Post-Brexit, the UK’s different economic direction to the Republic is underlined

The UK government put a political spin on its autumn statement on Wednesday, promising to lower the national insurance bill on employees and boost business investment. But after Brexit the UK’s growth remains sluggish and its public finances are under pressure.

The reality is that despite the national insurance cut, the tax burden is set to rise to its highest level for many years while public spending forecasts point to real cuts in departmental spending – which look near-impossible to achieve on the forecast scale – and lower state investment.

The next UK government, likely to be Labour, will be left with some difficult decisions. And the divergence between Britain and the Republic – where State investment and spending are on the rise – will be underlined. The UK could change course under Labour, of course, but promising higher spending would mean raising taxes, too – this is the political trap created by the Tories.

The numbers

The UK’s public finances were a bit better than expected in advance of the autumn statement, but remain under long-term pressure due to low growth and a relatively high national debt.

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The impact of inflation, which has pushed up tax revenues as price and wage increases, gave the chancellor of the exchequer, Jeremy Hunt, some room for manoeuvre.

He chose to direct this almost exclusively to cutting taxes, meaning he had little additional cash to provide to government departments. Borrowing is forecast to fall from 5 per cent of Gross Domestic Product (GDP) this year to 1.1 per cent by 2028-2029.

The UK spends more than 10 per cent of tax revenue on debt repayment while in the Republic it is less than 3 per cent

However, the Office of Budget Responsibility (OBR) – Britain’s budget watchdog – points out this is based on a £19 billion fall in the real value of government spending by 2027-2028. Previously, it says, spending has tended to be topped up by day-to-day spending as pressures emerge. If this happens, future borrowing levels will go higher, unless taxes rise to compensate.

Comparison with Ireland: Strong growth and surging corporate finance receipts have helped to push the Irish public finances into surplus. Ireland’s national debt is also less vulnerable to higher interest as the vast bulk of outstanding debt is at fixed interest rates, unlike the UK where a quarter of national debt is in index-linked bonds and so repayments have shot up due to higher inflation.

The UK spends more than 10 per cent of tax revenue on debt repayment while in the Republic it is less than 3 per cent.

The State’s budget surplus was forecast in the recent budget to be 2.7 per cent of GNI* (the aggregate which excluded the distortions caused by multinationals) and 4.4 per cent in 2025 and 2026.

However, the recent shortfalls in corporation tax and pressures on health spending are likely to reduce these forecasts –and it is worth noting the Department of Finance estimates that were all the “excess” corporation tax to disappear, the exchequer would be in deficit.

Tax

The headline-grabbing part of the autumn statement for the public was a cut in the main national insurance rate by 2 percentage points from January to 10 per cent.

This will benefit taxpayers. However, it will be more than offset by the impact of the classic budget stealth tax – the impact of non-indexation of tax bands and credits which will increase the tax burden on those in work.

If these are not adjusted for inflation, then the tax take rises as wages increase in response to inflation. Economists call this “fiscal drag”. The impact varies across different income levels.

But taxes on income are set to rise with 4 million additional workers paying income tax by 2028/29 and 3 million more moving to the higher rate. So despite the national insurance cut, the tax burden is set to rise to a post-war high of 37.7 per cent of GDP by 2029-29.

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The Resolution Foundation, a think tank, has worked out that because of the interplay of the social insurance and tax systems, the only groups who will be better off will be those earning between £11,000 and £13,000 and between £42,000 and £52,000.

Comparison with the Republic: The Irish income tax system is not adjusted automatically for inflation either, so taxpayers are reliant on ministers for finance increasing them each year if they are not to move into higher tax brackets and see the real value of credits eroded. This year credits and the standard band were increased and the USC was cut.

But this stealth tax has also acted as a quiet collector for Ireland over the years and a key question for parties in the forthcoming general election campaign is whether they would index the income tax system for inflation each year. Meanwhile, some modest PRSI increases have been flagged here to keep the social insurance fund in surplus.

The OBR calculates that the UK tax burden will rise towards 37.7 per cent of GDP over the coming years. From having a significantly lower tax burden over the years, this would move it up towards Irish-style overall tax levels. However, bodies such as the fiscal council have warned that the Irish tax take will have to rise in the years ahead to pay for the costs of ageing and the climate transition.

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An interesting point is that Ireland’s tax take is boosted by corporation tax, much of it based on activity outside the country. Excluding corporation tax, the overall taxation burden in the UK has now, on some calculations, edged above Ireland.

Spending

Spending in the UK is forecast to fall as a share of the economy from 44.8 per cent to 42.7 per cent of GDP, but to remain around 3 per cent of GDP above its pre-pandemic level.

However, serious questions have been raised about the likelihood of achieving planned reductions in spending by government departments and local authorities, many already squeezed for cash.

The OBR says that if service levels to the public are not to decline, then big – and unlikely – increases in public sector productivity are going to be needed. The likelihood is that services will remain under pressure.

Meanwhile, capital spending is to remain where it is in cash terms, implying a real decline. Instead, the government is trying to encourage private sector investment through an extension of a tax write-off for investment spending beyond its previous end date of 2026 – the other costly measure in addition to the national insurance cut.

The key question for Irish policymakers is whether spending can keep heading higher if tax revenue growth slows.

This will have some impact on investment and growth – and on the long-term potential of the economy to expand – but the OBR judges it will be marginal enough.

Comparison with the Republic: Government spending is expected to continue heading higher in Ireland – and forecasts for this year and next are already under pressure due to higher health expenditure.

State capital spending is also budgeted to keep rising – from €17 billion this year to over €23 billion by 2026. The key question for Irish policymakers is whether spending can keep heading higher if tax revenue growth slows.

The bottom line

One figure stands out in the OBR assessment. It is that living standards as measured by real household disposable income per capita are forecast to be 3.5 per cent lower in 2024-25 than their pre-pandemic level. This would be the largest fall since records began in the 1950s.

It would be 2027/2028 when living standards per capita get back to their pre-pandemic level. So despite the headline measures in the autumn statement, slow growth and a rising tax burden will hold down British living standards. The next government will also face an almost-immediate choice between cutting spending or hiking taxes, given the unrealistic spending figures in the latest document. This could be a more difficult job if corporation tax growth stalls.

Overall UK growth is sluggish, with GDP forecast by the OBR to rise by just 0.7 per cent next year and 1.4 per cent in 2025. The Irish domestic economy is expected to grow by 2.2 per cent next year, according to the Department of Finance.

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Here, household living standards have been rising, but mainly due to the fact that more people are at work, as inflation has eaten into the spending power of workers.

The prospects for the next Irish government look better than their UK counterparts, but it may see the forecast budget surpluses from 2025 on reduce sharply if the corporation tax fall-off evident in recent months continues. The UK experience shows how difficult a negative public finance cycle can be to break.

A key goal for Irish policymakers is to make sure that the current positive position of the public finances is maintained.