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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
To govern is to choose. Labour’s chancellor of the exchequer, Rachel Reeves, has made her choices in a Budget that sets out a strategy for the parliament and beyond. It marks the burial of Thatcherism. It also heralds a permanently bigger state.
Much of what Reeves said about the inheritance was correct, however much the Conservatives complain. Given this, the rise in taxation was inevitable. The outcome will be a substantially bigger state than almost ever before in peacetime. Indeed, this looks a decidedly “Old Labour” government. That can be defended as what the public chose in the election. But voters also hoped for faster economic growth and better public services. It is on these outcomes that the government will ultimately be judged. At present, scepticism is the sensible attitude. This grand project might work. But it also might not.
The dire legacy must not be forgotten. According to the IMF, in 2024 UK GDP per head will be 29 per cent below where it would have been if growth had continued at its 1990-2007 rate. That is the worst performance of any member of the G7, relative to those past trends. The fiscal legacy was also very difficult. A row has broken out over whether Labour did find a £22bn “black hole” in the public finances. But analysts knew that the promises on public spending made last March were fairy tales. (See charts.)
So, now we have the adjustment: higher taxes, higher spending and bigger borrowing. According to the Office for Budget Responsibility, “Budget policies increase spending by almost £70bn (a little over 2 per cent of GDP) a year over the next five years, of which two-thirds goes on current and one-third on capital spending.” The size of the state is forecast to settle at 44 per cent of GDP by the end of the decade, which is almost 5 percentage points higher than before the pandemic. Half of the increase in spending is funded through an increase in taxes, mainly on employer payrolls, but also on assets.
Not only are taxes and spending higher than previously forecast, so is borrowing. The net effect of the Budget is to increase the latter by £19.6bn this year and by an average of £32.3bn over the next five years. Net debt is forecast to fall only slightly, from 98 per cent of GDP this year to 97 per cent by the end of the decade. Underlying debt, excluding the Bank of England, is forecast to rise in every year of the forecast.
Yet again, a British government has tweaked its fiscal rules. It now proposes to achieve a balance on the current budget and for net financial liabilities to be falling, both initially in five years. The shift to the latter measure allows it to include financial assets recognised in the national accounts. The change itself is defensible. It also allows for more borrowing. The question is whether the UK will get away with this, especially given its heavy reliance on foreign lending.
In the meantime, government investment and consumption will be higher and private consumption and business investment lower. It is also likely that employment will be reduced, as higher taxation of employment, higher minimum wages and tighter regulation of labour markets bite together.
The government may claim not to be taxing “working people”. But this is nonsense. The incidence of taxes does not fall on those who seem to pay them. Employment taxes are a cost of doing business. In a competitive economy, they will fall mainly on employees and consumers. They will also cause a further shift into self-employment. Labour would have done far better not to have ruled out higher income taxes. It would also have done better to start serious tax reform, including of taxes on land.
Much will depend on the overall economic impact. The OBR judges that the supply-side effects on potential output will cancel one another out in the period to 2029-30. Thereafter, the package will have a net positive effect on potential output. But, claims the OBR, even if the rise in public sector investment were sustained as a share of GDP, the latter would only be some 1.5 per cent higher after 50 years. That shows how hard it is raise growth significantly.
Could the outcome be substantially better than that? This depends on the net outcome of higher taxation of business, on the one hand, and higher investment and other policy and administrative changes, notably in planning, on the other. A central element in this endeavour will be attempts to reform the effectiveness of a sick state. It may make a difference — at least, one hopes so — to have a government that does not despise those who administer it.
Yet there must also be doubts. The chancellor promises an “economy that is growing, creating wealth and opportunity for all, because that is the only way to improve living standards”. And, she adds, “the only way to drive economic growth is to invest, invest, invest”. Yes, investment is a necessary condition for faster growth in a country that invests as little as the UK has done. But it is not sufficient. Moreover, the investment that drives growth is not done by government alone, but by a motivated and dynamic private sector. The results of the last 14 years demonstrate that this is not what the UK now has. On that, the government is right. But will it emerge in a country shifting towards higher taxes and more regulation?
The British people hope that higher spending will deliver the better services they want. But they also hope for better jobs and faster growth. To achieve that, the government must deliver a more dynamic, innovative and entrepreneurial economy. It is also on its success at this that its measures must now be judged.
