OBR Questions Reeves’ Tax Plans Amid Improved Economic Forecasts

The Office for Budget Responsibility (OBR) has raised concerns about claims made by Chancellor Rachel Reeves regarding her decision to abandon plans for an income tax increase. The OBR asserts that Reeves was aware of improved economic forecasts well before her recent budget announcement. This revelation could intensify existing tensions between Reeves and the Treasury.

In an unusual move, OBR chair Richard Hughes addressed the Treasury select committee to clarify how the OBR’s forecasts evolved, citing the “circumstances” surrounding the situation. The budget announcement, which took place on November 4, 2023, was preceded by significant speculation and strategic briefings. Notably, the OBR inadvertently released its documents online earlier than planned, prompting further scrutiny of Reeves’s fiscal strategy.

Prior to the budget, Reeves had delivered a rare early morning “scene setter” speech, which many interpreted as a signal that she might breach a key pledge in Labour’s manifesto concerning income tax rates. Although Reeves did not explicitly deny the possibility of a tax increase, she ultimately decided against it just days before the final policy decisions were made. The Financial Times reported on November 13, 2023, that both Reeves and Labour leader Keir Starmer opted to abandon the tax increase.

The situation escalated when bond markets reacted negatively, leading to rising yields on government bonds as news broke of the tax plan’s cancellation. Treasury sources informed journalists that the income tax increase was no longer necessary due to improved forecasts from the OBR. These sources highlighted that unexpected inflation and wage growth had minimized the adjustments needed to comply with Reeves’s fiscal rules.

A headline on the Bloomberg website stated, “Reeves’ Tax U-Turn Came After Better Forecasts from UK Watchdog,” referencing unnamed insiders. Nonetheless, Hughes’s letter included a chart detailing the OBR’s forecast changes throughout the autumn, information typically withheld from public release. This chart confirmed an improvement in forecasts; however, it also indicated that even by October 3, 2023, Reeves was projected to breach her initial fiscal rule by just £2.5 billion. To restore compliance, she would have needed to adjust her budget by £12.5 billion or £22.5 billion to allow for a margin of error.

As of October 31, 2023, the OBR’s third forecasting round indicated Reeves would meet her fiscal rule with a surplus of £4.2 billion. Importantly, the OBR clarified that after this date, no significant changes were made to its economic or fiscal forecasts, apart from adjustments related to Treasury policy decisions.

Ultimately, Reeves opted to increase taxes by £26 billion over the forecast period to raise her compliance buffer to £21.7 billion and accommodate policy changes, including the removal of the two-child limit on welfare support.

Treasury sources have firmly rejected the notion that Hughes’s letter contradicts their account of the decision-making process leading up to the budget. They argue that it was only after the OBR provided forecasts that included the effects of planned budget measures that a final decision was reached.

Relations between the Treasury and the OBR have been tense, particularly in the lead-up to Reeves’s significant budget announcement. The Chancellor has publicly criticized the timing of the OBR’s revised productivity forecasts, which contributed to a downward adjustment in growth expectations. She stated, “I think that it would have been a lot better if they had adjusted their forecasts the year before the election,” emphasizing the need for clarity in economic assessments.

Hughes is scheduled to appear before the Treasury select committee on November 7, 2023, where he is expected to address what information Reeves had regarding the OBR’s forecasts, as well as the circumstances surrounding the early release of these critical documents.