Reeves’s Difficult Balancing Act is also a Growth Gamble

An independent viewpoint by Professor Stephen Barber
October 31, 2024

All Bud­gets are bal­anc­ing acts: Chan­cel­lors bal­ance what they want to spend with what they raise in tax­a­tion (and bor­row).  We need only look to Kwasi Kwarteng and Liz Truss’s dis­as­trous so-called ‘Mini Bud­get’ to see what hap­pens when Chan­cel­lors get that wrong. But rarely has a Bud­get been as dif­fi­cult to bal­ance as this one. Rachel Reeves found her­self in the unen­vi­able posi­tion of hav­ing ambi­tions to fund pub­lic ser­vices and artic­u­late a vision for this new gov­ern­ment, but amid the tight­est of pub­lic finances in a gen­er­a­tion. For Reeves, that bal­anc­ing act isn’t sim­ply one of mak­ing the income v expen­di­ture sums add up. There is a more fun­da­men­tal chal­lenge in that Britain has suf­fered an utter­ly anaemic econ­o­my for 15 years now. It has nev­er recov­ered the rates of eco­nom­ic growth expe­ri­enced before the eco­nom­ic cri­sis. Indeed, the econ­o­my in the 15 years before the cred­it crunch grew 10 times as fast as the last 15 years.

What­ev­er the ambi­tions of this gov­ern­ment, lit­tle of sub­stance will be achieved unless it tack­les this dire sit­u­a­tion. And here­in is the prob­lem with which the Trea­sury has been grap­pling. With tax as a pro­por­tion of GDP at his­toric highs, and wage and pro­duc­tiv­i­ty growth slow, the scope for rais­ing income is lim­it­ed — though Reeves man­aged to increase tax­a­tion by a sub­stan­tial £40bn in her debut. There is a fur­ther risk, which is that increas­ing tax­a­tion removes spend­ing pow­er from the econ­o­my. That in turn has an impact on demand and con­se­quent­ly growth. The increas­es in employ­er Nation­al Insur­ance, for instance, rep­re­sent some­thing of a gam­ble since it dis­in­cen­tivis­es pri­vate sec­tor employ­ment and pay ris­es. And it’s worth con­sid­er­ing the scale here —  employ­ers are being asked to stump up a whop­ping £25bn to pay for this Bud­get and that is not a risk-free mea­sure.  Squeez­ing busi­ness also risks reduc­ing the incen­tives to invest in R&D which is a key route to improved pro­duc­tiv­i­ty. The Office for Bud­get Respon­si­bil­i­ty (OBR), con­firmed that the bur­den will be felt by employ­ees through low­er pay, and con­sumers through price increases.

In the run up to the Bud­get there was also con­sid­er­able spec­u­la­tion that Britain could be in line for what was being described as Aus­ter­i­ty 2.0. The empha­sis on core pub­lic ser­vices, notably the NHS, in the mea­sures announced by the Chan­cel­lor, mit­i­gate against this and more impor­tant­ly Reeves has been care­ful to avoid one of the poten­tial errors of the coali­tion after 2010. Maybe the bold­est move, is the plan to revise the Trea­sury’s Fis­cal Rules, some­thing trailed well ahead of the offi­cial announce­ment so as not to fright­en the mar­kets. The con­se­quence is that the Chan­cel­lor has far greater scope for cap­i­tal spend­ing over the Par­lia­ment.  The announced £100bn of spend­ing over 5 years are impor­tant since they cre­ate demand in the econ­o­my beyond where geo­graph­i­cal­ly the mar­ket deter­mines and poten­tial­ly through­out the coun­try. Accord­ing to OBR cal­cu­la­tions, this spend will lead to an increase in GDP of 1.4% over the period.

Hav­ing got the bad news out of the way, Reeves is gam­bling on a future growth div­i­dend as tough deci­sions today pave the way for eas­i­er ones in the future.  It will be need­ed giv­en the OBR now fore­casts the tax bur­den will hit an his­toric high of 38% of GDP by 2029/30 accom­pa­nied by infla­tion and inter­est rate rises.