OBR warns higher taxes could hit growth ‘more than expected’

Chancellor Rachel Reeves has warned that an increase in the tax burden could cause the Office for Budget Responsibility’s (OBR) key forecast to be weaker as it becomes harder to predict how the measures will hamper growth.

In its budget brief, the fiscal watchdog said the tax increase could have unforeseen consequences for the UK economy and could be read as a warning to the Chancellor not to rely too heavily on the estimates he produces.

The OBR said that some taxes, including taxes on assets such as capital gains tax, are more difficult to measure because they are “particularly sensitive” to volatile asset behavior and prices, while the outcome of an income tax is easier to project.

But they warned that they may struggle to quantify how the overall tax rise would impact the UK economy, while estimates of the total tax taken come with “significant uncertainty”.

“In general, higher levels of tax take-up increase the risk that incentives in the tax system distort or constrain economic activity more than expected,” the OBR report said.

The comments come as Reeves took the tax burden to an all-time high, after adding £26 billion to the government’s take through the introduction of new levies and extending a freeze on income tax thresholds for a further two years.

Much of the new welfare spending increases in the Budget in areas such as child benefit and triple lock pensions depend on the success of Whitehall’s administrative efforts.

HMRC’s efforts to close the tax gap, i.e. the difference in expected tax revenue to the actual income paid, could raise an additional £2.3 billion although the OBR report indicated it was possible the revenue forecast was changed by £8 billion.

Higher income from capital tax is also heavily dependent on “projected increases” in property prices, with Reeves introducing a new homes tax surcharge on properties worth more than £2 million to raise additional funds.

The OBR’s fiscal report said the new homes tax would result in additional borrowing of £100 million in the next two years due to behavioral factors, including appeals from property owners against property assessments set by the government’s quango.

The policy is then expected to generate just £400 million after 2028 although that figure could change depending on how the Valuation Office Agency targets homeowners.

There are still many questions regarding estimated taxes

The estimated risks highlighted in the report do not just arise in public sector receipts, the OBR also highlighted “significant uncertainty” and “several risks” to spending projections.

Risks include higher-than-expected welfare spending over the next five years, additional costs to the NHS budget from the Trump administration’s protectionist approach to medicines, and the Home Office’s ability to end the use of asylum hotels and save up to £1.1 billion, among other factors.

A Treasury spokesperson said: “We are reducing borrowing and debt by spending wisely, reforming welfare and making fair tax choices by asking everyone to contribute, especially those with the most burdens. This will deliver on the country’s priorities of cutting NHS waiting lists, borrowing and the cost of living.”

Questions about government policy in the report reflect growing anxiety among economists over the use of forecasts to keep public finances in check.

Former OBR board member Sir Charlie Bean tells the story AM City that it was “completely unreasonable” to adjust loan and debt targets to specific figures in the report.

The series of questions asked in the report may also reflect tensions between the Treasury and the fiscal watchdog following a week in which the OBR chose not to assess any growth policies put forward by the government, mistakenly published its report before Reeves’ statement, and contradicted the government’s claim that the headroom figure had increased, allowing plans to raise income tax to be abandoned.