in terms of the total amount of capital in the economy, it doesn't make that much of a difference. You've got to do it year on year on year, on a sustained basis for the total amount of capital in the economy to be bigger. And so therefore you start to reap the rewards from that extra capital in spending, which is part of the reason why we should congratulate what is a difficult decision to spend on capital, rather than perhaps have lower taxes today or more day to day spending today, where we get a more of immediate benefit. This is the sort of longer-term policy. 
Mubin: Yeah, and I'm guessing you would be of a view that this is why this doesn't really happen very often, because for electoral gain doesn't pay off until much later when you may be out of power. 
Carl: Certainly. That's one of the concerns. It's one of the reasons why we think targeting the day-to-day budget surplus is a good idea. The fear is that if you target total borrowing a chancellor, any chancellor might look at that and go, well, I want to get total borrowing under control. I could either increase taxes or I could cut day to day spending, or I could cut investment. If I cut investment, that might be someone else's problem in the sense of ‘I may no longer be chancellor by the time that has a negative effect on the economy’. That's certainly the suspicion, and it's certainly a critique that's been made of certain other chancellors in certain periods. And I think that's one thing we can certainly look at right to and say, well, that's not what she's doing. Even though the public finance position is bad, she's actually added to the capital plans, not cut them back.
 Mubin: Let's go back to for employer's National Insurance contributions. So, can you just explain a bit more about what happened there? And this was in the context of it was quite a big giveaway by the Conservative government in terms of employees National Insurance before. And do they just cancel each other out? Can you just explain a bit about that?
 Carl: So the last government cut the employee rate of National Insurance and the self-employment rate, the main rates by four percentage points. On two occasions it was cut by £0.02 and the pound cost of around 20 billion pounds a year. The first tranche, loosely speaking, paid for by the fact that there had been more inflation in the economy, more wage growth as people were going through that cost-of-living crisis, negotiating with their employers for bigger wage increases that all delivered more tax revenue to the Treasury.
It also meant public services were having to deal with tighter budgets after inflation. And rather than top up those spending plans, the previous government did a 2p cut and then the second 2p cut, loosely speaking essentially “financed by pencilling in very tight spending plans” for what is now this parliament. So I think very questionable whether either of those cuts really would have been made by a Chancellor at the start of a parliament. So always questionable whether they were where we were a long run, really, funded. The new government has said that they've chosen not to reverse that. So those cuts remain in place, but they've instead increased the rate of a national insurance that employers pay. They've done that in two ways. Firstly, the main rate has been increased from 13.8% to 15%. So that's a 1.2 percentage point increase. And secondly, what they've done is reduced the threshold at which it kicks in for employees pretty dramatically down to just £5,000 a year. So employers will now start paying National Insurance on more of the wages of more of their workers. This is on the scorecard comes in at a £25 billion tax rise, although we think it actually raises far less than that. 
Indeed, so does the Office for Budget Responsibility, when you read the report a bit more carefully. And that's because if you think that the employer's National Insurance is really paid by employers, it means less profits, it means less corporation tax. Or as most economists tend to think, if you think in the long run, a large part of this will mean lower wage growth. It means wages will be lower. That means that employer National Insurance will be a bit lower. It also means employee National Insurance and income tax will also be a bit lower. And our best estimate is actually the tax rise is more like £16 pounds a year. So that's actually a bit less than the 4p cut inn employee rates, that Jeremy Hunt announced.
 Mubin: So they've got a black hole already have they? I in terms of its £9 billion that they are suggesting we're going to raise?
Carl: No, that is taken account of in the forecast, just not in the scorecard that everybody leaps at and looks at. So that £40 billion tax rise doesn't quite get you £40 billion. It probably gets you, you know, not about 9 billion pounds less. It's about 31/32 billion elsewhere in the numbers. They've adjusted for the fact that, wages will probably grow a bit less quickly as a result of this budget, at least over the next few years. Profits will also grow a bit less quickly. That affects those other tax spaces. So that's all accounted for. But just not in the most transparent way I think.
Mubin: The Labour government, and this was before the election as well. You know, the PM and the Chancellor making clear that they were not going to raise taxes on working people. Do you think effectively, they have as a result of the budget? 
Carl: Well, all taxes are paid by people and I literally cannot think of any tax increase that wouldn't be paid by at least one working person out there in the economy.
I said before that if you want to put taxes up a lot, you're probably choosing between income tax, national insurance and VAT. If you told me I had to pick one and I had to try and protect working people, I would pick either income tax or VAT because National Insurance is exclusively paid by workers and their employers.
It is not paid by people on their pension income who are retired, for example. It's not paid by people who are living off, for example, dividends or buy to let income. So it is exclusively paid by workers and their employees. And as I said before, I think in the medium run, it's pretty clear that by increasing employers national insurance, what will happen is that wages will grow a little bit less quickly and employees will find themselves a bit worse off in terms of their take home pay than what they would have done. But that's not to say the tax rises are bad ones, to say that they should not have been making those pledges, and it feels rather dishonest. And I know it's happened several times before to be saying you're not going to put up taxes, to be saying you're not going to put up National Insurance. And then just not long after the election doing that.  And actually, while the government will say that there was a black hole we didn't know about, there were always pretty obvious challenges in the public finances. We knew that the spending plans that Jeremy Hunt had pencilled in looked incredibly challenging. We knew the NHS had very high waiting lists. We knew that Labour's goal on waiting lists is actually very, very ambitious. So a large part of this really should not have come as a surprise to the government. And I think it is rather regrettable. 
Mubin: I mean, yeah, and you did write about 50 reports and briefings on this during the general election. So it shouldn't be a surprise really. Let's look at some of, other taxes that there were, including those relating to wealth. So inheritance tax, quite a lot of changes in terms of closing some of the loopholes. I'm guessing you were pleased with this. 
Carl: Yeah. There's obviously a debate about whether one should have an inheritance tax or not. And there are reasonable arguments for and against having one. But I think once you've got one, it's very important the tax base is as broad as possible.
So even if you don't like inheritance tax, broadening the base and then cutting the rate would be a sensible improvement over the current system. What the government's chosen to do is broaden the base and just use the money to spend on public services, which is obviously an alternative, valid choice with that, and in particular, they’ve broadened the base in three ways.
 Firstly, they've noticed that, if you die with a load of money in your pension that you haven't touched that currently escapes inheritance tax entirely. And as we wrote in a report that we did with, the abrdn Financial Fairness Trust back in December 2022, that's really very difficult to justify.  It almost looks like we've got in that position by mistake. We used to make people buy an annuity, so you couldn't really die with a big unused pension pot. And it's very welcome to see the government has taken that on board and is now including pensions in the inheritance tax net. 
They've also looked at some other reliefs.  One is around certain business assets and one is around agricultural land. Now these have clearly been quite high profile. In particular the agricultural land. But again these are reliefs which very, very, very rich people have been able to take a lot of advantage of. And actually very rich people have struggled to take advantage of. So some people have literally been buying up acres and acres of farmland, knowing that they can then bequeath that to their children completely free of inheritance tax. What the government has said is that, for a married couple who at the moment, if they've got a family home and they're passing it to direct descendants, they've already got a combined allowance of £1 million. In addition, when you die, you can only have an allowance of an additional million pounds on any business assets and any agricultural land in total, that you own.
 That means that the majority of people who die with those assets still will not pay any inheritance tax, but the majority of the generosity of those reliefs will be taken back by the government, because a very small proportion of people, were making a lot of use of those reliefs. 
Mubin: Yeah, but they are getting quite a lot of pushback from farmers who are saying, actually, this is going to affect many more people when than the projections suggest.
Carl:  And I suspect probably a whole load of people who are farmers need to go and take some financial advice and think carefully about their affairs. The allowances are still pretty big. It does look like the majority of people would still not be paying inheritance tax unless they had extremely large farmlands, or indeed, if they died very young or younger than expected or they didn't take suitable planning action. So, for example, if a married couple plans their affairs effectively, they could give away, I think in principle up to £3 million, because they'll both individually get an additional £1 million allowance that they could take use of.
And of course, it's still the case, if you give things away more than seven years before you die, there's no inheritance tax on that at all. So people who are retiring and looking for their children to continue as farmers, if they gift that farm to their children and then survive for another seven years, again, there'll be no inheritance tax.
 Mubin: So there are already, some loopholes there in terms of, giving things away early, and escaping even for these people who buy up huge amounts of land. 
Carl: And one of the ways the very, very wealthy have been able to avoid inheritance tax is by just giving money away several years before death. If you're merely very rich, and what you've mainly got is a very, very, very nice house and a very, very big pension, it's perhaps harder to give away your wealth earlier than if you have lots of other assets, lots of liquid wealth on top of your home and your big pension.
 So that's one of the reasons why, if you look at estates that are worth £5- 6 million plus, the average inheritance tax paid is actually lower than on people who are still pretty rich they've got £2 or £3 million worth of assets.
Mubin: Capital gains tax. We saw the rate increase and it was a modest increase, wasn't it? 
Carl: A modest increase. I think this is one of the areas where I'd be pretty critical of the government. I mean, there's a lot of debate about changes to a capital gains tax that might happen through the summer. The government allowed that debate to continue. I suspect a whole load of people may well have changed their financial affairs in anticipation of things which didn't happen in the budget, which is a very unhelpful distortion.
 So lots of people might have been selling assets and then rebuying them in order to realize capital gains. I think there are lots of improvements that could be made to capital gains tax, but just pushing up the rates a bit doesn't make those improvements. What we need to see is a situation where we move to a more generous tax base, in this case where we tell people, look, if you're if you buy an asset and it only goes up by a reasonable rate of return, perhaps inflation plus a small amount, we shouldn't be taxing you at all on those types of gains.
But if you make gains above that, then we should be taxing you at rates that are much more closely aligned to, for example, the rates of income tax. So I think I'd like to see, on the one hand, a more generous system in terms of what gets counted for capital gains tax. But on the other hand, a less generous system in terms of the rates that we have and the Chancellor didn't achieve that.  All she did was just push up a couple of the existing rates, raising very modest sums, no fundamental reform. And yet we still had the damage of recent weeks of speculation where people will have been engaging with financial advisers, changing their affairs in anticipation of what might happen in the budget, none of which is productive activity in the UK economy.
Mubin: And then we saw some things which are really well trailed, such as, you know, VAT on private schools. We saw big changes to non-doms and we also saw a change to this peculiarity called ‘carried interest’, which affects the private equity sector. Did you think that went far enough on that carried interest? 
Carl: So looking at the tax on carried interest, that's a form of income that, very small number of people working in the private equity business can get. At a principled level you might say, why is it reasonable that they can get a lower tax rate on that income than what other people can get in other forms? And that's a valid argument. There's a much more practical argument that says, well, actually other countries can have very privileged regimes for that kind of income. These people are pretty mobile. It's a very small number of people.
If you just want to get money out of them you've got to be very careful. So I think it's a big trade off. If you look at the government's estimates, they're not raising much money from this change. And they think that 86% and rising of the revenue they would have got is lost because of how people are changing their behaviour. So by year five of the forecast, a rise in 86% of what you would have got if no one had changed their behaviour has gone and that figure is still rising. So it's questionable whether in the long run that's getting any extra money at all. Now, you can still argue it's a fair and principled thing to do, but don't pretend it's going to fund any public services or any noticeable improvement elsewhere in the public sector.
Mubin: And do you think these changes to wealth are going to have any significant impacts on people migrating? So, you know, this is the big fear about taxing the wealthy. What's your sense from what you've seen so far and the evidence that there is? 
Carl: Well, I think in terms of the evidence it’s pretty thin. We don't have a lot of evidence. It's not it's very hard to know. And each of these tax changes is pretty different to things that have gone before it. I think people who've been in the UK a little while who've perhaps settled here, maybe even have children growing up here, I think actually they're less likely to move. I think probably what should be a greater concern to policymakers is what about the next generation of people who are thinking about coming here?
Because if they're making a choice between, well, I'm a private equity worker, I live in the US, I'm thinking about coming to the UK, but I quite like the idea of going somewhere else, like Italy. I have that choice. I might make a different choice if the tax rate is suddenly a lot higher in the UK. So rather than saying rich people here at the moment might get up and leave, I think a more likely thing to worry about is how you remain attractive to the next generation of potential new arrivals.
Mubin: Yeah, no, I think that's a really important point. But again, the evidence is really thin there as to, how people make these choices. So can I just ask you if a big question, this is really uppermost in the public's view, which is what is this going to do to living standards over the next five years?
 Carl: Well, the outlook for incomes, remains really quite weak. So the OBR’s outlook for, you know, the average household income over the next five years looks appalling for this parliament. I think in recent history, the only parliament where income growth looked worse is actually the last parliament. So in terms of that aspect of living standards, it still looks pretty dismal. That's because the growth rates that are being forecast by the OBR are still not anything like what we were used to prior to the financial crisis, prior to 2008, and that big tax rise largely being felt by people because that's who pay taxes. So when you put up taxes by the scorecard figure of £40 billion might be a bit less than that, you're taking money out of the economy.
Now, the reason I’m saying that aspect of living standards is, of course, the money is being used in large part to spend on public services. So the reason we spend on public services is because we want to have better roads, better hospitals, better schools. So the hope has to be that in particular, over the next two years where the money's going in, we will get better living standards from that aspect of what we want.
So the outlook for household incomes on average pretty weak over the next two years very much the hope is that public services improve and that will help us have better living standards, at least in that dimension. 
Mubin: So overall incomes, it's looking, as you say, appalling. But we might see a sort of feel-good factor in relation to public services. And that particularly in terms of NHS and schooling.
Carl: If waiting lists start coming down, people presumably do put a value on that. We're spending more on the NHS to get a better NHS. Bluntly, if we didn't want that, if we'd rather have the incomes then government's done completely the wrong thing, it shouldn't be putting up taxes to improve these public services. Presumably it's doing it because it believes that better public services is what we want to have, and that we're prepared to sacrifice a bit of income growth to have that. 
Mubin: And to be fair, a lot of the polling is basically saying that people do want, investment in public services. I suppose, reality is, how that will translate now and the next few years. And whether or not we actually do get those improvements in public services, because it's not a given that you invest the money and that happens. Right? 
Carl: Very much so. So it's about the day to day spending that's being done over the next two years. That's pretty quick. So it's going to be a challenge to make sure that really is spent well and we get the most out of it. The investment spending that's going in that's also over the next two years. Actually on that I wouldn't be surprised if some of that gets underspent and it gets pushed forward into later years. And if that happens and it's then spent well, I don't think that's necessarily such a bad thing. The most important thing is not spending the money, but actually spending it well.
Mubin: Can I just come back to the period before the budget and before the government was elected? Because the IFS, along with a number of other commentators, were quite adamant that the main parties in the general election were peddling fiscal fiction. You know, I heard Paul Johnson and yourself say this a number of times, that they just weren't being honest with the public as to what the country needed to do in relation to borrowing taxes or public spending. How close does the budget come to what Labour actually promised before it got elected to power? 
Carl: So the budget did, as you said, implement the manifesto commitments on tax so that’s things like VAT on independent school fees, the non-doms, the private equity, some measures on evasion. And Rachel Reeves in her budget speech said, hey, look, this lot was costed at £9 billion pounds a year and in our manifesto we said £8 [billion]. So aren’t we great? So they have done the measures that were in their manifesto. Of course, on the scorecard, the overall tax rise was not £9 billion but £40 billion. So, that's four and a half times bigger than what they said that they would do in their manifesto. So they've done the manifesto in terms of tax and spend measures, for sure. But the vast majority of what they announced in the budget was stuff that was not in the manifesto. I don't think that's surprising. It's not unusual at all to see the first budget of a parliament do a big tax rise. That's particularly true when the Chancellor is of a different political colour to his or her predecessor. So it doesn't surprise me at all, but it is rather disappointing. And of course, we'll never know what the Conservatives would have done had they been elected with a majority government in the July budget. But if that had happened, I also wouldn't have been surprised to see a tax raising budget, although perhaps it wouldn't have been as big as the £40 billion that Rachel Reeves has delivered.
Mubin: But effectively, they weren't telling us this in advance. They gave us a bit of a partial picture of the sort of taxes that they would raise. But we didn't get the full scale of it. We were expecting this to happen. 
Carl: We didn't get a sense of the scale of it. And also we didn't get a sense of who would be affected by it.
I think if you look at the measures in common that the Labour Party manifesto have in them? They were hitting very small groups of people who are usually quite well-off. Obviously, not everybody who sends their child to an independent school is well-off, but they disproportionately are people ticking the non-dom box on their tax return.
People getting interest, sorry, carried interest in their income, people who taxes, they're typically quite well-off people and often people who don't necessarily have widespread sympathy across the population. What we've actually seen in the budget is a mass, a broad based tax rise that's going to affect most employees in the country in terms of it being more expensive for their employer to offer them overtime, for example, more expensive for their employer to give them a pay rise, for example. 
Mubin: The Chancellor, had a sort of got out of jail card in relation to this, which was basically saying there was this fiscal black hole of £22 billion which we didn't know about. And so that's a big factor in why we had to raise these additional taxes. How accurate is that justification and claim? 
Carl: Well, the claimed black hole is all about spending this year running far ahead what the Conservative budget back in the spring said it would be, part of the increase in spending I think Rachel Reeves is right to be quite cross about. If you look at how the Home Office has been setting its budget for spending on asylum and immigration for each year for the last four or five years, it's been saying, oh, we'll have a budget of about circa £100 million, and it's been spending £4 or 5 billion. Now during the pandemic big forecast errors could be defensible. Perhaps fewer people are coming to the UK and paying for visas, for example, and that spend nets that off. But it seems pretty inexcusable it year after year after year. And it's pretty clear that the Home Office and the Treasury had signed off again on a budget this year of about £100 million pounds, fully expecting them eventually to spend somewhere in the magnitude of £4 to £5 billion. That is a really bad way of spending the reserve. It's not an appropriate way of budgeting. It's not a recipe for good value for money. So she's right to be cross about that. I think it leaves much to be desired, but the biggest part of the increase in spending was actually on public sector pay, £9 billion coming from the new government's decision to agree to the recommendations of the pay review bodies in July.
Now, it might have been the right thing to do to accept those recommendations, but I don't think we're really surprised that they came in well above the 2 to 3% that the spending review that the government inherited, that had been set back in September 2022, had been predicated on I think we all knew that the pay review bodies were going to recommend pay growth of around 5- 5.5%.
So it's not really a surprise. It might well be the right thing to agree to those recommendations, but I don't think the new government can claim that they didn't expect it. And again, we'll never know whether the previous Conservative government, if re-elected, would have accepted it or whether they'd have put more conditions on those awards. And that's about this year. And actually going forward, as you said, IFS and others were pointing out how tight the spending plans that Jeremy Hunt had pencilled in were, we were seriously questioning whether they could be kept to given aspirations on the NHS, defence, overseas aid, huge increase in spending on childcare and what seems like a desire not to be delivering cuts elsewhere and , you know, the struggles that the prison system obviously has, the struggles that the court system obviously has. The trade-offs just look too difficult there. So I think the forward looking aspect about it was already always known, and even the £22 billion black hole for this year, part of that is about the government making a choice that was probably and could be expected.
 Mubin: So the next fiscal event is going to be the spending review. And just, briefly, what are we expecting in relation to that? We're not going to see tax rises, but we are going to see what the departments are going to be getting. Is that right? 
Carl: So in the budget, at the end of October, the Chancellor confirmed spending totals for every department for this year and set them for the first time for the coming financial year.
Beyond that, we just know how much in total government departments have available. We don't know how much each individual department's going to get. So the spending review, which I think is now expected late spring, is going to go department by department and set their budgets for 26/7, 27/28 and 28/29, possibly beyond that too. So it’ll be really important in shaping the priorities of the government across spending departments.
And also, it will be hard for the Chancellor because that's where her spending plans also start to look much, much less generous. So how will she be able to convince her cabinet colleagues to sign up to settlements that, on average, on the day-to-day budget only add up to 1.3% a year real? How will she be able to square the demands for spending on, say, housing and communities versus climate change versus the NHS versus schools versus defence? There's going to be a lot of people around that table arguing why they should get a bigger share of the cake. 
Mubin: So do you think we could end up with them spending more than they actually have, with the potential for further tax rises to come down the line? 
Carl: I suspect these settlements next spring may well look just tight and be kept at that, at that point, I suspect we roll on another year, it will very much depend on what the fiscal situation is looking like, Rachel Reeves will obviously be hoping that the increases in spending are delivering big improvements in public services. She will also be hoping that growth turns out much stronger than the OBR expects, and that the public finances are healthier. If that all happens, I wouldn't be surprised to see the spending plans topped up. That's what's happened in the past. Often spending plans have been topped up as we get closer to those years actually happening. And the last Labour government did that for sure on several occasions. I think the challenging situation for the Chancellor will be what happens if public services are still disappointing, and what happens if growth and the public finances are not looking any stronger? Does she say then - I need to come back for more in the way of tax? Or does she find that a much harder ask?
Mubin: Lastly, given where we are now with the budget the government‘s announced some really big ambitions, for example 1.5 million extra houses by the end of the parliament. The fastest sustained growth in NHS, cutting NHS waiting lists beyond 18 weeks. Do you think this is enough to deliver those types of ambition? 
Carl: The NHS is clearly going to require more money beyond next year. The government has signed up to the previous government's NHS Workforce Plan, which we think will require spending growing at something like 3.5% a year in real terms. And that's before you factor in the possibility you might need more to get waiting lists down in order to meet, as what you rightly say, is Labour's pretty ambitious pledge in that area, I think in other areas, a lot is going to depend on whether the government is ambitious in other parts of its agenda. So is it going to be ambitious around planning reform? Is it actually going to be able to legislate and make that legislation work, or will it find that there's lots of reasons why previous governments have, in the end of it, shied away from making radical reforms there? It's also going to face trade-offs. There's a trade-off between improving public services and going for growth. Not all spending on investment is, the best thing you can do for growth. Some of it might be the right thing to do because it helps you get to climate change targets. Some of it might be the right thing to do because it improves public services, but in a way which isn't necessarily the most growth-friendly thing.
So I think the government's got a lot of thinking to do about how it trades off its various missions. And there's lots that remains to be seen about how far they're prepared to go in terms of doing radical reform. And I guess, you know, there's lots of things you can do to make the system as a whole more growth friendly. Planning reform is one, yet to see that. Tax reform I spoke about we've not seen much of that in the budget. There will be another opportunity next year. And we're very much hoping the Chancellor does come back with a set of radical reforms there. But if you look in other areas of government policy, perhaps one of the obvious things you could point to would be trade with the European Union, where it's pretty widely accepted amongst economists that, you know, getting closer to that, getting closer to the customs union in the single market would be the kind of thing you could do to boost growth, but it's explicitly ruled out in the manifesto. 
Mubin: Well, Carl, thanks so much for your thoughts on the budget. I can picture you now with a red box outside, Downing Street, giving your budget instead. So thanks very much for joining us today. 
Carl: Thank you very much Mubin.
Mubin: If you enjoyed this episode, please like, share, and subscribe on your preferred podcast platform. It really helps us spread the word. And don’t forget, series one and two are available now across all major podcast platforms and on our website. Until next time, thanks for listening.

Transcript

Mubin: Welcome to the Financial Fairness Podcast with me, Mubin Haq. It's been a long time since we had the Labour chancellor making a budget, and this was an eagerly anticipated one with many other policies trailed in advance. Today we're joined by Carl Emmerson, deputy director of the Institute for Fiscal Studies, to drill down into what was announced and what that means for people's living standards, the British economy, and whether we will see an end to stagnation.
So, Carl, welcome. Thanks for joining us today. And, great to have you here. Let's start with everyone's favourite subject, which is taxes. We'll come back to specific rises. But first, the big picture, the Chancellor raised an extra 40 billion pounds a year. Did she go far enough or did she go too far? And how coherent was it as a tax plan?
Carl: Well, it was certainly a big tax raising budget. The scorecard costing of about 40 billion makes it one of the biggest tax raising budgets in recent times. And I think it's pretty interesting. It means that taxes as a share of GDP will go faster over this Parliament than was previously expected, and that will be building on the big tax rises we had in the last Parliament.
So in terms of UK history, we've had this tax burden that was really rather flat during the 2010s, didn't change that much over the previous decade, but since 2019 has gone up a lot and it's set to go up a lot more, clearly bringing the UK up to the levels of tax that we've not experienced in this country before, about towards levels that are much more common in Western Europe and Scandinavia.
So we're becoming much more like them in terms of the role that the state is playing in society. Did the Chancellor do too much.? Well, I guess that depends on one's views about where you want the state to be doing stuff. You could say, well, no, we want the state to be earning less, but I'm not sure I see a lot of appetite for that actually in a relatively widespread way, if you look at the previous government, as I say, they were putting up taxes quite a bit and indeed adding to what the state does with Jeremy Hunt’s big expansion of childcare back in the spring budget of 2022. And if you read the words in the Labour manifesto, at least you see lots of ambitions to make public services better.
And that was always going to have a bit of a price tag. It was never going to be compatible with the kind of spending plans that the previous government had pencilled in, but, one suspects, might not have even been able to keep to themselves. So not a surprise that there was a big tax rise. 
Is it enough? I wouldn't be surprised if in a couple of years’ time she comes back and needs more. That's not definitely going to happen. She might get lucky on growth. She might find that her money that she's found for public services really does deliver a lot in terms of the quality. But I personally wouldn't be surprised if this won't be the last of the tax raising budgets of this Parliament, although I suspect it will be the biggest.
Mubin: Yeah, I mean, it would be hard to get bigger than this really, won't it? And was it coherent, you know, in terms of, various tax rises as a sort of tax plan? I mean, you know, you pride yourselves at IFS on wanting something that is coherent. So was it? 
Carl: Well, if any chancellor wants big sums of money, they're always going to have to push up the rates of income tax or VAT or national insurance.
So I don't think in that sense of surprise that she reached for National Insurance. That tends to be the one that Labour chancellors go for. Conservative chancellors either do National insurance or they do VAT. So putting up one of the big three taxes is not really a surprise. And that's where she got at least on the scorecard £25 billion.
So that was by far and away the biggest tax raising measure in the statement. I think more generally I think in some sense it was a bit disappointing that there wasn't a  oh yes, I'm going to push up taxes, which she was very honest about, but I'm also going to reform them to make them work better, make them more efficient, make them fairer.
If we're going to push up taxes, we might worry about the damage you have to do to our economy. We would clearly be more relaxed about pushing up taxes that are well-designed and then pushing up unreformed, badly designed taxes. A little bit of an exception on inheritance tax, where she did take some action to fix the tax base, which is pretty leaky and that means that very, very wealthy people can exploit loopholes. But in terms of other taxes, pretty disappointing on capital gains tax. Just pushed up the rates a bit. No attempt at serious reform. Very disappointing to see an increase in stamp duty. That's really not, it's probably the worst tax that we have in the UK, not one that should be going upwards and while landlords aren't particularly popular, if you take properties off the rental market, that's not going to be a good way to support those who end up in private rented accommodation for the entirety of their lifetimes. 
So across other taxes, I think actually a lack of reform, it's still early in the parliament. Maybe there’s time for her to come back next year and reform taxes to make them more growth friendly but that’s certainly a work in progress at best. 
And on fuel duties, I think very, very disappointing to see the charade of, oh yeah, we'll freeze, but only for one more year. Honestly, I'll increase it in line with inflation in a year's time. I don't know what the right rate of fuel duty is, but I do know that you shouldn't keep pretending you're going to put up in a year's time and then not doing it.
And surely at the start of a parliament with a new government, with a big majority with the oil price much lower than what it was before the fuel duty 5 pence  temporary cut came in. Surely this was the easiest moment in this Parliament to end that freeze? 
Mubin: Yeah on, fuel duty, it was quite a surprise not to make change there. Do you think that showed some of the risk averseness that the government has?  
Carl:  I mean, maybe it does just tell us how politically hard it is to be seen to be pushing up fuel duty in cash terms at all. And maybe we underestimate the politics of how hard that is to do. But as I say, it is disappointing because, it would be hard, I think, to think through a scenario where it would be easier for a Chancellor to do it.
I know George Osborne has said that when he froze it early in the 2010s, he felt that he had no choice, he has said. He said that he felt he wouldn't be able to carry a parliamentary vote on it, given he had a coalition government that this Labour government is not in that world. And as I say, the 5p temporary cut which Rishi Sunak introduced, as chancellor, when Russia invaded Ukraine for perhaps understandable reasons at that time well, that was when fuel prices were going up a lot. They're now well below that level, so it doesn't feel like it's going to get any easier in terms of increasing fuel duty later in this Parliament. And I guess bigger picture, we do need a strategy for how we're going to tax motorists in the longer term. We know that the, the quantity of petrol and diesel being bought is falling as more and more motorists are switching to electric vehicles.
 We know that one of the big costs that people impose on others when they drive is actually congestion. So if we stick with fuel duty, the revenue will dwindle away to nothing and we'll end up with even more congested roads, which won't be doing motorists any favour either. So we do need to come up with a strategy for how we replace fuel duty in the longer term.
Mubin: Yeah. So who knows. This could be more about road pricing going forwards, I think that's a potential, but I'm not sure that's what was in mind by the chancellor. 
Carl: Probably not. I mean, the economics would say, well, actually, fuel duty rates are set pretty high if you just look at the carbon emissions that cars do to justify the rates we have, you have to be thinking about other costs that motorists impose on others.
 Congestion is the really big one. And if you want to tax congestion, fuel duty is not a very good way of doing it because you could be driving around in a rural area, you could be driving around off peak, not imposing congestion on other people, but you could be driving around in a city in rush hour and imposing big costs. So actually a more efficient tax there would be one that taxes people according to their road use, according to how congested it is at the time they're choosing to drive and would involve redistribution away from drivers in London and the big cities towards motorists elsewhere in the country and in particular in rural areas. So there's a way of doing this that would sound positive for many drivers out there.
Mubin: Okay, so let's get back to one of other big things that happened in the budget, which was in relation to borrowing, what happened there? 
Carl: Well the Chancellor chose to set herself two new fiscal targets. One is around her day-to-day budget. And what that says is that government revenues from tax and other sources should be sufficient to cover all of day-to-day spending.
 And the idea is to be in a position where that looks like it's going to be the case. Five years out in 2029-30. But because Rachel Reeves has said she wants her plans to become a bit more credible than that, she's going to bring that forward. So in a year's time, it'll become a target for four years out, and then in two years’ time, it will become a target for three years out, and then it will remain a target for three years out, which will be aligned with how she sets spending.
 And I think that kind of fiscal target really has a lot to commend it. There's lots of reasons to think that each generation should be covering the day to day spending they get to enjoy, and looking three years out gives you a bit of time to adjust if bad shocks come along, and it should be one that attracts widespread support. It has a similar underpinning to Gordon Brown's Golden rule. It's very similar to the rule that George Osborne had when he was chancellor during the coalition. It's one that the previous shadow chancellor, John McDonnell, also signed up to. So lots to commend that. And that's the one that's really now very constraining on the Chancellor. She also signed up to a second target, which is to have a measure of debt falling again in five years’ time, but that will eventually become three years’ time.
 And she chose to target a different measure of debt to what the previous chancellor, Jeremy Hunt had. So she's targeting, not total debt net of short term financial assets, but total debt net of short and long run financial assets. So it takes into account, for example, the value of the student loan book. Now, the problem with that fiscal target is targeting the change in debt five years out is a really odd thing to say. It says it doesn't matter if debt rises for four years, come down a little bit in year five and then starts rising again. So it's a very odd target. But she's basically accepted the inheritance, albeit changing the precise measure that she's using. And that change, gave her a bit more headroom, which she used up to finance both more borrowing for day to day stuff and also more borrowing for investment. So big tax rises, but actually the increases in spending were bigger than that because the Chancellor has chosen to borrow a bit more in particular over the next couple of years. 
Mubin: So how much more is the government going to borrow as a result? 
Carl: Roughly speaking, you're talking about a £40 billion tax rise, another £30 billion a year on the deficit in the next couple of years in total financing, 70 odd billion pounds worth of spending. And I think it's noticeable that, she's borrowing more for investment, which was trailed before the budget, but she's also borrowing a bit more this year and next to pay for day to day spending too. 
Mubin: So let's talk about how we're going to be spending some of that money. The Chancellor pledged to no return to austerity. What does this extra tax and borrowing mean for public services?
Now, your boss, Paul Johnson, said this is not going to feel like Christmas has come for the public realm. So it's not Christmas. What is it? 
Carl: Well, I think it's a budget of two halves in a way. This year and next, there's a pretty big top up to day-to-day spending. Many public services will get extra money this year. That's been confirmed. And in setting their budgets for next year, most areas of government, but not all, are going to see their budget rise in real terms. The Chancellor, in her budget speech made a big play of the NHS, which is getting quite a sizable sum. But actually there's bigger increases in spending in areas like housing and areas like net zero and climate change.
So some big increases in spending this year and next. And clearly the big hope that the Chancellor has, that all of us should have, is that that spending will enable not just public services to stand still, but actually improve relative to, in many cases, the quite creaking position that they're in at the moment. So very much the hope is that the next 18 months will see a lot of money going in, and that money spent well and public services improving.
I think the big challenge with the plans is the second part of that budget of two parts, where public service spending growth thereafter is expected to slow to just 1.3% a year in real terms. In terms of the day to day budget. Now, that's a bit more generous than the 1% a year that Jeremy Hunt had pencilled in but it's still not very generous. And once the NHS, overseas aid, defence have had their share of those increases, you suspect it's going to be pretty tight for other government departments if those spending plans really are going to be kept to. And that's why I say I actually wouldn't be surprised if she gets to a couple of years’ time, decides she needs to top up the spending plans and at that point, you'll have to think about how she finances that. 
Mubin: So effectively. Some of these other departments, like the NHS and overseas aid, are going to be getting sort of 4-5% increases in spending. And that's going to mean a lot less for other departments, particularly given how much the NHS, takes up as a percentage of public spending
Carl: The NHS is a huge part of public spending now.
But not a surprise to see it getting more money. I mean, partly it's had, it's got the pressures of an aging population. Partly there has been a huge increase in waiting lists since the pandemic, which the government has clearly prioritized. So I think putting more resources in was always going to be part of, but only part of the solution to getting the NHS in a better state. And presumably the government in the next election wants part of its legacy to be able to point to an improvement in the NHS in particular. 
Mubin: Yeah, so we've got a lot more in taxes, we've got a lot more in terms of borrowing that's going to feed through into public spending. Some of that's going to go on to infrastructure and capital spending.
And the mantra of this government has been growth. In fact, the Chancellor borrowed the new Labour phrase of education, education, education quite early on in her speech. And she talks about invest, invest, invest. But this isn't going to turn into growth straight away. And in fact, the, numbers on growth, not for the first two years, but the next three years were actually downgraded.
 Could you say a bit about that? What's actually happening in terms of growth? Because for a lot of ordinary people, that would be quite unexpected. 
Carl: Saying the way to think about it is firstly, on the demand side of the economy, how much is the Chancellor putting in or taking out of the economy? What's going on there that gives you a kind of sugar rush. 
The extra spending we're doing both day to day and capital over the next two years, in part financed by borrowing, injects cash into the economy will, in part lead to more growth. In part, it's also expected to lead to more inflation. Then if you look at kind of years three, four and five, the judgment of the OBR is that, oh yes if you do the capital spending, that might help growth a bit in that in the sense of making the economy more productive and help on the supply side. But you've also got the drag of these tax rises, and in particular, that big increase in employers National Insurance expected to be a drag on the labour market. And that causes overall a downgrade in the growth forecasts.
 Now, if you look at the OBR’s longer run analysis, they're actually more optimistic there. They say, look, if we do this investment spending and we sustain it, they think that beyond the five year horizon, once you start to look out further into the 2030s, the increase in capital stock in the economy from investing more year on year on year will have a positive effect on the supply side of the of the economy,  will lead to GDP being higher than it otherwise would have done and will be more than enough to outweigh the negative effects of that employer National Insurance rise. So I guess stepping back, what it says is that really, if you want to go for growth, we should be applauding that as a strategy. But remembering it is a long-term strategy. We should also congratulate the Chancellor for the fact that she's inherited a very difficult public finance situation. And often in the past, chancellors that inherit a difficult fabric finance situation cut the capital budget straight away as perhaps the easiest thing to cut. She's very much chosen not to do that. But we should also remember that even if this capital spending happens, even if it's spent really well, we shouldn't expect to have big effects until, say, year ten, 11 and beyond. We have to be patient as well. 
Mubin: So you are saying it's going to take about a decade for us to see some of these results?
Carl: Yes. And the way to think about it is if you invest more for one, two, three, four years, that's all well and good. But in terms of the total amount of capital in the economy, it doesn't make that much of a difference. You've got to do it year on year on year, on a sustained basis for the total amount of capital in the economy to be bigger. And so therefore you start to reap the rewards from that extra capital in spending, which is part of the reason why we should congratulate what is a difficult decision to spend on capital, rather than perhaps have lower taxes today or more day to day spending today, where we get a more of immediate benefit. This is the sort of longer-term policy. 
Mubin: Yeah, and I'm guessing you would be of a view that this is why this doesn't really happen very often, because for electoral gain doesn't pay off until much later when you may be out of power. 
Carl: Certainly. That's one of the concerns. It's one of the reasons why we think targeting the day-to-day budget surplus is a good idea. The fear is that if you target total borrowing a chancellor, any chancellor might look at that and go, well, I want to get total borrowing under control. I could either increase taxes or I could cut day to day spending, or I could cut investment. If I cut investment, that might be someone else's problem in the sense of ‘I may no longer be chancellor by the time that has a negative effect on the economy’. That's certainly the suspicion, and it's certainly a critique that's been made of certain other chancellors in certain periods. And I think that's one thing we can certainly look at right to and say, well, that's not what she's doing. Even though the public finance position is bad, she's actually added to the capital plans, not cut them back.
 Mubin: Let's go back to for employer's National Insurance contributions. So, can you just explain a bit more about what happened there? And this was in the context of it was quite a big giveaway by the Conservative government in terms of employees National Insurance before. And do they just cancel each other out? Can you just explain a bit about that?
 Carl: So the last government cut the employee rate of National Insurance and the self-employment rate, the main rates by four percentage points. On two occasions it was cut by £0.02 and the pound cost of around 20 billion pounds a year. The first tranche, loosely speaking, paid for by the fact that there had been more inflation in the economy, more wage growth as people were going through that cost-of-living crisis, negotiating with their employers for bigger wage increases that all delivered more tax revenue to the Treasury.
It also meant public services were having to deal with tighter budgets after inflation. And rather than top up those spending plans, the previous government did a 2p cut and then the second 2p cut, loosely speaking essentially “financed by pencilling in very tight spending plans” for what is now this parliament. So I think very questionable whether either of those cuts really would have been made by a Chancellor at the start of a parliament. So always questionable whether they were where we were a long run, really, funded. The new government has said that they've chosen not to reverse that. So those cuts remain in place, but they've instead increased the rate of a national insurance that employers pay. They've done that in two ways. Firstly, the main rate has been increased from 13.8% to 15%. So that's a 1.2 percentage point increase. And secondly, what they've done is reduced the threshold at which it kicks in for employees pretty dramatically down to just £5,000 a year. So employers will now start paying National Insurance on more of the wages of more of their workers. This is on the scorecard comes in at a £25 billion tax rise, although we think it actually raises far less than that. 
Indeed, so does the Office for Budget Responsibility, when you read the report a bit more carefully. And that's because if you think that the employer's National Insurance is really paid by employers, it means less profits, it means less corporation tax. Or as most economists tend to think, if you think in the long run, a large part of this will mean lower wage growth. It means wages will be lower. That means that employer National Insurance will be a bit lower. It also means employee National Insurance and income tax will also be a bit lower. And our best estimate is actually the tax rise is more like £16 pounds a year. So that's actually a bit less than the 4p cut inn employee rates, that Jeremy Hunt announced.
 Mubin: So they've got a black hole already have they? I in terms of its £9 billion that they are suggesting we're going to raise?
Carl: No, that is taken account of in the forecast, just not in the scorecard that everybody leaps at and looks at. So that £40 billion tax rise doesn't quite get you £40 billion. It probably gets you, you know, not about 9 billion pounds less. It's about 31/32 billion elsewhere in the numbers. They've adjusted for the fact that, wages will probably grow a bit less quickly as a result of this budget, at least over the next few years. Profits will also grow a bit less quickly. That affects those other tax spaces. So that's all accounted for. But just not in the most transparent way I think.
Mubin: The Labour government, and this was before the election as well. You know, the PM and the Chancellor making clear that they were not going to raise taxes on working people. Do you think effectively, they have as a result of the budget? 
Carl: Well, all taxes are paid by people and I literally cannot think of any tax increase that wouldn't be paid by at least one working person out there in the economy.
I said before that if you want to put taxes up a lot, you're probably choosing between income tax, national insurance and VAT. If you told me I had to pick one and I had to try and protect working people, I would pick either income tax or VAT because National Insurance is exclusively paid by workers and their employers.
It is not paid by people on their pension income who are retired, for example. It's not paid by people who are living off, for example, dividends or buy to let income. So it is exclusively paid by workers and their employees. And as I said before, I think in the medium run, it's pretty clear that by increasing employers national insurance, what will happen is that wages will grow a little bit less quickly and employees will find themselves a bit worse off in terms of their take home pay than what they would have done. But that's not to say the tax rises are bad ones, to say that they should not have been making those pledges, and it feels rather dishonest. And I know it's happened several times before to be saying you're not going to put up taxes, to be saying you're not going to put up National Insurance. And then just not long after the election doing that.  And actually, while the government will say that there was a black hole we didn't know about, there were always pretty obvious challenges in the public finances. We knew that the spending plans that Jeremy Hunt had pencilled in looked incredibly challenging. We knew the NHS had very high waiting lists. We knew that Labour's goal on waiting lists is actually very, very ambitious. So a large part of this really should not have come as a surprise to the government. And I think it is rather regrettable. 
Mubin: I mean, yeah, and you did write about 50 reports and briefings on this during the general election. So it shouldn't be a surprise really. Let's look at some of, other taxes that there were, including those relating to wealth. So inheritance tax, quite a lot of changes in terms of closing some of the loopholes. I'm guessing you were pleased with this. 
Carl: Yeah. There's obviously a debate about whether one should have an inheritance tax or not. And there are reasonable arguments for and against having one. But I think once you've got one, it's very important the tax base is as broad as possible.
So even if you don't like inheritance tax, broadening the base and then cutting the rate would be a sensible improvement over the current system. What the government's chosen to do is broaden the base and just use the money to spend on public services, which is obviously an alternative, valid choice with that, and in particular, they’ve broadened the base in three ways.
 Firstly, they've noticed that, if you die with a load of money in your pension that you haven't touched that currently escapes inheritance tax entirely. And as we wrote in a report that we did with, the abrdn Financial Fairness Trust back in December 2022, that's really very difficult to justify.  It almost looks like we've got in that position by mistake. We used to make people buy an annuity, so you couldn't really die with a big unused pension pot. And it's very welcome to see the government has taken that on board and is now including pensions in the inheritance tax net. 
They've also looked at some other reliefs.  One is around certain business assets and one is around agricultural land. Now these have clearly been quite high profile. In particular the agricultural land. But again these are reliefs which very, very, very rich people have been able to take a lot of advantage of. And actually very rich people have struggled to take advantage of. So some people have literally been buying up acres and acres of farmland, knowing that they can then bequeath that to their children completely free of inheritance tax. What the government has said is that, for a married couple who at the moment, if they've got a family home and they're passing it to direct descendants, they've already got a combined allowance of £1 million. In addition, when you die, you can only have an allowance of an additional million pounds on any business assets and any agricultural land in total, that you own.
 That means that the majority of people who die with those assets still will not pay any inheritance tax, but the majority of the generosity of those reliefs will be taken back by the government, because a very small proportion of people, were making a lot of use of those reliefs. 
Mubin: Yeah, but they are getting quite a lot of pushback from farmers who are saying, actually, this is going to affect many more people when than the projections suggest.
Carl:  And I suspect probably a whole load of people who are farmers need to go and take some financial advice and think carefully about their affairs. The allowances are still pretty big. It does look like the majority of people would still not be paying inheritance tax unless they had extremely large farmlands, or indeed, if they died very young or younger than expected or they didn't take suitable planning action. So, for example, if a married couple plans their affairs effectively, they could give away, I think in principle up to £3 million, because they'll both individually get an additional £1 million allowance that they could take use of.
And of course, it's still the case, if you give things away more than seven years before you die, there's no inheritance tax on that at all. So people who are retiring and looking for their children to continue as farmers, if they gift that farm to their children and then survive for another seven years, again, there'll be no inheritance tax.
 Mubin: So there are already, some loopholes there in terms of, giving things away early, and escaping even for these people who buy up huge amounts of land. 
Carl: And one of the ways the very, very wealthy have been able to avoid inheritance tax is by just giving money away several years before death. If you're merely very rich, and what you've mainly got is a very, very, very nice house and a very, very big pension, it's perhaps harder to give away your wealth earlier than if you have lots of other assets, lots of liquid wealth on top of your home and your big pension.
 So that's one of the reasons why, if you look at estates that are worth £5- 6 million plus, the average inheritance tax paid is actually lower than on people who are still pretty rich they've got £2 or £3 million worth of assets.
Mubin: Capital gains tax. We saw the rate increase and it was a modest increase, wasn't it? 
Carl: A modest increase. I think this is one of the areas where I'd be pretty critical of the government. I mean, there's a lot of debate about changes to a capital gains tax that might happen through the summer. The government allowed that debate to continue. I suspect a whole load of people may well have changed their financial affairs in anticipation of things which didn't happen in the budget, which is a very unhelpful distortion.
 So lots of people might have been selling assets and then rebuying them in order to realize capital gains. I think there are lots of improvements that could be made to capital gains tax, but just pushing up the rates a bit doesn't make those improvements. What we need to see is a situation where we move to a more generous tax base, in this case where we tell people, look, if you're if you buy an asset and it only goes up by a reasonable rate of return, perhaps inflation plus a small amount, we shouldn't be taxing you at all on those types of gains.
But if you make gains above that, then we should be taxing you at rates that are much more closely aligned to, for example, the rates of income tax. So I think I'd like to see, on the one hand, a more generous system in terms of what gets counted for capital gains tax. But on the other hand, a less generous system in terms of the rates that we have and the Chancellor didn't achieve that.  All she did was just push up a couple of the existing rates, raising very modest sums, no fundamental reform. And yet we still had the damage of recent weeks of speculation where people will have been engaging with financial advisers, changing their affairs in anticipation of what might happen in the budget, none of which is productive activity in the UK economy.
Mubin: And then we saw some things which are really well trailed, such as, you know, VAT on private schools. We saw big changes to non-doms and we also saw a change to this peculiarity called ‘carried interest’, which affects the private equity sector. Did you think that went far enough on that carried interest? 
Carl: So looking at the tax on carried interest, that's a form of income that, very small number of people working in the private equity business can get. At a principled level you might say, why is it reasonable that they can get a lower tax rate on that income than what other people can get in other forms? And that's a valid argument. There's a much more practical argument that says, well, actually other countries can have very privileged regimes for that kind of income. These people are pretty mobile. It's a very small number of people.
If you just want to get money out of them you've got to be very careful. So I think it's a big trade off. If you look at the government's estimates, they're not raising much money from this change. And they think that 86% and rising of the revenue they would have got is lost because of how people are changing their behaviour. So by year five of the forecast, a rise in 86% of what you would have got if no one had changed their behaviour has gone and that figure is still rising. So it's questionable whether in the long run that's getting any extra money at all. Now, you can still argue it's a fair and principled thing to do, but don't pretend it's going to fund any public services or any noticeable improvement elsewhere in the public sector.
Mubin: And do you think these changes to wealth are going to have any significant impacts on people migrating? So, you know, this is the big fear about taxing the wealthy. What's your sense from what you've seen so far and the evidence that there is? 
Carl: Well, I think in terms of the evidence it’s pretty thin. We don't have a lot of evidence. It's not it's very hard to know. And each of these tax changes is pretty different to things that have gone before it. I think people who've been in the UK a little while who've perhaps settled here, maybe even have children growing up here, I think actually they're less likely to move. I think probably what should be a greater concern to policymakers is what about the next generation of people who are thinking about coming here?
Because if they're making a choice between, well, I'm a private equity worker, I live in the US, I'm thinking about coming to the UK, but I quite like the idea of going somewhere else, like Italy. I have that choice. I might make a different choice if the tax rate is suddenly a lot higher in the UK. So rather than saying rich people here at the moment might get up and leave, I think a more likely thing to worry about is how you remain attractive to the next generation of potential new arrivals.
Mubin: Yeah, no, I think that's a really important point. But again, the evidence is really thin there as to, how people make these choices. So can I just ask you if a big question, this is really uppermost in the public's view, which is what is this going to do to living standards over the next five years?
 Carl: Well, the outlook for incomes, remains really quite weak. So the OBR’s outlook for, you know, the average household income over the next five years looks appalling for this parliament. I think in recent history, the only parliament where income growth looked worse is actually the last parliament. So in terms of that aspect of living standards, it still looks pretty dismal. That's because the growth rates that are being forecast by the OBR are still not anything like what we were used to prior to the financial crisis, prior to 2008, and that big tax rise largely being felt by people because that's who pay taxes. So when you put up taxes by the scorecard figure of £40 billion might be a bit less than that, you're taking money out of the economy.
Now, the reason I’m saying that aspect of living standards is, of course, the money is being used in large part to spend on public services. So the reason we spend on public services is because we want to have better roads, better hospitals, better schools. So the hope has to be that in particular, over the next two years where the money's going in, we will get better living standards from that aspect of what we want.
So the outlook for household incomes on average pretty weak over the next two years very much the hope is that public services improve and that will help us have better living standards, at least in that dimension. 
Mubin: So overall incomes, it's looking, as you say, appalling. But we might see a sort of feel-good factor in relation to public services. And that particularly in terms of NHS and schooling.
Carl: If waiting lists start coming down, people presumably do put a value on that. We're spending more on the NHS to get a better NHS. Bluntly, if we didn't want that, if we'd rather have the incomes then government's done completely the wrong thing, it shouldn't be putting up taxes to improve these public services. Presumably it's doing it because it believes that better public services is what we want to have, and that we're prepared to sacrifice a bit of income growth to have that. 
Mubin: And to be fair, a lot of the polling is basically saying that people do want, investment in public services. I suppose, reality is, how that will translate now and the next few years. And whether or not we actually do get those improvements in public services, because it's not a given that you invest the money and that happens. Right? 
Carl: Very much so. So it's about the day to day spending that's being done over the next two years. That's pretty quick. So it's going to be a challenge to make sure that really is spent well and we get the most out of it. The investment spending that's going in that's also over the next two years. Actually on that I wouldn't be surprised if some of that gets underspent and it gets pushed forward into later years. And if that happens and it's then spent well, I don't think that's necessarily such a bad thing. The most important thing is not spending the money, but actually spending it well.
Mubin: Can I just come back to the period before the budget and before the government was elected? Because the IFS, along with a number of other commentators, were quite adamant that the main parties in the general election were peddling fiscal fiction. You know, I heard Paul Johnson and yourself say this a number of times, that they just weren't being honest with the public as to what the country needed to do in relation to borrowing taxes or public spending. How close does the budget come to what Labour actually promised before it got elected to power? 
Carl: So the budget did, as you said, implement the manifesto commitments on tax so that’s things like VAT on independent school fees, the non-doms, the private equity, some measures on evasion. And Rachel Reeves in her budget speech said, hey, look, this lot was costed at £9 billion pounds a year and in our manifesto we said £8 [billion]. So aren’t we great? So they have done the measures that were in their manifesto. Of course, on the scorecard, the overall tax rise was not £9 billion but £40 billion. So, that's four and a half times bigger than what they said that they would do in their manifesto. So they've done the manifesto in terms of tax and spend measures, for sure. But the vast majority of what they announced in the budget was stuff that was not in the manifesto. I don't think that's surprising. It's not unusual at all to see the first budget of a parliament do a big tax rise. That's particularly true when the Chancellor is of a different political colour to his or her predecessor. So it doesn't surprise me at all, but it is rather disappointing. And of course, we'll never know what the Conservatives would have done had they been elected with a majority government in the July budget. But if that had happened, I also wouldn't have been surprised to see a tax raising budget, although perhaps it wouldn't have been as big as the £40 billion that Rachel Reeves has delivered.
Mubin: But effectively, they weren't telling us this in advance. They gave us a bit of a partial picture of the sort of taxes that they would raise. But we didn't get the full scale of it. We were expecting this to happen. 
Carl: We didn't get a sense of the scale of it. And also we didn't get a sense of who would be affected by it.
I think if you look at the measures in common that the Labour Party manifesto have in them? They were hitting very small groups of people who are usually quite well-off. Obviously, not everybody who sends their child to an independent school is well-off, but they disproportionately are people ticking the non-dom box on their tax return.
People getting interest, sorry, carried interest in their income, people who taxes, they're typically quite well-off people and often people who don't necessarily have widespread sympathy across the population. What we've actually seen in the budget is a mass, a broad based tax rise that's going to affect most employees in the country in terms of it being more expensive for their employer to offer them overtime, for example, more expensive for their employer to give them a pay rise, for example. 
Mubin: The Chancellor, had a sort of got out of jail card in relation to this, which was basically saying there was this fiscal black hole of £22 billion which we didn't know about. And so that's a big factor in why we had to raise these additional taxes. How accurate is that justification and claim? 
Carl: Well, the claimed black hole is all about spending this year running far ahead what the Conservative budget back in the spring said it would be, part of the increase in spending I think Rachel Reeves is right to be quite cross about. If you look at how the Home Office has been setting its budget for spending on asylum and immigration for each year for the last four or five years, it's been saying, oh, we'll have a budget of about circa £100 million, and it's been spending £4 or 5 billion. Now during the pandemic big forecast errors could be defensible. Perhaps fewer people are coming to the UK and paying for visas, for example, and that spend nets that off. But it seems pretty inexcusable it year after year after year. And it's pretty clear that the Home Office and the Treasury had signed off again on a budget this year of about £100 million pounds, fully expecting them eventually to spend somewhere in the magnitude of £4 to £5 billion. That is a really bad way of spending the reserve. It's not an appropriate way of budgeting. It's not a recipe for good value for money. So she's right to be cross about that. I think it leaves much to be desired, but the biggest part of the increase in spending was actually on public sector pay, £9 billion coming from the new government's decision to agree to the recommendations of the pay review bodies in July.
Now, it might have been the right thing to do to accept those recommendations, but I don't think we're really surprised that they came in well above the 2 to 3% that the spending review that the government inherited, that had been set back in September 2022, had been predicated on I think we all knew that the pay review bodies were going to recommend pay growth of around 5- 5.5%.
So it's not really a surprise. It might well be the right thing to agree to those recommendations, but I don't think the new government can claim that they didn't expect it. And again, we'll never know whether the previous Conservative government, if re-elected, would have accepted it or whether they'd have put more conditions on those awards. And that's about this year. And actually going forward, as you said, IFS and others were pointing out how tight the spending plans that Jeremy Hunt had pencilled in were, we were seriously questioning whether they could be kept to given aspirations on the NHS, defence, overseas aid, huge increase in spending on childcare and what seems like a desire not to be delivering cuts elsewhere and , you know, the struggles that the prison system obviously has, the struggles that the court system obviously has. The trade-offs just look too difficult there. So I think the forward looking aspect about it was already always known, and even the £22 billion black hole for this year, part of that is about the government making a choice that was probably and could be expected.
 Mubin: So the next fiscal event is going to be the spending review. And just, briefly, what are we expecting in relation to that? We're not going to see tax rises, but we are going to see what the departments are going to be getting. Is that right? 
Carl: So in the budget, at the end of October, the Chancellor confirmed spending totals for every department for this year and set them for the first time for the coming financial year.
Beyond that, we just know how much in total government departments have available. We don't know how much each individual department's going to get. So the spending review, which I think is now expected late spring, is going to go department by department and set their budgets for 26/7, 27/28 and 28/29, possibly beyond that too. So it’ll be really important in shaping the priorities of the government across spending departments.
And also, it will be hard for the Chancellor because that's where her spending plans also start to look much, much less generous. So how will she be able to convince her cabinet colleagues to sign up to settlements that, on average, on the day-to-day budget only add up to 1.3% a year real? How will she be able to square the demands for spending on, say, housing and communities versus climate change versus the NHS versus schools versus defence? There's going to be a lot of people around that table arguing why they should get a bigger share of the cake. 
Mubin: So do you think we could end up with them spending more than they actually have, with the potential for further tax rises to come down the line? 
Carl: I suspect these settlements next spring may well look just tight and be kept at that, at that point, I suspect we roll on another year, it will very much depend on what the fiscal situation is looking like, Rachel Reeves will obviously be hoping that the increases in spending are delivering big improvements in public services. She will also be hoping that growth turns out much stronger than the OBR expects, and that the public finances are healthier. If that all happens, I wouldn't be surprised to see the spending plans topped up. That's what's happened in the past. Often spending plans have been topped up as we get closer to those years actually happening. And the last Labour government did that for sure on several occasions. I think the challenging situation for the Chancellor will be what happens if public services are still disappointing, and what happens if growth and the public finances are not looking any stronger? Does she say then - I need to come back for more in the way of tax? Or does she find that a much harder ask?
Mubin: Lastly, given where we are now with the budget the government‘s announced some really big ambitions, for example 1.5 million extra houses by the end of the parliament. The fastest sustained growth in NHS, cutting NHS waiting lists beyond 18 weeks. Do you think this is enough to deliver those types of ambition? 
Carl: The NHS is clearly going to require more money beyond next year. The government has signed up to the previous government's NHS Workforce Plan, which we think will require spending growing at something like 3.5% a year in real terms. And that's before you factor in the possibility you might need more to get waiting lists down in order to meet, as what you rightly say, is Labour's pretty ambitious pledge in that area, I think in other areas, a lot is going to depend on whether the government is ambitious in other parts of its agenda. So is it going to be ambitious around planning reform? Is it actually going to be able to legislate and make that legislation work, or will it find that there's lots of reasons why previous governments have, in the end of it, shied away from making radical reforms there? It's also going to face trade-offs. There's a trade-off between improving public services and going for growth. Not all spending on investment is, the best thing you can do for growth. Some of it might be the right thing to do because it helps you get to climate change targets. Some of it might be the right thing to do because it improves public services, but in a way which isn't necessarily the most growth-friendly thing.
So I think the government's got a lot of thinking to do about how it trades off its various missions. And there's lots that remains to be seen about how far they're prepared to go in terms of doing radical reform. And I guess, you know, there's lots of things you can do to make the system as a whole more growth friendly. Planning reform is one, yet to see that. Tax reform I spoke about we've not seen much of that in the budget. There will be another opportunity next year. And we're very much hoping the Chancellor does come back with a set of radical reforms there. But if you look in other areas of government policy, perhaps one of the obvious things you could point to would be trade with the European Union, where it's pretty widely accepted amongst economists that, you know, getting closer to that, getting closer to the customs union in the single market would be the kind of thing you could do to boost growth, but it's explicitly ruled out in the manifesto. 
Mubin: Well, Carl, thanks so much for your thoughts on the budget. I can picture you now with a red box outside, Downing Street, giving your budget instead. So thanks very much for joining us today. 
Carl: Thank you very much Mubin.
Mubin: If you enjoyed this episode, please like, share, and subscribe on your preferred podcast platform. It really helps us spread the word. And don’t forget, series one and two are available now across all major podcast platforms and on our website. Until next time, thanks for listening.

Further information

The Trust funded the IFS to undertake analysis of General Election policy proposals from the main political parties. That analysis can be found here.