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Tax Hikes, Population Decline Threaten UK Economic Rebound

UK economic outlook

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The spectre of higher taxes and a falling population are said to be two reasons to be cautious on the UK economy's rebound potential, according to Capital Economics.

Economists at the independent research house say they are confident that the UK economy will put in a strong rebound in 2021 as the UK covid crisis fades and lockdowns are eased, and finally removed altogether.

But there are two reasons to be cautious of this assumption says Paul Dales, Chief UK Economist at Capital Economics.

Dales says the first area of concern lies with an untimely, and arguably unnecessary tax hike from Chancellor Rishi Sunak in the March budget.

Rumours abounded this week that Sunak and his team at the Treasury would look to plug a gaping hole in the public finances by raising corporation taxes in the March budget, and in a second review pencilled for November.

The reports suggest the Chancellor could be eyeing a raid on UK companies by raising taxes on profits from 19% to 23%.

"A major tightening in fiscal policy over the next couple of years is unnecessary and could prevent GDP from returning to its pre-crisis trend," says Dales.

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The second potential headwind to a sustained UK economic recovery is the fall in the size of the UK population, says Capital Economics, who note evidence that the population may have fallen by about 1.4 million, or 2%, in the year to Q3 2020.

A study by the Economic Statistics Centre of Excellence highlighted an “unprecedented exodus” of foreign-born workers following the outbreak of the virus as well as shortcomings in official surveys inflating the number of UK workers. The fall in population is said to be driven by the pandemic which prompted some UK residents born overseas to return home.

"This could partly explain why GDP in the UK fell more last year than in some other European economies and mean that actual employment is lower than current estimates. And, unless those people return to the UK or are replaced by other migrants, then a smaller workforce would make it more challenging for GDP to return to its pre-pandemic trend," says Dales.

Capital Economics expect unemployment may have risen above 5% in November as the second lockdown prompted firms to shed more labour, despite the extension of the furlough scheme.

But with the vaccine rollout going well, Capital Economics expect the unemployment rate to peak at “only” 6.5%, significantly lower than the OBR and the Bank of England.

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