The UK’s Spring Budget 2024: more of the same on growth and net zero?
Today’s Budget prioritised short-run tax cuts, with the Chancellor of the Exchequer taking an extra 2% off national insurance contributions. This was anticipated, given we are in an election year – but it marks another missed opportunity to make progress on boosting living standards on a longer-term basis, and increase investment in a sustainable and resilient future for the UK.
The growth and investment challenge
The UK entered a technical recession in the second half of 2023, and the outlook is still weak, with the Office for Budget Responsibility (OBR) expecting the economy to grow by just 0.8% this year. This is against a background of lacklustre productivity performance since the financial crisis, which has fed into stagnant real wages and living standards. Fifteen years of lost wage growth have cost the average worker £10,700 annually. Boosting productivity will therefore be critical to sustainably improving living standards for British households and doing this requires increased investment, innovation and improved skills across both the public and private sectors.
In a recent report with co-authors at LSE, we argued that restoring productivity growth and building the resilience, sustainability and competitiveness of the UK economy will mean phasing up public sector investment to the order of an additional 1% of GDP per annum (around £26 billion at current prices). This should be accompanied, and reinforced, by additional reforms seeking to increase business investment by around 2 percentage points of GDP.
New support for British manufacturing and innovation set out in the Budget, including a £120 million boost for the Green Industries Growth Accelerator (increasing the fund’s total value to over £1 billion), and plans to boost innovative sectors and public sector productivity, are steps in the right direction. But these initiatives are unlikely to move the dial on UK productivity. The overall picture is still one of declining public sector investment, with capital spending set to decrease from 3.6% of GDP in 2024–25 to 3.1% by 2028–29. And significant barriers to business investment remain.
Paying for investment
The argument goes that the UK cannot afford a large-scale public investment programme in the current fiscal context. In truth, targeted and temporary borrowing to invest in sustainable technologies and infrastructure is fiscally responsible. Fiscal frameworks should be reformed to enable this. Significant opportunities could be realised from such investment, building on the UK’s real strengths in growing areas, including clean technologies where specialisation is spread across the country. There is good reason to believe that with targeted and evidence-based interventions to address market failures that hinder investment for productivity, sustainability and resilience, much-needed growth will be induced and government support can be phased down over time. By boosting productivity and wages, and reducing the country’s dependence on expensive and volatile fossil fuels, such investment is a prerequisite for alleviating the impacts of the cost-of-living crisis on working families.
Public sector investment plays a key role across many areas, including infrastructure, hospitals, schools and funding for research and development, and crowds in additional private sector investment. On net zero infrastructure needs in particular, the OBR has set out how around a quarter of the UK’s substantial investment is expected to come from the public sector. And the resilience benefits of frontloading investments are clear. According to the OBR, if the UK continues its dependence on gas at the current level, recurring gas price spikes could add around 13% of GDP to public debt by 2050.
If the Government wants to rely more on the private sector to do the heavy lifting, then it will need to go further on reforms to improve the investment ecosystem, building on steps taken in the last Autumn Statement. In that respect, the measures set out today were more incremental – with a commitment to extend full expensing of investment to leased assets (by an unspecified date), further steps to channel pensions and savings into productive UK investment, and various sector-focused incentives. The urgency of restoring the UK’s position as an attractive place to invest was highlighted in a recent survey showing that two-thirds of UK energy companies have moved, or plan to move, their investments to markets more supportive of their sustainability goals. Delays to planning reform and challenges to grid access continue to hold the country back.
Tax incentives
The Budget contained a few changes to the tax system that align with the net zero transition. Among the positive changes were an air passenger duty for business travel and an extension of the windfall tax on oil and gas producers, which could strengthen signals for investors and consumers about the direction of travel while raising much-needed tax revenue.
But progress was not made in a crucial area: fuel duty. Freezing the rate of fuel duty for yet another year (albeit as was expected) is a failure both in terms of using the tax system to accelerate the low-carbon transition and preparing the system itself for a transition that is already underway. The freeze makes the cost of driving fall in real terms, creating a perverse incentive for private car use over sustainable transport options. In the meantime, the growing uptake of electric vehicles is expected to cost the Exchequer £13 billion a year in forgone fuel duty as early as 2030, according to the OBR.
There are many other ways the tax system could be leveraged to drive the low-carbon transition, some of which featured in calls to the Chancellor from environmental organisations and business groups ahead of the Budget. A proposal that was particularly discussed in the media was for a cut to VAT on public charging for electric vehicles – this did not materialise in today’s Budget but remains relevant to the effort to redesign the UK’s tax system in line with net zero. Further improvements could come from enhancing existing forms of tax relief (e.g. capital allowances or R&D tax credits) for targeted clean investments, taking inspiration from the Inflation Reduction Act in the US and considering new targeted human capital tax credits in certain areas (e.g. green skills seeing increased demand).
The long-term view
Tax cuts now are a gamble with the future public finances. The UK tax burden is not particularly high by international comparison. The reality of the country’s public service needs, an ageing population, increased defence spending, and support for the creaking criminal justice system, as well as net zero spending requirements, imply that taxes will also need to stay high relative to the past to fund current spending. Spending and investment now can act to cut costs later: for example, by ending costly reliance on imported gas, improving insulation and efficiency in one of the leakiest housing stocks in Europe, and building supply lines and knowledge clusters in burgeoning clean-tech and green finance sectors.
Sustainable borrowing, based on domestic savings, requires action to encourage voluntary household saving, for example phasing up employer and employee contributions through pension auto-enrolment, and through public dissaving. UK business is looking for a clear steer from government to show that it has ‘skin in the game’ when it comes to investing in the new economy as countries worldwide vie to attract new business and the highly paid jobs that they bring.
An enduring growth strategy
The need to invest in a sustainable and productive future does not become any less urgent in an election year. Individual programmes and increased spending here and there will only get the UK so far. Ultimately, what the country needs is a holistic, coordinated and enduring growth strategy aligned with the mission to rapidly decarbonise the economy. Strategic coherence and credibility matter. Markets will fund public borrowing for investment that raises underlying growth and delivers higher tax revenues in the long run. They understand that not all debt is created equal and will penalise borrowing for tax cuts that fuel current consumption in place of future prosperity. A dedicated, independent policy institution focused on finding solutions to the UK’s growth and productivity problem could help ensure such a strategy is put in place and does not become a casualty of short-term political priorities.
The overwhelming priority for the UK is to drive innovation, boost worker skills and build competitiveness in the intelligent, efficient and productive net zero economy. Above all else, that requires investment.