Rachel Reeves has made some difficult decisions in her first year or so as chancellor of the Exchequer, and not all of them, in all candour, are necessarily ones she might opt for now. It has left her and the public finances in a difficult position – one that might be even more serious than has hitherto been supposed.
The National Institute of Economic and Social Research (NIESR), one of the more established and well respected organisms in the economic research ecosystem, has suggested that the current “day to day” deficit in the Treasury’s current account could stretch to £41.2bn at the end of the forecast period in 2029 – a figure that would break the Reeves rulebook, as well as the patience of the markets, in fairly violent fashion.
The NIESR describes things straightforwardly: “Our view is that it will be crucial for the chancellor to restore market confidence by demonstrating fiscal discipline. This will require a determined attempt to rebuild the fiscal buffer, and that will inevitably involve gradual but sustained tax increases, or spending cuts.”
The NIESR adds that the government should “prioritise protecting public expenditure that supports society’s most vulnerable, while safeguarding public investment essential for sustainable future growth”. That is not only compassionate and sensible advice, but it reflects the reality of the restive mood on the Labour benches in the House of Commons. The MPs, and the country, would like the Labour government to demonstrate what it is for.
Labour is in a “trilemma": raise taxes, cut spending, or borrow more. Something has to give – and that something is taxation.
The most economically sound option is, as so often, also the most politically difficult choice – to raise income tax, and at the moment that means the two highest bands, cutting in at about £50,000 and £125,000 respectively (possibly allied to new thresholds and allowances to iron out some accidentally extreme marginal rates). An increase of a few percentage points in each case, with some other adjustments, would go a long way to addressing the looming chasm in the current account.
It is true that there are other options available, but either they are too small to generate sufficient revenues, or they fall on the shoulders of those least able to bear the burden, or they are easily avoided by the super-rich, or they have unpleasant side effects on investment, productivity, and thus longer-term growth in living standards.
Some upward adjustments in “sin” taxes on online gambling, drinking and smoking are inevitable, and thoroughly justifiable, though running into the territory of diminishing returns. An increase in fuel duty on petrol and diesel would be ecologically sound, and long overdue, but bad for smaller businesses, so it could not be pushed too hard.
A wealth tax – a vogueish project in some Labour circles – is, unfortunately, all too easily escaped by those who can skip the country; and hikes in capital gains tax for the merely better-off can also blunt savings and investment. The same goes for a rumoured raid on pension pots.
By far the most reliable and fairest way to place the public finances on a sustainable track is also the most straightforward. The downside is obvious: a clear breach of a much-repeated manifesto commitment. Yet, in the final analysis, no government can be tied to promises made in different circumstances, especially when adherence to them would risk even worse damage to the economy, public services, and long-term living standards.
Sir Tony Blair once said that good policy is good politics, while one of Sir Keir Starmer’s more memorable and resonant soundbites was “country before party”. That means that the government has little choice other than to break its promise for higher earners.
It should, in truth, have done so sooner. One thing that the chancellor definitely has failed to do, even without the benefit of hindsight, was to build enough “fiscal headroom” into her plans to deal with what might be termed “known unknowns” – more commonly known as Donald Trump’s tariff policies.
Those, and other vicissitudes, not least the sullen refusal of Labour backbenchers to compromise with ministers on social security reform, have left Ms Reeves badly exposed at each “fiscal event” and keynote speech since her appointment.
The combination of a lack of wriggle room and the rightly tough fiscal rules that she has (or rather, the markets have) imposed has left her constantly trying to plug fiscal gaps. It has left the government looking incompetent, as though it is not in control of events, and constantly suffering from speculation about tax rises and spending cuts.
After her first Budget, Ms Reeves declared that she would not be “coming back with more borrowing or more taxes”. That pledge, for whatever reason, did not hold. She must now deliver a follow-up Budget that is tough enough to ensure that she won’t have to spend the rest of the parliament executing screeching U-turns.
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