Facing the prospect of tax hikes? It all boils down to a single, crucial factor: the UK's productivity. But why does a dip in how efficiently we work translate into potentially higher taxes? Let's dive in. This is important because Chancellor Rachel Reeves is considering tax increases in her upcoming Budget on November 26th. One of the main reasons is the anticipated adjustment in the UK's productivity growth forecast by the Office for Budget Responsibility (OBR). This raises a key question: how does productivity, or the lack thereof, directly influence the government's financial decisions? And, could this have been foreseen before the promise of no tax increases on working people in the 2024 election manifesto? Let's explore.
So, what exactly is productivity? Simply put, it's a measure of how much the entire UK economy produces for every hour of work done by everyone in the workforce. We can also call it "output per hour." Think of it as a gauge of how effectively the country uses its workforce and resources to generate goods and services. A nation with high productivity often sees higher average wages and incomes.
In March 2025, the OBR predicted that the UK's overall productivity would grow by approximately 1% each year for the next five years.
Now, here's where it gets controversial... if productivity grows more slowly than anticipated, the overall growth of the Gross Domestic Product (GDP) – and, consequently, overall tax revenues – will be lower than expected. The Institute for Fiscal Studies (IFS) has calculated that every 0.1 percentage point reduction in the official productivity growth forecast increases projected government borrowing by a staggering £7 billion by 2029-30.
For instance, if the OBR were to revise its forecast for average UK productivity growth over the next five years from 1% to 0.8% (a decrease of 0.2 percentage points), this would lead to an increase in projected borrowing of £14 billion in 2029-30.
Back in March, the Chancellor had a "headroom" of only £9.9 billion to meet her borrowing rules in 2029-30. This was the buffer between meeting and missing her targets. Therefore, a 0.2 percentage point downgrade in the OBR's productivity forecast (£14 billion) would, by itself, eliminate this headroom, pushing the government into a projected deficit in that year.
To restore that headroom, the Chancellor would need to either cut government spending or raise taxes by an equivalent amount. Considering that departmental spending budgets were set in the June Spending Review, the Chancellor is expected to try and restore her headroom against her fiscal rules by increasing taxes.
But what's been happening to UK productivity over the longer term? The UK's productivity growth has been unusually weak since the financial crisis. Between 1971 and 2009, output per hour in the UK grew by an average of 2% annually. However, since 2010, this has slowed to an average of just 0.4% per year.
This slowdown isn't unique to the UK; it's a trend seen in most developed countries since 2010. However, the UK's slowdown has been particularly significant. Between 2010 and 2023, the UK's average annual growth rate fell by an average of 1.9 percentage points compared to the 1971-2009 period. This was worse than all G7 nations except Germany and Japan.
Why has UK productivity growth been so weak? For years after 2010, economists struggled to explain the UK's productivity slowdown. Some pointed to the lasting impact of the financial crisis, given the UK's reliance on financial services through the City of London. Others suggested that austerity measures and tax increases by the previous government had contributed by reducing overall economic activity.
More recently, Brexit has been cited as a factor, both due to reduced trade since 2020 and the damage to business investment caused by the uncertainty following the 2016 referendum.
There's still no consensus on the exact causes, but many economists believe that historically low levels of investment in the UK economy, both from the private sector and the government, are likely a major part of the story.
Should this latest productivity downgrade come as a surprise? Not really. The OBR was notably more optimistic about UK productivity growth than other forecasters, including the Bank of England and the International Monetary Fund (IMF), in its most recent forecast.
In March, the OBR projected medium-term potential supply growth for the UK (a broader measure of productivity) of 1.79%, compared to the Bank of England's 1.5% and the IMF's 1.36%. The OBR has consistently been optimistic about UK productivity growth since 2010.
Given this, it's not surprising that the OBR has adjusted its forecasts to align more closely with other forecasters. Public finance experts note that if Rachel Reeves had provided herself with more headroom against her fiscal rules in March 2025, she might not have needed to respond to this downgrade by raising taxes. Many experts cautioned after her last Budget in October 2024 that her plans and promises not to raise taxes again looked vulnerable if productivity growth disappointed.
What are your thoughts? Do you agree with the analysis presented? Do you think the government could have anticipated this? Share your opinions in the comments below!
