By Cameron Brown, former Special Adviser to Chancellor Jeremy Hunt (2022-2024)
Quick summary…
In a matter of days, expect Reeves to sell her first Budget like this:
“This is a balanced Budget that will restore economic stability after 14 years of Tory chaos. There will be no return to the dark days of austerity. The economy is growing, debt is set to fall, interest rates are on a downward path and inflation remains low. Those with the broadest shoulders will bear the greatest burden, and with new flexibilities to unlock investment, we can fund our NHS, tackle the backlogs, back new infrastructure, support low-income families and raise living standards for all.”
More detail…
Labour has waited 14 years for this moment. With their hands firmly on the nation’s fiscal levers, this is the first proper opportunity for the party to deliver the ‘change’ the public voted for in droves.
After a rocky few months settling into government, and the post-election honeymoon period firmly in the rearview mirror, it falls on the new Chancellor to reset the narrative and communicate a clear plan to grow the British economy.
But beyond the frenzied speculation, political spin and kite flying – and with the OBR deadline to submit major measures fast approaching – here’s the lay of the land.
Rules are made to be broken?
So-called ‘fiscal rules’ were conjured up with politics firmly in mind, or at least in the mind of former Chancellor George Osborne. The theatrics of forcing an annual parliamentary vote would, in theory, constrain any incoming Labour government over their tax and spend plans.
Unfortunately for Osborne, it looks like Rachel Reeves is set to call his bluff. It is now clear the new Chancellor will tweak those self-imposed rules to allow for up to £60 billion of new borrowing to invest in public services and new infrastructure.
The fact the Treasury is allowing the debate to continue in full public glare, this close to Budget day, seems to be an attempt to warm up the money markets to the scale of Labour’s ambitions.
Bond traders are clearly nervous. Over the past month, the cost of government borrowing – the 10 year gilt yield – has increased by over 15 per cent. Reeves would be wrong to assume Labour, or any other party, has some intrinsic credibility with the market. As we saw in Autumn 2022, markets can punish governments if their spending plans are deemed too risky.
The cynic within me does ask, therefore, whether the Chancellor will arrive at a smaller than speculated borrowing figure – say £30 billion – to calm nerves and surprise on the upside on the day?
This is a tricky line to walk. But what Reeves spends the ‘windfall’ on is just as important to the markets as the amount she intends to borrow.
‘No return to austerity’
Under the previous Conservative spending plans, the growth in total government expenditure was due to be capped over the next 5 years. In reality, many unprotected departments beyond health, schools and defence would have seen see their budgets reduced over the coming years.
To prevent a return to ‘austerity’, the IFS believes the Chancellor will need to make available an additional £25 billion over this parliament to prop up public services. This appears to be the main candidate for any new borrowing resulting from a change to fiscal rules.
One-off costs, such as compensation for the Infected Blood and Post Office Horizon scandals, will also pile further pressure on the Chancellor’s scorecard as she seeks to balance the books.
There is a subtle communications issue here. The last thing Reeves and her advisers will want on the day after the Budget is for influential think tanks, such as the IFS and Resolution Foundation, to loudly declare that Labour’s first budget ‘bakes in’ austerity for years to come.
I don’t suspect Labour MPs will be too thrilled with that framing either. They too will be grabbing every Treasury minister they can find, armed with a shopping list of local projects to fund.
Facing pressure from all sides, and with expectations high, Reeves is in a deeply unenviable position.
Until the pips squeak?
Targeting ‘those with the broadest shoulders’ is undoubtedly a tried and tested political strategy. When public services are under strain and the cost of living still biting, it can be more than appealing for chancellors to ask the wealthy to ‘pay a bit more.’ Plenty of Conservative chancellors did the same too.
It was also former Labour Chancellor Denis Healy’s view too. He infamously ploughed ahead with wealth taxes “until the pips squeak”, defying warnings of capital flight.
But what if Labour’s manifesto commitments on tax don’t raise anywhere near as much as first thought? You can forgive them for that, of course. Opposition parties don’t have access to the wealth of knowledge and financial modelling closely held by the Treasury and the OBR.
Against the backdrop of the unfortunately-timed DP World workers rights row, and a recently reported exodus of UK millionaires, the Chancellor will want to avoid any accusation she is actively driving investment away from the UK. The record-breaking outcome of the recent International Investment Summit will go some way to relay concerns.
At this point, Treasury officials will have costed Labour’s pledge to tax carried interest for private equity fund managers as income. They’ll also have delivered the bad news: doing so won’t raise much, if anything. It may even cost money, some £300 million. Her advisers are already rowing back in the media by briefing that a ‘compromise’ option is now being considered.
Reeves and her team are similarly facing challenges over Capital Gains Tax. After allowing speculation to run wild that the headline rate could increase to some 39 per cent, the Prime Minister has now publicly poured cold water on the idea.
That said, it is likely the Chancellor will increase the rate of CGT in a scramble to raise as much headroom as possible to finance her spending plans. The IFS is also calling for specific reforms to close loopholes and increase revenue, which are no doubt being seriously considered.
However, Reeves will also have received a warning from Treasury officials that a higher headline rate doesn’t always lead to higher revenue. As former Chancellor Jeremy Hunt was told, a modest reduction in the headline rate on the sale of residential property can actually increase tax revenue.
What seems to be underpriced, however, is the prospect of applying Inheritance Tax to pensions. It is possible the Chancellor will include the value of pensions within the estate, potentially subjecting it to IHT at 40 per cent, on death. With only 4 per cent of estates subject to IHT, this is seen as a more politically favourable option in the Treasury over reducing the 25 per cent tax-free pension lump sum, which had been touted recently.
‘I wanna live like working people’
For any budget to be fiscally credible, Treasury officials will be reminding the Chancellor that you need a mix of ‘revenue raisers’ (tax rises, to you and I) to help justify any additional borrowing. Doing so sends a clear signal to the money markets that HM Treasury can pay its way. The IFS, for example, say the Chancellor will need to raise £9 billion from higher taxes to complement additional borrowing to avoid a ‘return to austerity.’
If we take the Labour Party’s pledge not to increase taxes on “working people” literally, this opens up the possibility of increasing National Insurance Contributions for employers. A single percentage point increase could raise more than £8 billion, according to the OBR. If you need to find additional headroom, while remaining fiscally credible, this seems like the obvious lever.
As you would expect, though, any increase in employer NICs would not go down well with small businesses who are already reeling from higher input costs and wage pressures. The Conservatives too will dust off their attack lines and label any increase a ‘Jobs Tax’.
Fuel Duty too presents a political challenge for the Chancellor. After a decade of rate freezes, will Reeves listen to Treasury officials, break with precedent and finally increase the rate? Reversing the ‘temporary’ 5p cut to Fuel Duty followed by an inflationary uplift could raise some £6 billion. Pump prices are lower than they were last year, so any increase now could arguably be justified. But the rising price of crude oil driven by instability in the Middle East may make that relief short-lived.
Expect to see further increases in ‘sin taxes’ too – gambling and tobacco duties, for example – to help increase headroom.
Spare change for Change
In the weeks running up to a Budget, Chancellors are keen to avoid feeding the media frenzy by talking down the prospect of ‘rabbits out of the hat’. A noble aspiration, of course, but for any politician the element of surprise always proves too hard to resist.
The routine goes as such: if you manage expectations in the press now, you can surprise people on the day with a raft of new, exciting, retail policies.
For Labour’s first budget to land well with their new flock of MPs and the wider general public eager for change, Reeves will be under pressure to deliver something more than just economic stability.
But with the public finances in such a tight position, will there be any eye-catching freebies?
Any political adviser worth their salt will immediately look to the public’s two main priorities – the cost of living and the NHS. Means testing Winter Fuel Payments has added further pressure on the Chancellor to announce more relief for families.
It’s likely Reeves will confirm the increase in next year’s National Living Wage, expected to be more than £11.90 an hour. ‘A pay rise for 2 million hard-working Brits’, she will likely declare.
The NHS too is likely to be a beneficiary of any additional headroom at the Budget. Expect to see some additional funding to address backlogs in particular, with the promise of further productivity improvements to satisfy growing calls for substantial reform.
Long-term infrastructure commitments are also likely to be included in a drive to support economic growth. The multi-billion pound Road Investment Strategy is set to be revealed, along with a raft of supply-side reforms to planning and business regulation to address structural weaknesses.
