Rachel Reeves has a problem on her hands. With news of the Government’s worsening fiscal “black hole” and the approaching Autumn Budget, increasing taxes is back on the agenda — exactly what the Chancellor said she wouldn’t do.
The cause of her problem is clear enough — making promises she couldn’t keep, and which now darken her days. Having pledged during last year’s election campaign to rebuild the country’s degraded public services without raising taxes on working people or worsening the fiscal deficit, she was left to load the burden onto a small share of the tax base. She also held out hope she could restore the country’s growth rate sufficiently to generate most of the revenue she’d need to fund the repairs and investment she wanted to carry out.
But growth, while improving slightly in the most recent quarter, has not yet sufficed to cover the added expense the Exchequer is having to bear from rising interest rates, which are nearly 1% above where they were last year. There’s no sign of an imminent reduction in borrowing costs, either, with Britain’s inflation rate proving hard to bring down.
Her critics blame her tax measures for impeding economic growth — in particular, the inflationary impact and potential deterrent to hiring and investment she caused by raising employer National Insurance contributions in last year’s Budget. But it’s doubtful this is the problem. While investment and employment have both remained weak, it’s not obvious that Reeves’ tax measures caused it. The country’s tepid economic growth rate has to be set against a backdrop of a global economy that is weaker than before the pandemic, dragged down by sluggishness across all developed economies.
This sluggishness, moreover, is deep-rooted and structural. Economic growth across the developed economies has been slowing for decades, the first signs of this deceleration appearing as early as the late Sixties and then really becoming apparent after the 2008 global financial crisis. Slower growth has then brought deeper downturns which, when they come, have led governments to medicate the pain with borrowing. As a result, fiscal deficits, which before the Seventies were rare outside of wartime, have become the norm, and an almost perfect mirror to growth: they have been rising steadily, with higher peaks and higher troughs, and rare surpluses.
So, Reeves can’t be reasonably blamed for slowing the country’s growth. However, a case can be made that she understated the scale of the challenge that lay ahead, and therefore has no viable solution to the problem. In keeping with a long line of politicians who promised to repair the economy and restore growth, with little to show for it, Reeves trumpeted her “securonomics” as a cure for what ails Britain. But talk is cheap, because even the recent US growth boom, which has been the envy of other G7 countries, was itself something of an illusion: the growth spurt was driven entirely by borrowing which, now removed from the picture as interest rates rise, has revealed an economy that is itself rapidly decelerating.
In short, Reeves’ growth panacea looks unlikely to materialise. If erring on the side of caution in preparing her Budget, she might go further and pencil in a possible downturn later this year, given that both the American and Chinese economies are presently slowing, which will further hinder the global economy. Yet given the stubbornness of inflation, which remains above the Bank of England’s target and is also now rising in the US, bond yields are unlikely to fall unless there’s a recession — which would in any event merely deplete tax revenues.
“Reeves’ growth panacea looks unlikely to materialise.”
No matter how she cuts it, Reeves is facing either rising costs or declining revenues, and possibly a mix of both. As a result, the Government’s finances remained strained. That leaves her with only three options — bend her fiscal rules, cut spending or raise taxes. The first isn’t on the table, since it would risk raising interest costs further yet (for further reading, see “Liz Truss”). Meanwhile repeated backbench rebellions within her own party make spending cuts an unlikely recourse.
Thus, tax rises look inevitable. Therein lies her problem. When running for election last year, Reeves could have made a case that to re-start growth and repair public services, Britain needed to spend and invest more, which required more tax revenue. However, Keir Starmer had made winning the election the Labour Party’s highest priority. And to win the election, Starmer judged, the party needed to assemble a winning coalition with targeted, cost-free pledges.
This kind of short-term approach to politics, a method called the permanent campaign, stems from a theory of politics called the median-voter model. It became canonical in the late Nineties under leaders including Bill Clinton and Tony Blair and it was based on a simple logic: voters were self-interested and little moved by ideological visions. Thus, by targeting voters in the median of the political spectrum with pledges of increased benefits and reduced costs, a party could capture the largest coalition possible.
One upshot of this approach is that you concentrate the benefits on those inside your coalition and impose the costs on those outside. Hence we got “no taxes on working people” — a sleight of hand since almost everyone considers themselves workers and hardly anyone considers themselves to be rich. “Tax the rich” thereby became a coded phrase that amounted to “tax someone else”.
As an election strategy, Labour’s landslide spoke for itself. But as an economic one, it left Reeves with little room for manoeuvre, since in the eyes of almost all British voters, she has no mandate to raise their taxes. Thus, she’s constantly looking to squeeze more revenue from a small share of the base and raising taxes in small but repeated steps, or by stealth, generating funds inadequate for the economic task ahead but sufficient to make her increasingly unpopular.
The Labour Party is now reviving the idea of a wealth tax, which would target accumulated wealth over income. But while such a tax would enable her to satisfy her pledge to not touch people’s incomes, it might provide only a temporary balm. That’s because while effective as a one-off fundraising measure, typically in response to a crisis that has blown the Budget, wealth taxes become less effective if made annual, given the costs involved in assessment. It could also take years to implement, given that the required administrative infrastructure is not currently in place.
Another possibility being mooted is a so-called mansion tax — applying capital gains tax, which currently only affects investment properties, to primary residences above a certain threshold. The obvious risk here is that the way to avoid paying tax in such cases is to not sell the property, which would reduce the volume of business in this segment of the market.
In other words, there are no easy solutions. Reeves is, in effect, stuck in what might be called the barn-raid trap, from the refrain of the old reggae tune: Nobody wants to plant the corn, everybody wants to raid the barn. This willingness of politicians to make ostensibly cost-free pledges hardly started with Labour. The Cameron-Osborne Tories hid the cost of their tax cuts in the gradual decline of public services. Boris Johnson told his compatriots that their vote for Brexit would not only be costless, but that their prosperity would immediately improve and the National Health Service would be flush with cash. Instead, Britain’s average annual economic growth rate, which had since the turn of the millennium tracked the European Union’s, fell by half while the NHS — well, enough said.
The fate of those previous politicians who succumbed to the barn-raid trap should give Reeves pause: once stuck in it, there seems to be no exit, save in the premature end to a political career. What the current moment requires is political leaders who don’t merely follow public opinion but instead mobilise support for the sort of bold changes Britain will require if it’s to tackle its structural decline once and for all. Leaders who lead.
Mind you, it may be that politicians keep telling us lies simply because they reckon we won’t hear the truth. Unless Reeves can overcome that resistance and declare bold action, she appears destined to become the next victim of the barn-raid trap. Thereafter, it will no doubt come for the next politician who wins power with cost-free pledges.
