Rachel Reeves made a significant impact with her debut budget presentation last week, showcasing a substantial increase in public spending that could amount to an additional £75 billion annually in the later years of this parliament.

This ramped-up spending is primarily funded through additional borrowing and tax hikes. Borrowing is set to increase by £40 billion in the current financial year and by an additional £30 billion compared to previous projections for 2028-29. The Chancellor has announced substantial tax increases that will commence in April 2025, totaling over £40 billion per year by the end of the parliament.

The foremost tax-raising initiative involves increased national insurance contributions from employers, coupled with hikes in capital gains and inheritance taxes, along with various technical tax adjustments that will enhance revenue. It is important to note that these new measures are on top of previous tax increases implemented by the prior government, which included a freeze on income tax allowances and thresholds since 2022, as well as a rise in corporation tax commencing in 2023.

Prior to the COVID-19 pandemic in 2020, the UK’s tax burden (measured as taxes as a percentage of GDP) was at 33.1%, which was roughly consistent with the average since 1997 (32.8%). By the 2023-24 financial year, this tax burden has risen to 36%. Reeves indicated in her budget speech that the tax-to-GDP ratio is anticipated to surpass 38% during this parliament, marking a post-war high.

From 2019 to 2027, the projected tax burden is expected to rise by more than 5 percentage points, the steepest increase in an eight-year span since the 1960s. Historically, the trend of increasing public spending, borrowing, and taxation in the 1960s contributed to the inflation and economic instability experienced in the UK during the 1970s and early 1980s.

This scenario underscores the potential risks associated with the Chancellor’s budgeting approach. While Reeves emphasized the need for stability and growth driven by investment, her proposed budget could unintentionally yield contrasting results.

The hike in employer national insurance contributions combined with a 6.7% increase in the living wage poses inflationary pressure, likely affecting interest rates. Starting April next year, the expense of employing someone at the living wage will escalate by 10.5% when factoring in the higher national insurance contributions. Average earnings continue to rise at nearly 5%, and the uptick in employer national insurance is expected to add around 2.5 percentage points to the average costs of employment, layering additional expenses onto wage increases beginning in April.

Moreover, the UK’s economic growth may face challenges if elevated national insurance impedes job creation, especially among smaller enterprises. Higher employer national insurance is often viewed as a ‘tax on jobs.’ Coupled with new employment regulations introduced by the government, the increase in employer national insurance could diminish labor market flexibility, which has been critical to job growth in the UK.

Lastly, the rise in employer national insurance and corporation tax could constrain the flow of retained profits that underpin business investment. The Office for Budget Responsibility’s forecasts indicated that a reduction in business investment might partially counterbalance the increase in public investment announced by the Chancellor. Additionally, other tax hikes that adversely affect the business environment in the UK, such as capital gains and inheritance taxes, could lead to more severe negative repercussions on investment than anticipated.

Overall, the persistent, long-term elevation in taxes, particularly those impacting businesses, is poised to obstruct the Chancellor’s efforts to enhance growth and investment, possibly undermining the broader economic strategy of the new government.

Andrew Sentance is an independent business economist and a former member of the Monetary Policy Committee.