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UK Company Profits Forecast to Plunge to Financial Crisis Low
Company profits in the UK are predicted to plummet to their lowest proportion of national income since the financial crisis, according to a stark warning from the nation’s independent budget watchdog. The Office for Budget Responsibility (OBR) attributes this significant decrease to recent substantial pay increases outpacing inflation, which have severely impacted company profit margins. Businesses are bracing for a series of increased expenditures in the coming week, further threatening their financial performance.
Triple Blow of Rising Costs for Businesses
UK businesses are poised to encounter a “triple whammy” of amplified costs next week, placing additional strain on their profitability. These impending financial pressures include:
- A £25 billion surge in employer National Insurance Contributions.
- An increase in the national minimum wage.
- Reduced business rates relief.
Economic Growth Stagnant
Economic expansion has stagnated since the announcement of contentious fiscal measures by the Chancellor in the recent Budget, significantly damaging business confidence. This downturn represents a considerable setback for the government, as the OBR has revised its economic growth forecast for the current year downwards to a mere 1 percent. This revised outlook is attributed to the escalating risk of a global trade conflict and rising governmental borrowing expenses.
Corporation Tax Revenue Under Forecast
The budget watchdog has also reduced its projections for revenue generation from corporation tax, which is levied at 25 percent on the majority of company earnings and contributes approximately £90 billion to the national Treasury. This fiscal year, corporation tax is anticipated to yield £5.5 billion less than previously estimated by the OBR in October, following the autumn Budget. The OBR stated that this shortfall is partly attributable to persistent wage growth compressing profits and higher than anticipated inflation and interest expenses for smaller enterprises.
Profit Share of GDP to Fall
Corporation tax revenues are now projected to be £4.6 billion below earlier forecasts for each remaining year of the current decade. Consequently, company profits as a proportion of Gross Domestic Product (GDP) are expected to decline from 15.1 percent in 2024 to 14.3 percent this year – a level not witnessed since 2010 in the aftermath of the global financial crisis, according to the OBR.
Wage Growth Exceeds Productivity
The OBR further noted that “Wage settlement expectations have continued to surpass productivity growth and inflation.” The impending increase in employer National Insurance Contributions will also initially negatively impact profits. Wage growth accelerated to 5.9 percent in the final quarter of 2024, exceeding double the current inflation rate, thereby enhancing workers’ real earnings. The OBR expresses concern that these wage increases are adversely affecting company profitability due to a lack of corresponding improvements in productivity, measured by output per hour worked.
OBR Productivity Forecasts Questioned
The official forecasting body has consistently overestimated the potential for increased efficiency in worker output of goods and services. One economist critiqued the OBR‘s projections as excessively optimistic, bordering on “insane.” The OBR’s medium-term forecast anticipates productivity growth of 1.25 percent, significantly more optimistic than the Bank of England’s estimate of 0.7 percent.
Fiscal Headroom and Trade War Risks
This optimistic outlook enabled the Chancellor to meet fiscal targets, albeit narrowly, with a minimal £10 billion margin. However, Richard Hughes, chairman of the OBR, cautioned that this slender fiscal buffer could be entirely eliminated in the event of a full-scale trade conflict with the United States.
US Trade Negotiations
Government ministers are engaged in what the Chancellor has described as “intense negotiations” with the US concerning a trade agreement. These discussions are crucial to avert the imposition of 25 percent tariffs on British automobiles, potentially taking effect as early as Wednesday.
Inflationary Pressures and Tax Rises
The upcoming rise in employer payroll taxes is expected to exacerbate inflation as companies transfer the additional expenses to consumers through elevated prices. Nonetheless, the OBR anticipates that businesses will also absorb a portion of these costs through reduced profits. Overall taxation as a percentage of GDP is projected to increase from 35.3 percent this year to 37.7 percent in 2027-28, which the OBR terms “a historic high.”
Fiscal Challenges and Tax Thresholds
The Chancellor has assured business leaders of her commitment to avoid increased borrowing or further tax hikes. Yet, financial analysts contend that the precarious state of public finances leaves limited alternatives. While the Chancellor has ruled out tax increases for “working people,” economists speculate that an extension of the existing freeze on income tax thresholds remains a likely option. These thresholds, typically adjusted for inflation, were frozen in 2022, pushing millions of workers into higher tax brackets as inflation surged, thereby augmenting Treasury revenue. The freeze is currently slated to remain until 2028, but extending it to the decade’s end could generate an additional £10 billion annually.
Economist’s Perspective
Anna Leach, a senior economist at the Institute of Directors, commented that extending the income tax threshold freeze would generate substantial revenue for the Chancellor, describing it as “a really obvious one to do.”