One of the many regrettable features of the government’s conduct of its economic policy is that there seems to be some dissonance both between and within No 10 and the Treasury.
As the experience of previous administrations bears out, if such differences are not resolved in a politically and economically coherent way, then trouble usually lies ahead. The enhanced economic clout drafted into the prime minister’s office at the last reshuffle – when Darren Jones, the chief secretary to the Treasury, was moved to a new senior role in Downing Street – was supposed to give clearer focus to the economic “narrative”, but there is thus far little evidence of that, and it may have merely complicated matters.
All the more reason, therefore, for the Budget in a little less than a month to offer some much-needed clarity for the whole government.
The dissonance seems to be wider than ever. The Office for Budget Responsibility (OBR) data, reported by the BBC, certainly confirms the scale of the challenge facing the chancellor, Rachel Reeves.
Ms Reeves already knew she faced a gap in the finances of between £30bn and £40bn. But she has been dealt a further blow with the decision by the OBR to downgrade its productivity forecast – which means she must find a further £20bn.
Obscure as it may be, that decision by the OBR is a bigger deal than it sounds. A reduction of 0.3 percentage points on an already anaemic projection is substantial, and points to lower overall economic growth in the years ahead. That, in turn, means that tax revenues will be lower, and public spending higher, than would have been the case on the previous estimate, with obvious dire implications for Britain’s strained public finances. It creates another, additional “black hole” in Ms Reeves’s plans, which will have to be covered by either tax hikes or cuts to state spending, as she has already indicated.
Yet to some extent, at least, this may be read as spin. Ever since George Osborne set up the independent OBR in 2010, the Budget process has been an iterative one, in which the Treasury and OBR swap proposals, projections, and policy assumptions in successive rounds for some weeks before Budget day. That is how the OBR invariably attaches its imprimatur to the chancellor’s package of measures; they are, in effect, pre-approved. At this still-early stage in proceedings, the Treasury will be looking to create policies for growth (such as radical reform of the planning system) and investment, in a bid to persuade the OBR to adjust its previously pessimistic view of productivity upwards.
The chancellor now knows that raising income tax is the only way she can balance her Budget. As the Institute for Fiscal Studies (IFS) has pointed out, trying to right the ship by raising lots of smaller taxes, instead of breaking Labour’s manifesto pledge not to increase income tax, will “cause unnecessary amounts of economic damage”. That barrier has been repeated ad nauseum since last year, or least until fairly recently, when such radical action has obviously drifted from the realms of the unmentionable into the plausible.
On that column of her ledger, Ms Reeves faces a choice, broadly speaking, between policies that would be politically effective in limiting the historic slide in the government’s popularity, and those that would tend to protect longer-term economic growth.
As we have argued before, if the chancellor is going to break the manifesto pledge, she should do it openly, in a manner that raises significant sums, and in a manner that is fair. She should raise the basic rate of income tax, which will take money from the broadest base of taxpayers according to their ability to pay. It would apply to all forms of income, including rent, dividends and interest: everyone who can afford to do so would pay, with those on higher incomes paying more.
On the other hand, attacks on savers, pensions, capital gains, property (the “mansion tax”), banks, and companies more generally offer a politically palatable menu for Labour’s restive backbenchers, but wouldn’t help investment. Labour MPs have, after all, already vetoed the modest reform of social security, and a “soak the rich” Budget might, it is supposed in some circles, rescue the prime minister from a coup d’etat. But it would leave the UK economy crawling.
The Budget speech should make clear that control of public spending, given the demands of defence, cannot be left to one side, even by a Labour administration. The argument for welfare reform was lost for the time being earlier this year, but that doesn’t mean the project has to be abandoned: it has to be reinstated in this Budget and in the OBR’s judgements. Fuel duty, frozen since 2011, could raise a handy sum, as could a levy on online gambling, but these were never likely to generate enough revenue to fill the black hole.
Whatever else, this time around Ms Reeves has to give herself enough fiscal “headroom” for contingencies, so that she won’t have to come back with yet another “tough” Budget in 2026. Her fiscal plan has to be, and has to be seen to be, realistic and serious. Neither the voters’ patience nor that of the markets, already severely tested, would survive a repeat of this “doom loop” performance in a year’s time.
