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In the July election, voters demanded a responsible government that would borrow wisely, fix public services, grow the economy, and minimize tax increases. Labour promised all of this. Now in government, they have to face the public with the trade-offs that come with power.
Based on emerging soundings and analysis, Chancellor Rachel Reeves is expected to announce a traditional Labour budget on October 30, focusing on tax, spending, and borrowing. Her approach seems to lean towards increased public investment and tax hikes, with a cautious stance on additional borrowing and limited day-to-day public spending.
Since the election, incoming ministers and external experts were surprised by the public spending situation left by the Conservatives. The Tories had swept various problems, including costly asylum and public sector pay pressures, under the rug labeled “no longer our problem.” This was hidden even from the independent fiscal watchdog, the Office for Budget Responsibility. While the left will portray the upcoming moves as fixing this legacy, the right will criticize Labour for being profligate. However, the reality is that the trade-offs are more challenging than either side acknowledged during the election.
Reeves has opted to deviate from the existing public debt fiscal rule while still adhering to its essence. The current rule, which aimed to see “net public debt excluding the Bank of England” decrease as a share of GDP after five years, will be discarded. Instead, other metrics of public liabilities, deemed more effective, will be set to decrease. This shift will allow Reeves to plan public sector net investment levels similar to this year’s 2.4% of GDP, rather than the 1.7% projected by the previous administration.
This is a substantial increase. While it falls short of some unrealistic expectations, it surpasses the average of 1.5% of GDP invested by the previous Labour government between 1997 and 2010, as well as the nearly 2% invested by the Conservatives. Consequently, the government must demonstrate that the funds allocated under this “full-fat” Labour strategy will be put to good use.
The decision to redefine the debt target implies higher borrowing than previously planned by the government, rendering the debt rule no longer the primary fiscal constraint. It will be replaced by the “golden rule,” reminiscent of the one introduced by Gordon Brown in 1998, demanding that tax revenues match day-to-day public spending requirements. The target for achieving this balance is likely to be set for the end of this parliament in 2029-30, with a fixed deadline rather than a rolling target that can be ignored.
While the current budget rule significantly limits borrowing, keeping it aligned with investment levels, it also stabilizes most measures of public debt and provides assurance to markets. Although borrowing will increase, it will be directed towards productive investments, avoiding unnecessary expenditures. This “semi-skimmed” approach is expected to delay the Conservative government’s compliance with the current rule by a year.
A modest rise in the current budget deficit implies that any increase in day-to-day public spending will necessitate tax hikes. The roughly £40 billion gap that officials aim to close represents the difference between projected current public expenditure in 2029-30 and the expected revenue from the tax system. This calculation considers Labour’s manifesto pledges and aims to avoid cuts to departmental budgets relative to national income.
While the spending plan is realistic, it falls short of the Conservative proposals criticized by the OBR. However, it is not overly generous and is already drawing complaints from ministers. It would increase real current public spending at approximately half the rate of Tony Blair’s governments in the 2000s, despite the current state of public services being worse and demographic pressures higher. This “skimmed” Labour approach may not satisfy many on the left, requiring ministers to address low productivity growth, particularly in healthcare.
Despite the limited spending, significant tax increases are necessary. Some proposed measures were already outlined in Labour’s manifesto, such as imposing VAT on private school fees and introducing additional levies on non-domiciled individuals. Reeves may benefit from last-minute forecasts, but substantial tax hikes are still expected. The growth benefits from increased public spending are marginal and may be offset by the negative effects of the planned tax increases.
Raising employer national insurance contributions, either by increasing the main 13.8% rate, applying NICs to pension contributions, or both, is likely to cover most of the shortfall. While raising such a tax, which ultimately affects workers and jobs despite being formally paid by employers, may not be ideal, it remains the best option for a government aiming to improve public services. This measure aligns with Labour’s principles, representing a tax increase at least twice as large in real terms as that of Brown’s initial budget in 1997.
Reeves faces inevitable constraints. She cannot simultaneously increase spending, reduce borrowing, and maintain existing tax levels. This challenge was evident during the election campaign. Her decision to invest, tax, borrow, and manage day-to-day spending represents a sensible approach to managing these trade-offs. While she could have communicated this strategy sooner, dwelling on past mistakes is futile at this point.
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