Britain’s Payroll Tax Blues Start Meeting the Data

Waiting is one of life’s most important skills, and investing offers copious opportunities to practice it. Waiting for compound growth to bear fruit. Waiting for short-term volatility to even out. Waiting for an investment thesis to play out. And one we practice a lot: waiting for data to confirm a theory. Like this one: Two months ago, as the UK’s payroll tax hike took effect, we studied historical data and determined that—contrary to widespread fears—the increase was unlikely to cause mass layoffs and economic trouble. But there is always a period of limbo where we must wait to see if that proved right. And while UK stocks are up bigtime since early April, that also coincides with global stocks’ rebound from this spring’s correction—and reading into short-term volatility is as much of an error when the volatility is good as when it is bad. But now, happily, we have a smidge of actual data.

We refer to S&P Global’s Services Purchasing Managers’ Index (PMI), a survey measuring the percentage of businesses reporting better, steady or worse conditions across a range of metrics. Readings over 50 indicate a majority of businesses reported improvement, which generally corresponds to growth.

The tax hike was supposed to hit services firms hard, hammering employment and demand while forcing companies to raise prices. That was the narrative. Yet in May, the UK Services PMI rose to 50.9 from April’s 49.0—returning to expansion after a very brief contraction.^[i] Output rose, new orders’ decline slowed to an “only marginal” rate, and businesses reported a rise in demand from European clients that offset weaker demand from tariff-spooked Americans.^[ii] Survey respondents blamed April’s weakness on those tariffs and the uncertainty they generated, not domestic tax changes. And while headlines spent months warning those modestly higher taxes would force businesses to cut back and raise prices, it seems the opposite happened.

As S&P Global’s release notes: “Service providers reporting an increase in business activity generally cited the impact of improved business optimism after the US tariff-related slump seen in April. Resilient consumer confidence, new marketing initiatives and competitive pricing strategies also helped to boost overall output levels, according to survey respondents.”[iii] While businesses reported cost increases, they broadly didn’t pass them to consumers, with the inflation reading slowing to a seven-month low. Marketplace competition kept prices in check.

As for jobs, while businesses reported a drop in total employment, this wasn’t the result of tax-induced layoffs. Instead, businesses opted not to immediately backfill employees who resigned voluntarily. This is a fairly standard reaction to rising costs and uncertainty, and it is part and parcel of employment trends being a late-lagging indicator. Hiring and training are a big up-front investment of time and money, and businesses will often put it off until their existing headcount isn’t enough to keep up with demand. Eventually, as the economy grows, businesses add to their ranks to keep up, deciding it is worth the added cost.

Overall, a PMI of 50.9 isn’t off the charts, and as a breadth measure, we still need more output-related data to assess the full effects. But the PMI does suggest waiting for the bloodbath headlines predicted the UK economy would endure may be tantamount to waiting for Godot. These data instead signal modest growth, which is all the UK needs to continue trouncing exceedingly dreary expectations. And this backdrop likely remains a-ok for UK stocks.