Newsletter #6: Post-budget analysis

A line-by-line of the 'black hole' — investment as fetish — drizzling on the rich

Good morning.

A post-budget update this morning, ahead of the announcement of the winner of the Tory leadership contest later today. That short guy who responded to Rachel Reeves seemed pretty good, didn’t he? Probably has a big future ahead of him.

PS: To maintain our focus in today’s newsletter, we’re not covering the bombshell update on the Southport attack today, but I promise to discuss it soon!

This newsletter’s agenda: The Budget I: A summary of the budget (free) The Budget II: On the £22bn ‘black hole’… (free); The Budget III: Public sector investment has become a fetish (paid); The Budget IV: Drizzling on — not soaking — the rich? (paid).

The Budget I: A summary of the budget

As expected, this was a big tax-raising budget: indeed, the biggest since 1970, beating out Norman Lamont’s previous record in 1993. But what was in it?

Core tax changes. As promised, no changes were made to Income Tax, VAT, or (Employee) National Insurance, and a pledge has been made to cap Corporation Tax at 25% for the duration of this parliament.

There was only really one big change here, which we all expected: employer National Insurance was hiked (by 1.2pp to 15%) and the threshold reduced (from £9,100 to £5,000), raising around £20bn per year (£26bn minus around £6bn on refunds to the public sector). This may, however, prove an overestimate, with some predicting more like £10bn due to lower pay.

The 75% relief on business rates for the Retail, Hospitality and Leisure sectors was slashed to 40% for 2025-26, capped at £110,000 per business. The relief — which was first introduced (at 100%) during the Pandemic — was set to expire, but has instead merely been reduced, costing £1.7bn. As things stand, the reduction will cost the average pub around £5,000 per year. Reeves has, however, promised an overhaul of business rates next year. These changes were accompanied by a freeze on the small business multiplier at 49.9p.

‘Soak the rich’ taxes. The extra rate of Stamp Duty Land Tax on second homes was increased from 3% to 5% (for example: the rate of tax on the portion from £250,001 to £925,000, which is taxed at 5% for a first home, is increasing from a previous 8% to a new 10% on second homes), raising around £200-300m by the time the tax takes full effect. Unused pension funds and death benefits are now included in the value of estates for inheritance tax (over £1bn per year raised by 2029-30). Relief on inheritance tax on agricultural and business property will partially be withdrawn on any combined assets over £1m, raising around £500m per year by 2029-30. ‘Non-dom’ status was abolished (many changes), allegedly raising over £12bn over five years — though this seems extremely optimistic. The lower rate of Capital Gains Tax (paid by basic rate taxpayers) has increased from 10% to 18%, and the higher rate (paid by higher rate taxpayers) from 20% to 24%. Business Asset Disposal Relief (BADR), and Investors’ Relief (IR) on Capital Gains Tax will be reduced.

The tax on ‘carried interest’ — which is used by private equity managers to reduce their tax bill, and is currently taxed as a special type of capital gains — will increase from 28% to 32%, with a view to eventually reclassifying carried interest as income, albeit at a substantially lower rate than standard — thus allowing Reeves to keep her pre-election promise without scaring off private equity funds.

‘Sin’ taxes. Taxes on soft drinks (currently 18p/24p per litre, depending on sugar content, but now being gradually uprated to account for inflation since the last uprating in 2018), tobacco (many changes, but previously £294.72 per 1,000 cigarettes plus 16.5% of retail price, now £316.70 per 1,000 cigarettes plus 16.5% of retail price, i.e., an increase of 54p for a pack of 20 cigarettes), and vapes (a new flat rate of £2.20 per 10ml of vape juice) were increased. Together, these will raise around £300m per year in 2029-30. Air passenger duty was increased (the change is complex, but this will increase the tax on short-haul economy fares by £2, from £13 to £15), raising around £600m a year (the tax increase on private jets is much higher). VAT has been levied on private school fees (raising an estimated £1.5bn per year), and the eligibility of private schools to charitable rate relief has been revoked. Surprisingly, there have been no hike to taxes on gambling.

The Energy (Oil and Gas) Profits Levy was extended to 2030, and increased to 38% from 35%, bringing the headline rate of tax on oil and gas activities up to 78%, and changes to the levy’s investment allowances were made (mostly withdrawing them except for decarbonisation). This raises a few hundred million a year.

The rabbits. Despite Keir Starmer seemingly promising that there would be ‘no rabbits’ in this Budget, in the end, there were a few. The first, and most expensive, was the surprise decision to end the freeze on income tax thresholds, instead uprating them in line with inflation from 2028-9. The 5p cut to fuel duty was extended for one year, and the planned increase in line with inflation was cancelled, costing £3bn next year. The tax on a pint of draught beer was changed so as to reduce the tax by 1p (£85m next year), though alcohol duty on other products will increase with inflation as planned.

Other tax-raising and revenue-saving changes. Right to buy discounts were reduced (from a maximum of over £100,000 to between £16,000 to £38,000), saving £250m per year. Around £1.5bn per year was saved by means-testing Winter Fuel Allowance. Many measures (too many to list) were taken to try to reduce the ‘tax gap’, which is supposedly meant to raise around £6.5bn a year in 2029-30. Some of these measures are substantive, but around £4.7bn of this is from vague claims of improved compliance from more HMRC staff. A few hundred million a year will allegedly be saved from a crackdown on benefits fraud due to more DWP staff, and £2.5bn will be saved in 2029-30 from an extension of ‘targeted case reviews’ of Universal Credit claims from 2028.

Spending. Spending has increased by £70bn, of which only £35bn will be funded by tax rises. £44bn of this is day-to-day (or ‘resource’) spending, meaning a real terms rise of 3.3%, though this is not evenly spread between departments. Partly taking advantage of the extra headroom created by her changes to the fiscal rules, this year capital investment will increase by £13bn, reaching £131bn a year — with additional capital spending (as compared to previous plans) totalling over £100bn over the course of the parliament.

The day-to-day spending plans for this parliament seem to be extremely front-loaded: 4.3% real terms growth this year, then 2.6% the following year, before falling to just 1.3% for the rest of the parliament. As such, many doubt whether there is much of a ‘plan’ for the money at all, or that spending limits will actually be stuck to. It’s perhaps not surprising that the markets reacted so negatively to the Budget once it sank in.

Planned day-to-day NHS spending for 2025-6 was increased by £22bn, with another extra £3bn promised for equipment and buildings. £6.7bn of capital spending was promised for schools (a real terms increase of 19%), and an extra £2.3bn for day-to-day spending (a real terms increase of 3.5%, of which £1bn will be for special educational needs). An extra £1.9bn of day-to-day spending for the Ministry of Justice, and £2.3bn for prison expansion over two years. £2.9bn for Defence: a real terms increase of 2.3%. £1.3bn of extra grant funding for local government, including at least £600m for social care. An additional £1.8bn for childcare. And lots more money for the devolved nations: £6.6bn!

An extra £500m was promised for fixing potholes. The Affordable Homes Programme’s budget was increased by £500m. HS2 is confirmed to go to Euston; also announced were a Transpennine Route Upgrade between York and Manchester, via Leeds and Huddersfield, and a rail link between Oxford, Milton Keynes, and Cambridge — but the Department for Transport will be faced with real terms cuts in day-to-day spending (though partly due to reductions in rail subsidies as passenger numbers recover after the pandemic). £500m for digital infrastructure; billions for aerospace, life sciences, and automobiles over a number of years.

£125m for GB Energy — far below what was anticipated. £134m for port infrastructure for wind turbines. £3bn of ‘additional support’ for private housebuilding. £3.9bn for ‘carbon capture’. £3.4bn for household energy efficiency. £5bn for green agriculture schemes over two years.

Other. The triple lock was maintained. The minimum wage was increased by 6.7%, from £11.44 to £12.21 an hour, and the 18-20 minimum wage was increased from £8.60 to £10.00 an hour, reducing the differential with a view to eventually abolishing the lower rate. Single bus fares will be capped at £3 instead of £2. Compensation has been set aside for those affected by the infected blood (£11.8bn over five years) and Horizon (£1.8bn over three years) scandals, and £750m a year for Ukraine has been announced. The Office for Value for Money was established. The annual regulated rail fares cap will rise by 4.6%, 1pp above RPI.

The Budget II: On the £22bn ‘black hole’…

We’ve heard a lot about Rachel Reeves’ £22bn ‘black hole’ — first £9bn, then £16bn, and later around £40bn (though this was a rhetorical sleight of hand) — but what is it, and where did it come from? Debate continues to rage, and the OBR have pointedly refused to endorse some of Reeves’ claims: while their report is hardly exculpatory of Jeremy Hunt, they seem to be perturbed in particular by Reeves’ attempt to use the concept of the ‘black hole’ to incorporate decisions to raise spending beyond merely plugging the existing shortfall; and in any case, as the Treasury itself notes, you are (quite naturally) more likely to be able to identify overspending as the year goes on rather than in advance, rather dampening the charges of dishonesty against Hunt. But we finally (sort of) have our answer.

Firstly: what is it? The ‘black hole’ is usually (since Rachel Reeves has attempted to extend the concept further and further) a reference to day-to-day spending by Departments that is above pre-agreed limits. While there is a reserve — as some amount of overspend is anticipated, given that government spending is always at least to some extent unpredictable — anything beyond this reserve will necessarily force some kind of fiscal adjustment sooner or later.

Secondly: where did it come from? The key summary table is here:

As we can see, a little under half (£9.4bn) of the £21.9bn ‘black hole’ was a consequence of the pay awards for 2024-5. Another £2.2bn was a result of ‘overhang from previous awards’, and £1.7bn was due to our support for Ukraine. A further £6.4bn was a consequence of spending on ‘asylum and illegal migration’, of which around two-thirds (£4.2bn) was spending on ‘asylum support’ rather than on enforcement measures, such as the Rwanda scheme. (NB: ‘New policy commitments’ (£2.6bn) refers to ‘commitments announced since Spending Review 2021 assumed to be funded from the Reserve’.)

You can read the full document here. However, for your convenience, I have gone through the full list for you (namely, the ‘Line by line breakdown of “Fixing the foundations: public spending audit” Resource DEL pressures’, pp. 28-40). Here are some of the spending pressures that I thought would be of interest to our readers, whether because of their size or because of their nature. Please note that I have made no attempt to be comprehensive or to give equal treatment to all spending pressures:

Health and Social Care:

£45m: Covid antivirals (who knew this was still costing us so much money?)

£12m: DHSC Smokefree Generation enforcement (the plan to ban tobacco sales for everyone born after a certain year)

£239m: Estimate of industrial action pressure

£6,090m: Agenda for Change and Review Body on Doctors’ and Dentists’ Remuneration (DDRB) costs

Education:

£1,008m: Impacts of demographic change, demand and inflation (this seems strange, given the baby bust in Britain — is this just a way of disguising the costs of immigration?)

£1,428m: School teacher and support staff 2024-25 academic year pay

Home Office:

£4,204m: Asylum support (I’d like to see a further breakdown of this spending)

£120m: Illegal migration cooperation with France (doesn’t seem to be achieving much…)

£278m: Home Office: Afghan Resettlement

£254m: Police pay (we need ‘performance-related’ pay)

£74m: Home Office: Civil Service pay 2024-25

Defence:

£308m: Ministry of Defence: Afghan Resettlement (yes, that’s on top of the £278m spent by the Home Office)

£1,500m: Support to Ukraine

Foreign, Commonwealth and Development Office:

£60m: Tokyo estate sale drawdown

£35m: British Indian Ocean Territory migrant costs

Housing, Communities and Local Government:

£148m: Budget Exchange: Homelessness Prevention Grant top-up and additional Homes for Ukraine funding

£14m: Hong Kong British Nationals (Overseas) integration funding

£338m: IFRS 9 expected credit loss provisions relating to loans made to housing supply programmes (presumably, losses made on loans to fund the construction of affordable housing)

£4m: English language and employment support for Ukrainians

£153m: Homes for Ukraine

Culture, Media and Sport:

£64m: Commonwealth Games legacy funding (a complete waste of money)

£1m: Covid Commemoration funding

Environment, Food and Rural Affairs

£200m: Farming and Countryside Programme: Payments for environmental action

Work and Pensions:

£503m: Extending the Household Support Fund (a slush fund that councils can access in order to give money to ‘anyone who’s vulnerable or cannot pay for essentials’ — we can guess who this usually means — without needing to raise Council Tax)

HM Revenue and Customs:

£20m: HMRC Smokefree generation enforcement (on top of the £12m of DHSC spending listed above)

The Budget III: Public sector investment has become a fetish