Budgets are always important, but this month’s is unusually so. An unpopular government is struggling with a huge financial problem. None of the choices facing Rachel Reeves are easy, and for the government, and the Labour Party, the stakes could hardly be higher.
The inheritance
Reeves inherited a dire situation, building since the global financial crash of 2008 led to the Cameron/Osborne government’s ‘austerity’ programme. That forced major cuts on public services and especially in the local government services which people see (or don’t) every day. Then Brexit cut our GDP by 4%. Then Covid created rising demands on the NHS, ill health unemployment and SEND costs. And global instability calls for more spending on defence, while an ageing society means fewer people generating wealth, and more depending on pensions and health and care services.
Although some radical economists challenge the underlying principles, most experts agree that Reeves needs to find £20–30bn to balance the books.
There are three ways of balancing the books
Governments can borrow to pay for services. But you pay interest on loans. For years, interest rates were extremely low, and borrowing was easy, but now they have returned to normal, and the repayments are much larger. One tenth of all government expenditure is now simply interest payments.
An alternative is to cut services. But most public services have been cut to the bone. We see this in the crisis in the justice system, and the closure of local government services. And even the NHS, which has been singled out for favourable treatment, is struggling. All governments promise ‘efficiency savings’ but they rarely produce significant change.
So, the only remaining option is to raise taxes. By international standards Britain is not a very high tax country, but tax is always unpopular. To get elected, the Labour Party promised not to raise any of the three main taxes: income tax, VAT and National Insurance. But together, these account for two thirds of all government income.
One big blow
As is now clear, that was a foolish promise, and the first and biggest choice facing Reeves is whether or not to break it. This could balance the books with a single clear decision. But politically, it would be a big gamble.
It would horrify many of her own supporters, including many MPs, and the press and social media would have a field day. Historically, the right-wing media have always presented Labour as the spend-thrift party, willing to tax hardworking people in order to spend on their own pet projects. Unless people feel much better off by 2029, Labour is unlikely to win another term with the charge of breaking tax promises hanging round their necks. The party might never recover and the latest rumours suggest she is rowing back on this.
Multiple taxes
But the alternative is to put together a menu of smaller tax changes. This is more complex, they might not all deliver, and it risks upsetting a host of special interest groups. Finding £25bn from perhaps a dozen tax changes risks creating a dozen hostile campaigns. We have seen the political damage done by a relatively minor change to inheritance tax for farmers. And that was only expected to raise £0.5mn.
Assessing her budget
If she chooses this option, here are five tests to apply to her budget. Will it…
Control the cost of living? The highest priority for voters. Average wages have been rising slightly faster than inflation, but that is not what most people experience. Increasing VAT, or extending it to more things, would be a blow that people feel in rising prices. So would taxes on energy, or fuel duty (governments always say they will raise that in line with inflation, and never dare do it).
Reassure business and the bond markets? Her growth agenda depends on convincing investors that Britain is a safe place to invest. If she is too radical, they could be scared away, creating growing economic problems.
Reduce poverty? Thanks to the pensions ‘triple lock’, pensioner poverty is now much lower than it was, but child poverty has been rising. The quickest way of fixing this would be to abolish the two-child benefit cap. But that would add £3.5bn to the financial hole to be filled.
Balance the taxation of wealth and income? Because income for work is taxed at a much higher rate than earnings from investments and property, inequality has risen to historically high levels. The last 25 years have seen total personal wealth triple, driven mainly by house values and private pensions. Those who got ‘on the ladder’ have seen their assets balloon, while the bottom of the ladder has risen rapidly away from younger people. This is unfair, and penalises precisely the ‘working people’ the government is committed to supporting. But countries which have tried ‘wealth taxes’ have mostly given them up. They are difficult to enforce, and raise less than hoped. So, will she find other ways of taxing wealth?
Simplify the system? Our tax system is hugely complicated. Its code runs to over 10 million words. Anything which simplifies the system would make it easier and cheaper to administer and more difficult to evade/avoid.
A menu
Many agencies have made suggestions about tax changes. The two approaches we have highlighted are adopted by two of the most reputable. The Institute for Fiscal Studies (IFS) proposes raising income tax, while the Resolution Foundation (RF) proposes a list of 14 measures.
The table shows some of the larger options proposed by these two.
Radical options
There are more radical options. The Patriotic Millionaires group propose a tax on the ‘super rich’. This would raise £24bn from the 20,000 richest people with a tax of 2% on wealth of over £10mn.
Our regular contributor, Professor Richard Murphy, has proposed nine tax reforms and a series of administrative reforms, which he claims would raise substantial sums, which would make the tax system more efficient and fairer.
However, Reeves has prioritised ensuring stability to reassure investors. The shadow of Liz Truss’ radical tax ideas hangs over any Chancellor. She is unlikely to want to ‘frighten the horses’ with seriously radical change.
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