It’s back to school this week for MPs and government ministers – and few can be facing a more challenging new term than Rachel Reeves. After being moved to tears in the unforgiving glare of the cameras before the summer break, the chancellor’s allies say she is returning to the frontline with a renewed sense of purpose. She is ready, as the kids would say, to “lock in”.
But team Reeves is also well aware of the scale of the economic and political obstacles ahead. Most pressing, yet out of the chancellor’s hands, is the Office for Budget Responsibility’s (OBR) summer “supply stocktake” of its economic model.
As we reported in June, it looks likely that the OBR will move its key productivity forecast closer to the less-positive consensus. Given the crucial importance of productivity in determining economic growth, this shift could create a £20bn headache for the Treasury.
The downgrade – not anything Labour has actually done – is likely to be the biggest factor pushing Reeves off track from her fiscal rules. That creates a formidable challenge in explaining what has gone awry – and why she needs to come back with more tax increases, after last year’s historic £40bn budget package.
Expect to hear much more of the kind of language Reeves used in her recent Guardian article, in which she argued that “if renewal is our mission and productivity is our challenge, then investment and reform are our tools”.
She does have a story to tell here: changing the fiscal rules to prioritise investment has allowed the Treasury to give the green light to scores of pro-productivity infrastructure projects (with the next expected to be Northern Powerhouse Rail).
In the same vein, expect tax rises to be badged as efficiency enhancing, as well as revenue raising.
Officials do not yet know the scale of the fiscal gap they will need to fill, though they expect it to be large. Reeves’s decision to involve Torsten Bell, formally the pensions minister, in budget preparations points to a willingness to think more radically.
Bell has argued in the past for changes to the taxation of unearned income, property wealth – which we know the Treasury is looking at closely – and pensions.
Reeves made moves in this direction last autumn, with changes to inheritance and capital gains taxes, but this budget must be the moment to “go big”, as Bell’s former boss Ed Miliband would put it. (Arguably, the moment was, in fact, last July, but here we are.)
Yet as she draws up her plans, Reeves must have her eye on at least three different audiences, each in their way as tough as the meanest girls in the dining hall.
The first, and most important, is the public, to whom the chancellor may be best known as the author of last year’s botched removal of the winter fuel allowance.
While she is claiming to have been “fixing the foundations” in her first year in the job, it may not feel like it for families facing resurgent inflation, which hits low earners hardest.
And unfortunately, “Labour crashed the economy”, while unfair, is a much cleaner explanation for fresh tax rises than “the OBR has systemically overestimated productivity, which hasn’t recovered since the financial crisis”.
Reeves will need to convince cash-strapped voters she understands their struggles and has a plan to help.
Also watching Reeves closely will be those behind her, in her own party. Once seen as a potential future leader, she is blamed by some Labour MPs for a series of dire missteps, including on winter fuel and the botched spring statement welfare cuts.
Keir Starmer’s decision to bring in the former Bank of England deputy governor Minouche Shafik as his economic adviser, and the senior Treasury civil servant Dan York-Smith as principal private secretary, appears to indicate a new determination in No 10 to shape the government’s economic project instead of subcontracting it wholesale to Reeves.
Given the prime minister’s temperamental caution, these hires seem unlikely to presage any dramatic change of course. But they do raise the prospect of cracks emerging between No 10 and No 11, which rarely ends well.
Reeves’s third audience is among what her battle-scarred Labour predecessor Denis Healey called “the faceless men” (and, these days, women) managing the “atomic cloud of footloose funds” in financial markets.
Talk of an IMF bailout is well wide of the mark but with debt interest expected to cost the taxpayer more than £100bn this year, even modest moves in government bond markets can be extremely costly.
Judging by the bond sell-off in July when Reeves’s tears were read as a sign that she was on the way out, investors are minded to trust her – or at least, more than any potential alternative.
But to keep the support of this tough crowd, tax rises will have to be straightforward (and big) enough to close any fiscal gap convincingly, yet calibrated not to put the kibosh on growth or jack up inflation.
Given the 10 weeks’ formal notice the Treasury gives the OBR of the budget date, it cannot now happen until November.
Reeves will want to set some parameters in public long before that, to contain what has already become frenzied speculation, but she would be wise not to waste what may be Labour’s best crack at reforming our out-of-kilter tax system.
