Growth Slows in Second Quarter
The UK economy grew by 0.4% in the three months to June, down from 0.6% in the first quarter, according to the Office for National Statistics. The slowdown comes as the disruption unleashed by the Iran war began to take its toll, with continued high energy prices starting to weigh on growth.
The UK economy had been more resilient in the face of the ongoing Middle East conflict than some analysts feared, but the latest data suggests the effects are now being felt.
Deficit Larger Than Expected
Alongside the growth figures, the ONS reported that public sector borrowing in July was £1.8bn, despite strong tax receipts. City economists had expected a shortfall of zero for the month, when Treasury receipts tend to be swollen by self-assessment income tax payments.
In the first four months of this financial year, the cumulative deficit was £56.7bn – lower than last year but still running £2.3bn ahead of the Office for Budget Responsibility forecast. Total public debt was £2.98tn, or 94% of GDP, up £96bn on a year earlier, in line with Labour's plan to borrow for investment in infrastructure projects.
The government faces a £24bn squeeze on public finances, according to reports, as Prime Minister Andy Burnham's spending pledges – including cutting business rates for pubs, taking VAT off household energy bills, and capping single bus fares at £2 – add to the pressure.
Fiscal Challenges Ahead of Budget
Chancellor John Healey will present his first budget on 28 October, and the public finances are expected to be gloomier than forecast at Rachel Reeves's spring statement in March, when the Iran war had only just begun. At that time, Reeves had a generous £23.6bn buffer against her fiscal rules, but analysts believe a significant proportion of that may be eaten away by higher inflation, slower growth and rising bond yields.
Responding to July's public finances, Healey said: "Fiscal discipline is the bedrock of our UK economic stability and national security, which is why we are committed to meeting our fiscal rules, with a buffer against global uncertainties. We are cutting the deficit faster than any other G7 economy, while giving people a bit of breathing space with cost of living pressures and focusing support to get young people into work."
Labour committed in its 2024 manifesto not to increase income tax, National Insurance or VAT. However, leading think tank NIESR has said ministers will need to consider either sweeping reforms on property and tax reliefs, cutting the welfare bill, or breaking the manifesto commitment on tax.
Craig Rickman, personal finance expert at interactive investor, said: "The combination of John Healey committing to his party's election manifesto pledge not to raise taxes for working people and the sweeping hikes unleashed at the previous two budgets, means the government is short on levers to pull."
Potential Tax Changes Under Consideration
With Healey constrained by manifesto commitments, attention has turned to other areas where taxes could be raised.
Capital Gains Tax – Currently, the first £3,000 of gains each year is tax-free, with basic-rate taxpayers paying 18% and higher-rate taxpayers 24%. Healey has previously floated the idea of bringing Capital Gains Tax rates closer to income tax rates, which could mean paying as much as 40% or 45% on investment profits. Shaun Moore of Quilter said a significant change would be "controversial" and could deter investment.
Property taxes – A proportional property tax could see homeowners pay a flat 0.48% charge on their property's value. Campaign group Fairer Share claims 77% of households would benefit from such a shake-up, saving an average of £556. However, critics warn it could hit older homeowners and those in London and the South East hardest. A "mansion tax" announced by previous chancellor Rachel Reeves means properties valued above £2m could be charged up to an extra £7,500 per year.
Inheritance tax – Under inheritance tax plans, unused pension funds and death benefits will be included in the value of a person's estate for the first time. This is estimated to drag another 10,500 estates into paying inheritance tax and increase the tax paid by 38,500 estates by an average of £34,000.
Income tax – Income tax bands have been frozen since 2021, and the personal allowance is £12,570 per year. Sarah Coles of AJ Bell said if Healey says nothing about thresholds, pay rises will drag more people into paying income tax and bigger bills. There are signs the government could unfreeze tax thresholds; Burnham hinted at this during the Makerfield by-election. Some experts suggest a 50% income tax rate could replace the 45% additional rate, costing someone earning £150,000 about £1,250 more per year.
Households Face Winter Pressures
With energy prices remaining high, Healey could come under pressure to offer additional support to households this winter. Burnham announced a VAT cut for electricity bills last month, but told the BBC he would like to go further. "I can accept criticism that this isn't enough, because I wouldn't say it's enough," he said.
Inflation figures for July will be published next week and are expected to show a higher reading than June's 2.6%, reflecting rising utility bills. Sustained high inflation will increase pressure on the Bank of England to raise interest rates.