In June, it will be ten years since the EU referendum. How the date will be marked is not clear. The Festival of Brexit a few years ago was rebranded as something else but was ultimately a bit of a flop. The Museum of Brexit proposed by leading Brexiteers has a website and charitable status but not yet a building.
Given that it has been nearly ten years, you may wonder why Brexit is back in the news. Leaving the EU is being blamed in part by Rachel Reeves for the tax hikes she will announce in her budget next month. Andrew Bailey, the Bank of England governor, provided a surprise story last weekend by saying in Washington that, on the impact of Brexit on economic growth, “the answer is that for the foreseeable future, it is negative”.
• Brexit impact will be negative for foreseeable future, Bank chief warns
He is correct, as every credible assessment demonstrates. Some people have questioned Reeves’s decision, economically and politically, to place the blame now on Brexit for some of the productivity downgrade the Office for Budget Responsibility (OBR) will unveil on November 26 — budget day. That downgrade will be a key ingredient in the need for tax rises to meet the government’s fiscal rules.
After all, the OBR’s position on this has been clear for some time: it is that Brexit will, over time, reduce the UK’s productivity potential by 4 per cent, and result in a 15 per cent drop in trade intensity (exports and imports as a percentage of gross domestic product). Not only that, but economists agree that the UK’s productivity slowdown began not in the referendum year of 2016, but during or immediately after the global financial crisis.
Some, it is true, question whether the OBR’s assumptions are too cautious, with other estimates suggesting a bigger hit to growth already. Either way, the period since the UK decided to leave the EU, and then left, has been associated with weak growth. The UK’s real gross domestic product (GDP) per capita rose by 4.4 per cent between 2016 and 2024, less than half the eurozone’s 9 per cent increase and, strikingly, well below Italy’s 11 per cent rise.
• How Rachel Reeves will use Brexit blame game to defend budget tax rises
Much of the UK’s weakness has been since Britain formally left the EU on January 31, 2020, a period in which comparisons are complicated by Covid and energy-price inflation. Real GDP per capita in the second quarter of this year was up by a tiny 0.8 per cent compared to the pre-Brexit final quarter of 2019 and by 0.1 per cent between 2019 and 2024, when the eurozone managed a 3.3 per cent rise and even troubled France 2.6 per cent.
It remains to be seen precisely what the OBR says, but the chancellor has heard enough already, it seems, to know that it will lay the blame for the productivity downgrade not on the 15 to 16 months Labour has been in power but on the previous 14 years since the body’s inception in 2010.
Brexit is part of that story. Its most obvious influence is on trade, an important driver of productivity growth, where UK export performance since 2019 has been much weaker than other G7 countries. Exports of goods and services in volume terms were lower in the second quarter of this year than in the final pre-Brexit quarter of 2019.
Some of that weakness may reflect Donald Trump’s tariffs, but they themselves are proof of how the world has changed. They and current tensions with China show that dreams of a painless transition to non-EU trade were the wishful thinking of a different age.
The weakness of exports has been concentrated in goods, down 14 per cent since late 2019. But all is not well for services either, as a recent London School of Economics research study showed.
The report from the LSE’s Centre for Economic Performance, titled Deglobalisation in Disguise and co-authored by Bank monetary policy committee member Swati Dhingra, said: “We have assessed what Brexit has meant for the ability of UK businesses to export their services abroad. The short answer? Services exporters now face higher trading costs, more red tape and fewer opportunities. The country remains a services powerhouse, but services exports have been underperforming due to Brexit barriers.”
The reason a productivity slowdown that began in 2008-09 could also be blamed on Brexit is that the 2016 referendum snuffed out the recovery in business investment. This investment is crucial for productivity growth and the referendum embedded its weakness.
The Bank governor, while probably not wanting to be accused of blaming other factors for high UK inflation, might also have usefully looked at Brexit’s impact on price rises. The latest UK inflation figure of 3.8 per cent was lower than expected but compares with just 2.2 per cent in the eurozone. UK food price inflation is 4.5 per cent, compared with the eurozone’s 3 per cent. Some of that difference may reflect the UK’s new trade frictions.
Whether Reeves’s tactic was wise politically, we will see. I do not suppose many supporters of the anti-immigration Reform UK party are concerned with the details of the OBR’s medium-term productivity projections, or aware that Brexit has resulted in much higher levels of net migration into the UK than when we were an EU member.
Is the issue of EU membership back in play? When Reeves and Bailey both opined on the damage in recent days, the ears of some people who want to rejoin the EU pricked up. Was something afoot in respect of closer relations with Europe, or even renegotiating membership? I don’t think so. The chancellor and governor were both offering commentary, not indicating an impending policy shift.
In a part of his speech that was not much reported, Bailey also said that after the damage to growth for “the foreseeable future”, economic theory suggested things would then settle down. Citing the great economist Adam Smith, he argued that there would be a “partial counterbalance”, saying: “Make an economy less open and it will restrict growth, though over a longer time trade will adjust and rebuild.”
This could eventually happen, but it will take time — the very long run. And in the meantime, the economy will be slower growing and people poorer than they would have been.
The chancellor and governor put the issue of Brexit back on the table. Neither had a solution to the slow-growth trap in which we find ourselves.
PS
There has been a backlash from tattooists following a suggestion here last week that they should be subject to a higher “luxury” rate of VAT. Many people, including tattoo artists, regard their service as a necessity, not a luxury. I pointed out that it was not my idea. It has, however, quite put me off getting one, in case the artist is a reader.
Leaving this aside, the most consistent theme following my call for budget ideas has been that Rachel Reeves should get rid of the 60 per cent marginal rate of income tax — 62 per cent with national insurance — which kicks in at £100,000.
It is a feature of our income tax system that steps are steep: from zero to a marginal rate of 20 per cent when people move above the £12,570 personal allowance; from 20 to 40 per cent at the higher-rate threshold, £50,271; and from 40 to 60 per cent at £100,000. Bizarrely, the marginal rate then falls to 45 per cent (the additional rate) at £125,140. A marginal rate, to remind you, is the tax paid on each additional £1 earned above each step.
A combined income tax and national insurance rate of 62 per cent between £100,000 and £125,140 thus means people in that bracket keep only 38p of every additional pound earned. And some of that 38p will go in other taxes, such as VAT, when it is spent.
So why does the chancellor not try to win some friends by getting rid of this curious anomaly, which dates to when George Osborne was chancellor? I have not found an official estimate for the cost of doing so. There are 1.23 million 45 per cent taxpayers, part of whose income falls into the 60 per cent band. There are also about 700,000 people whose total income falls in it, for whom I assume an average income of £112,500.
Combining the two, my estimate of the cost of starting the 45 per cent rate at £100,000 instead of £125,140 is £5.5 billion to £6 billion a year. Extending the 40 per cent band to £125,140 would cost between £7.5 and £8 billion annually. As a check, I asked Stuart Adam of the Institute for Fiscal Studies, and he came up with the same numbers.
Given the cost, sadly we can assume this will not be a priority for Reeves, and that this nonsensical feature of the income tax system will continue.