Three days after getting the keys to 11 Downing Street and in her maiden speech as chancellor, Rachel Reeves unveiled her plans to “get going with economic growth”.
Speaking to journalists and assorted business leaders in Westminster, Reeves confirmed she was already working on producing her first budget this autumn and had already ordered Treasury civil servants to produce an “assessment on the state of our spending inheritances so that I can understand the full scale of the challenge”. The findings will be published in the next few weeks.
That was the only reference to Labour’s fiscal conundrum in a speech focused on a blitz on obstructive planning regulations, the introduction of mandatory housebuilding targets for local authorities and the reversal of a ban on building onshore wind turbines, which now will be designated as “nationally significant” infrastructure.
These are welcome and much-needed policies that have the potential to change the trajectory of Britain’s woeful productivity performance and years of under-investment in technologies and infrastructure. Yet even if Labour can get it right, the fruits of these efforts will reveal themselves over the course of years, with any potential boost to growth showing up towards the end of this parliament or the start of the next.
Laudably, Reeves’ maiden policy announcements moved away from the penny-pinching fixation on short-run tax-and-spending plans that have dominated this country’s economic policy debate since November 2022, when Jeremy Hunt took over from the ruins left by the mini-budget. That’s a worthy aim and I am highly sympathetic to Labour’s need to want to shift the debate.
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According to Neil Shearing, chief economist at Capital Economics, the consultancy, bloviating over the precise amount of fiscal space for governments in the United States, Britain or France “misses the point. The most pressing issue that policymakers must address is not fiscal in nature, it is the chronically low growth rates of their economies. It is not obvious that the cause of weaker growth is a lack of demand that needs to be addressed through fiscal expansion.”
Labour can’t always have it both ways, though. Reeves has spent months limiting the scale of her ambition to policies that need to be “costed” and not “unfunded”. That’s why Labour was forced into dialling down its green investment ambitions before the election and why it has now given the private sector an outsized role in helping to meet its investment goals. The fiscal picture will dictate the scope of Labour’s activism whether it wants to admit it or not.
The biggest multibillion-pound reason that Reeves can’t escape the fiscal dilemma that plagued Hunt is because she has chosen to retain the Conservatives’ binding fiscal rule to bring down the debt ratio within a rolling five-year period. That’s the same debt rule that led the Office for Budget Responsibility to call the Tories’ last spending forecasts worse than fiction. That’s not to say Reeves will try to game the system, but the fury of the OBR — an institution she has pledged to respect — means she is under pressure to provide realistic spending plans that don’t draw the watchdog’s ire.
So here are some back-of-the-envelope calculations on how she can raise money and where to spend over the next few years.
As it stands, Labour has inherited a fiscal in-tray that implies cuts of £14 billion a year to government departments between 2025 and 2029, an unedifying and unnecessary injection of austerity. To raise cash, the party’s manifesto promises to add VAT to private school fees and to clamp down on tax evasion, which is meant to generate about £8 billion to £9 billion on the most ambitious end. But only about £6 billion of this has been pencilled in for public spending needs, leaving departments such as transport, justice and local government suffering budget cuts.
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On the revenue side, Reeves again ruled out tax rises on the big three of personal income, national insurance or VAT, with most of her activism likely to be concentrated on areas such as capital gains tax and changes to inheritance tax laws. The revenues involved will depend on the size and scope of the measures and how much the OBR estimates they will be worth.
Beyond tax rises, there are stealthy fiscal measures that potentially could magic up tens of billions in headroom for Reeves, all of which involve the Bank of England. The first and most controversial is a measure to reduce the Bank’s interest payments to commercial lenders keeping overnight money at the central bank. The introduction of a tiered reserve system seems to be off the table. Reeves looks to have listened to Andrew Bailey, the Bank’s governor, who fears that it would interfere with the working of monetary policy. She said she had “no intention” to reduce the Bank’s losses with this policy.
With that avenue closed off, there are two other routes through which the Bank and its bond losses can give a headwind to the public finances. The first is the Bank’s tapering off of bond sales that it’s been carrying out for the past two years. This process of “quantitative tightening” has exacerbated losses as the bonds have been sold for less than they were bought. If the Bank reduces the pace from the assumed £48 billion to closer to £13 billion this year, that would earn Reeves a precious £10 billion in headroom in her autumn statement, according to estimates from Goldman Sachs.
Another significant technocratic fix would be for Labour to adopt an alternative measure of the national debt in its fiscal rulebook. Switching from the present measure of underlying public sector debt to a “headline” measure that includes the central bank’s debts could magic up an additional £20 billion for Reeves.
To be clear, this is a brazen example of moving the goalposts to hit arbitrary fiscal targets. However, Labour is operating in an imperfect world where there are no easy options. It should opt for the path of least resistance.
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Mehreen Khan is Economics Editor of The Times
