Facing potential tax hikes? That's the question on everyone's mind, and it all boils down to a single, crucial factor: UK productivity. Chancellor Rachel Reeves is reportedly considering tax increases in her upcoming Budget on November 26th, and the primary reason is a predicted slowdown in the growth of UK productivity. But why does this seemingly technical economic forecast have such a significant impact on our wallets? Let's dive in.
What exactly is productivity? Simply put, it's a measure of how efficiently the UK economy transforms work hours into goods and services. Think of it as 'output per hour.' A higher productivity rate generally translates to higher average wages and incomes for a country's citizens. It reflects how well a nation utilizes its workforce and resources.
In March 2025, the Office for Budget Responsibility (OBR) projected a productivity growth of about 1% annually for the next five years. However, if this growth slows down, it directly impacts the overall economic growth and, consequently, tax revenues.
Here's where it gets controversial... The Institute for Fiscal Studies (IFS) has estimated that even a tiny 0.1 percentage point decrease in the productivity growth forecast could increase government borrowing by a staggering £7 billion by 2029-30.
To illustrate, if the OBR lowers its average UK productivity growth forecast from 1% to 0.8% (a 0.2 percentage point decrease), borrowing in 2029-30 could increase by £14 billion. This is a significant issue because, in March, the Chancellor had a 'headroom' (the leeway to meet borrowing rules) of only £9.9 billion for 2029-30. A 0.2 percentage point downgrade in productivity would completely eliminate this headroom, potentially leading to a deficit. The government would then need to either cut spending or raise taxes to compensate. Considering that departmental spending budgets are already set, tax increases seem like the most likely solution.
But what about the long-term trends? The UK's productivity growth has been notably weak since the financial crisis. Between 1971 and 2009, output per hour grew by an average of 2% annually. However, since 2010, this figure has dropped to an average of just 0.4% per year. While this slowdown isn't unique to the UK, our decline has been relatively significant compared to other developed nations. From 2010 to 2023, the UK's average annual growth rate fell by 1.9 percentage points compared to the 1971-2009 period, a worse performance than most of the G7 countries, except for Germany and Japan.
Why the slowdown? The reasons behind this productivity slowdown have puzzled economists for years. Some experts point to the lasting impact of the financial crisis, considering the UK's reliance on financial services. Others suggest that austerity measures and tax increases implemented by previous governments may have hindered economic activity. More recently, Brexit has been cited as a contributing factor, due to reduced trade and uncertainty affecting business investment.
And this is the part most people miss... There's no single consensus on the cause, but many economists believe that historically low levels of investment in the UK economy, both from the private sector and the government, play a significant role.
Should the latest downgrade be a surprise? Not really. The OBR has been more optimistic about UK productivity growth compared to other forecasters like the Bank of England and the International Monetary Fund (IMF). In March, the OBR projected a medium-term potential supply growth of 1.79%, while the Bank of England estimated 1.5% and the IMF 1.36%. Given this persistent optimism, it's not surprising that the OBR is now aligning its forecasts with others. Public finance experts have noted that if the Chancellor had allowed for more leeway in her fiscal rules, she might not have needed to consider tax increases in response to this downgrade.
What do you think? Do you agree that low productivity is the primary driver behind potential tax increases? Are there other factors you believe are more significant? Share your thoughts in the comments below!
