Years of stagnation await Britain as Labour gives up on growth

Sir Keir Starmer’s flagship pledge to grow the economy and raise living standards is in tatters.

The Prime Minister’s number one pledge after stepping foot in Downing Street was to deliver a more prosperous economy. People were meant to feel richer, with living standards rising at world-beating rates.

Instead, the Government’s own tax and spending watchdog has delivered a damning verdict that means most Britons will be barely better off by the next election.

The outlook for living standards has worsened, with growth in real disposable incomes over this parliament now expected to be second worst since records began in the 1950s.

If growth is still Labour’s number one priority, this Government has a funny way of showing it.

Living standards stagnate

The Office for Budget Responsibility (OBR) downgraded its growth forecasts for real household disposable income (RHDI) per person over the next five years.

Growth is now projected to ease from 3pc in 2024-25 to an average of 0.25pc a year over the forecast. The OBR noted this was “well below the last decade’s average growth of 1pc a year”, at the tail end of austerity.

The long squeeze on pay also shows no signs of abating. By the end of this decade, workers’ real terms hourly pay – adjusted for inflation – will still be 0.5pc below its 2009-10 level.

That’s more than two lost decades of growth.

David Miles, an OBR official, described the growth in household incomes as “disappointingly low” and was clear on who was to blame.

He said: “The central forecast is for a period of very low growth in RHDI per person in the UK. After this year, looking forward, it’s running at about 0.2 or 0.3pc a year. That’s substantially lower than the long-run average in the UK and it’s a disappointingly low number.”

When asked what is responsible for this slow-burn crisis, the former Bank of England rate setter said: “It reflects partly the productivity judgment and partly the tax take, which obviously is a factor behind disposable income rising, and there are some pretty big tax increases down the road. So it’s hardly surprising given those things that there is pretty low growth in RHDI.”

The Joseph Rowntree Foundation said the picture was even bleaker once broader housing costs were taken into account.

On this broader measure, the average household will be £850 poorer in 2029-30 than in 2024-25.

Economy downgrade

While Reeves insisted she will continue to “defy” what she believes are pessimistic forecasts by the Budget watchdog, the outlook remains disappointing.

The OBR upgraded its growth forecasts for 2025 to 1.5pc, following a stronger expansion at the start of the year. However, it downgraded its projections for the rest of the decade to 1.4pc in 2026, down from 1.9pc, and 1.5pc each year to 2030.

Much of the downgrade was down to the OBR’s widely anticipated cut to productivity forecasts, amid what is described as “a clearer and weaker” picture for growth.

It warned that continued weakness in productivity meant it was becoming “less and less likely” there will be a bounce-back in growth rates that the UK has experienced in the previous shocks.

In other words, Britain may never return to the growth rates seen in the past.

The fiscal watchdog said: “Since the 2008 financial crisis, the UK has experienced its most significant and long-lasting slowdown in productivity growth since the Industrial Revolution.

“The UK’s productivity slowdown has also been greater than in any other major advanced economy.”

Inflation is projected to be slightly higher this year and next, partly because of Reeves’s previous Budget measures, before falling back to the Bank of England’s 2pc target by 2027 – a year later than previously forecast in March.

“Greater domestically generated inflation, alongside higher food prices, mean we also expect inflation to stay higher for longer,” the OBR said.

Its forecasts also predicted the average person would have £423 more to spend by the end of the parliament than they did at the start.

Analysis by the National Institute of Economic and Social Research (Niesr) also showed that Reeves’s decision to freeze tax thresholds for another three years will squeeze people on the lowest incomes hardest, in contrast to Reeves’s pledge to ensure those with the broadest shoulders pay their fair share.

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Adrian Pabst, at Niesr, said: “The Chancellor is right that the cost of living continues to be a burden on millions of households.

“Her decision to extend the freeze in income tax thresholds from 2028 to 2031 – this Budget’s single largest tax rise – will hit the bottom 30pc of UK households hardest.”

Mr Adrian added: “Their household disposable income will fall by close to 5pc compared with the alternative of uprating the thresholds in line with inflation in 2028, as the Chancellor had promised in her October 2024 Budget. This tax rise will knock, not boost living standards.”

Work is harder to come by

Unemployment is rising faster and further than previously expected, and will stay higher for the rest of the decade.

The jobless rate is set to peak at 5pc, not the 4.5pc forecast in March. Only in the final months of this decade will it fall back into line with prior projections, at 4.1pc.

The proportion of adults in work will hold steady at just under 61pc, while the share of people who are economically inactive – neither in work nor seeking a job – will creep up.

That is because of rising long-term sickness, as well as the ageing population.

However the increase will also be stemmed by the rise in the state pension age which encourages more people to stay in work for longer, and childcare subsidies helping parents to stick with their jobs.

For those in work, prospects are bleak. Pay growth is slowing sharply and is barely expected to beat price rises in the years ahead.

Debt keeps climbing

Reeves railed against debt in her Budget speech, complaining that “today, one in every £10 that the Government spends is on debt interest – not on paying down that debt, but just on paying the interest”.

Yet under her plans that bill will keep rising.

This year, the Chancellor will spend £113.7bn on servicing the debt. In five years’ time, that annual cost will hit £140bn.

That is partly because cheap debt taken out after the financial crisis and in the pandemic is maturing and needs to be refinanced at highest rates. But it is also because the national debt keeps on rising.

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Reeves will borrow £100bn per year on average between now and the end of the decade.

Reeves favours a measure called public sector net financial liabilities (PSNFL), which nets off debt against some assets. On this metric, the debt is rising from £2.57tn to more than £3tn in five years’ time.

As a share of GDP, it will start the next decade at 82.2pc – down from 83.1pc now, but still higher than the 81.3pc in Labour’s first year of office.

But the Government has to pay interest on all of its debt, not just the number that excludes assets.

On the previous Conservative government’s chosen borrowing metric, public sector net debt excluding the Bank of England, the total will reach £3.5tn in 2030-31.

As a share of GDP, that will keep rising to 95.3pc.

She now meets her borrowing targets with a margin of around £22bn. That is more than double the previous buffer of £9.9bn – enough, the Chancellor hopes, to avoid being thrown off track every time there is a wobble in financial markets or a rebellion on her back benches.

Tax burden continues to soar

The tax burden is now forecast to rise to a new post-war high of 38.3pc of GDP thanks to the biggest tax raid at the start of any parliament since at least 1970.

And it’s workers who are paying the price.

Reeves’s biggest revenue raiser by far is her decision to freeze the £12,570 level at which workers start paying income tax beyond the next decade.

The rate at which workers start paying the 40p and 45p rate have also been held for a further three years, a move that in total the OBR says will raise an extra £8.3bn in 2030 and £12.7bn in 2031.

Tom Josephs, who sits on the executive committee that oversees the OBR’s forecasts, said the 3.6pc of GDP increase in the tax take over the next six years was driven by “personal tax increases” such as the stealth raid that was first introduced by Rishi Sunak in 2021.

He said: “Personal threshold freezes in particular [raise the tax burden], which obviously applies to anyone who is working.”

It’s also worth looking at how the tax burden has shifted over the past decade and a half. Recent work by Tax Policy Associates shows the average UK worker now pays roughly less wage tax than at any time since the 1990s.

It’s a very different story if you’re a higher earner.

As Paul Johnson, the former director of the Institute for Fiscal Studies (IFS), highlighted last year, someone in the top 1pc of earners, whom HMRC estimates takes home £219,000, is now paying £10,000 a year more in tax than they were in 2009.

Britain’s reliance on higher earners to pay for public services continues to grow.

In fact, HMRC data show that the top half of earners, or anyone earning over £31,300, pay 90pc of all income tax. That’s £290.7bn of £323bn a year.

By contrast, the bottom quarter of earners, earning below £21,600, pay just 2.4pc of all income tax – or £7.5bn this year – according to estimates published by the taxman.

HMRC estimates that the top 1pc of earners pay 27pc of all income tax revenues, up from 25pc in 2010 and 21pc at the turn of the century.

There was also a broader health warning from the fiscal watchdog: higher taxes damage the economy.

“A higher level of the tax take increases the risk that incentives within the tax system distort or constrain economic activity by more than expected,” it said in its latest economic and fiscal outlook.

Spending keeps rising

The OBR described Reeves’s Budget as including “an array of spending increases”, mainly to fund higher benefits including £3bn to fund the removal of the two-child benefit cap and keeping working age welfare rising in line with the cost of living.

The Chancellor raised public spending by an average of £33bn a year over the next five years.

This means that by the end of the decade, spending is expected to settle at just over 44pc of GDP, a full five percentage points higher than it was before the pandemic.

However, economists highlighted that while much of the spending increase will be implemented over the next few years, Reeves’s “backloaded Budget” means that some of the more controversial tax rises – including a £4.7bn cut to salary sacrifice schemes as a surcharge on middle class homes – are coming into effect in 2028-29, on the eve of the next election.

Richard Hughes, the OBR’s chairman, said successive governments had failed to keep their plans on track.

He said: “To some extent, the nature of policy is that spending pressures are always upfront [while] taxes only generate additional revenues when you put up the rates.

“But it does follow a pattern of fiscal consolidations which ... have tended to slip.”

Mr Hughes added: “We’ve seen successive governments have plans for reducing the deficit ... and for various reasons – both shocks as well as new pressures emerging – the deadline for that consolidation slips.”

Ruth Curtice, the chief executive of the Resolution Foundation, a think tank, agreed that revenues were far from secure.

She said: “This Budget leaves much of the fiscal repair job to 2028 and beyond. Economic winds could change dramatically between now and then.

“The Chancellor has taken the sensible step to increase her wiggle room at the start of the parliament but the effects will be felt at the end.”

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