The political row over this Budget will be about whether Labour has stuck to its manifesto commitments on tax and borrowing. As I argued yesterday, the government is not on strong ground on this point. It promised to stick to its existing fiscal rules and maintained that – beyond the very limited tax increases it had identified – there would be no need for higher taxes. The spending plans which they inherited were recognised as being tight but not undeliverable. Any additional spending would be paid for from higher economic growth.
That is not what we heard from Rachel Reeves today. Instead, we heard an argument for higher spending funded by higher taxes and higher investment funded by higher borrowing.
The political cost of this inconsistency will depend upon whether the policies work. If living standards have risen and public services have improved by the time we get to the next general election, the arguments about tackling long-term problems will be persuasive. If they do not, the charge of dishonesty and betrayal – forcefully made by Rishi Sunak in his Budget response – will stick.
But enough of the politics. What we are getting from Reeves is an attempt to change the UK’s economic model. Compared to most other European countries, we spend less on public services, we invest less, we tax less, and our labour market is less regulated. All of that is changing.
We should start with tax. Contrary to received wisdom, the UK does not lightly tax the wealthy. We are more dependent on the highest earners than other countries and have become more so in recent years because of policy choices by recent governments of all colours. Reeves is looking to raise more from the wealthy by increasing capital gains tax rates and restricting inheritance tax reliefs but is conscious that one can only go so far before the very rich vote with their feet. Unfortunately, quite a few such votes have already been cast by the wealthy but there has been some pragmatism shown on non-doms and private equity, where other jurisdictions – such as Italy – are competitive.
Where the UK has been an outlier in recent years is that the median taxpayer is taxed less than their counterpart in most European countries. The difference is mostly accounted for by other countries imposing higher social security contributions than we do. Our social security regime is not very contributory and there is something dishonest about badging National Insurance Contributions as anything other than another tax. (While we are on the topic of honesty in the tax system, employers’ NI is ultimately a tax on employees.) Nonetheless, if she wanted more revenue, it is hard to see where else she could have got it.
It has enabled her to increase public spending, predicted to settle at 44.5 per cent of GDP, five points higher than its pre-pandemic level and now closer to the European average. Capital spending is also set to be maintained at a higher level than in recent times (averaging 2.5 per cent over the forecast period).
As for the labour market, greater employment protections, a higher minimum wage and the NICs rise (which will have a bigger impact on those employing low-paid workers because of the threshold decrease) will all make life harder for some employers. The cost of employing people in the UK has traditionally been cheaper than many western European countries; that may no longer be the case. The Office for Budget Responsibility is still relatively bullish about employment but there is a risk that some employers will no longer be viable. One can argue that these will be employers with low levels of productivity and any destruction will be creative. Higher unemployment, however, would be unwelcome news.
Taken in the round, this puts the country on a trajectory of a more European-style, socially democratic economic model. I am enough of a Conservative to think that this comes with risks. Will the internationally mobile choose to locate and invest here? Will higher capital spending be invested wisely? How much will it crowd out private sector investment? (The OBR thinks this is an issue.) Will the combination of higher NICs, a higher minimum wage, and greater employment protections price some people out of the labour market? Does the higher borrowing announced today leave us vulnerable to a further economic shock?
There is a further concern about a more European approach to tax and spend. European economies have access to a much larger domestic market than we do which brings advantages in terms of investment and productivity. If the thinking is that we want public services comparable to those in France and Germany we will have to pay for them, not least as we will not enjoy the economic advantages of belonging to the European single market. The issue of our relationship with the EU – only briefly alluded to near the beginning of the Budget speech – should not be ignored.
Reeves has set out her economic vision which entails a larger state. Labour has a big majority and nearly five years to make it work. If she succeeds, this will be seen as a transformative Budget, like those delivered by Geoffrey Howe in 1979 and 1981. But success is by no means guaranteed.
[See also: Labour’s rhetorical black hole]
Content from our partners
Related
