Goldman Sachs predicts greater impact from Budget tax increases on employment and inflation

Goldman Sachs has warned that the tax increases introduced by Rachel Reeves in the Budget could have a more significant impact on employment and inflation than official estimates suggest.

The US investment bank's research is the latest effort to understand the potential effects of the tax changes announced in October’s Budget, as reported by City AM.

In the Budget, Rachel Reeves increased the rate of employer national insurance by 1.2 percentage points to 15 per cent, while lowering the threshold at which firms start paying the levy from £9,100 to £5,000. The Office for Budget Responsibility (OBR) predicted that workers would bear most of the cost of the tax rise through lower real wages, as companies cut wages and raised prices.

The fiscal watchdog said the tax increase would reduce labour supply by 50,000 average-hours equivalent. However, Goldman Sachs analysts suggested it was "reasonable" that most of the tax rise would be passed on through lower real wages, but cautioned that the risks to employment were "skewed to the upside", implying they will be felt more intensely than currently predicted.

They noted that the tax increase would hit lower earners hardest, with both labour supply and demand being more responsive to wage changes in this group, increasing the likelihood of a larger impact on employment. The analysts also referred to recent academic studies, which found that payroll taxes have "notable impacts on employment".

Analysts have predicted a short-term rise in unemployment of around 0.2 per cent due to the recent Budget, expecting it to peak at 4.6 per cent by the end of next year. Over the longer term, they anticipate the labour market will adjust with lower participation rates rather than higher unemployment levels.

Meanwhile, Goldman Sachs has indicated that the tax increase may be more inflationary than the Office for Budget Responsibility (OBR) forecasts, citing that firms often adjust prices more frequently than wages. Moreover, a 6.7 per cent hike in the minimum wage is set to prevent significant downward wage adjustments for many lower-income earners.