British taxes are set to rise. That will come as no surprise to anyone who has been studying the public finances closely. The choice facing any chancellor now would be the same: increase taxes or preside over a further deterioration in health, education and other core government functions. Tax rises have not only been entirely predictable but also widely predicted.
The politics surrounding those tax rises has been equally plain to see. Rachel Reeves will argue that the new Labour government had no plans for tax changes beyond those already set out in its election manifesto but that – having examined the books – it has been forced to take “tough choices” owing to the failures of the previous Conservative administration. Rishi Sunak and Jeremy Hunt will respond that this is all preposterous: there have been no nasty surprises and Labour always intended to increase taxes after entering office. The political battle is not so much over the coming tax changes themselves as over the question of who is really responsible for them.
The true contest, then, is over the nature of Labour’s economic inheritance. Ministers have taken to describing this as the worst since the Second World War – a message Reeves will reaffirm in her House of Commons statement today – while Tory spokespeople insist that the new government was gifted a robust recovery.
All too often political debate on the economy resembles painting by numbers. Depending on the measures and time periods one chooses, radically different stories can be told.
Instead of focusing on the rather nebulous concept of Labour’s economic inheritance, it helps to isolate three distinct, but closely related, areas: macroeconomic performance, the public finances and public services.
How one judges the economy that Labour inherited depends very much on how far back one looks. Yes, in recent months economic growth has outperformed expectations (GDP rose by 0.7 per cent in the first quarter) and inflation has finally fallen back to the Bank of England’s 2 per cent target. Cuts in interest rates are likely to follow. But the better-than-expected numbers for the first half of 2024 follow a tepid 2022 and a disastrous 2023. For the first time on record, living standards were lower at the end of the last parliament than at the start.
More broadly, the story of the British economy since 2010 has been of weak growth in GDP per head (just 0.9 per cent a year) – a far more useful measure – low investment and dismal productivity growth. The economy is not in the deep hole it seemed to be slipping into in late 2022 or early 2023 but it is hard to argue that the macroeconomic inheritance is in any sense good.
Then there are the public finances. Government borrowing, the annual deficit, is far lower than that inherited by the coalition government in 2010 (4.5 per cent compared to 9.9 per cent) but that is where the good news ends. Back in 2010, when George Osborne argued he had to embark on austerity to prevent Britain going the way of Greece, government debt (excluding that held by the Bank of England) was worth around 65 per cent of national income. Now it is 91.6 per cent. Much of that reflects the costs of the Covid-19 pandemic. But whatever the exact cause, it still needs to be serviced.
Back in 2010, the interest payments on government debt stood at around 2.5 per cent of GDP and then fell below 2 per cent for most of the 2010s. As anyone who has ever taken out a loan knows, the interest rate on that debt can be just as important as the amount borrowed. Throughout the 2010s, the level of government debt might have been relatively high but the actual burden of paying for it was the lowest it had been in decades. That is no longer the case. This year the cost is expected to be around 3.2 per cent of GDP.
This poor fiscal inheritance is all the more problematic given the dire state of public services. The 7.6 million-strong NHS waiting list, a chronic teacher shortage, the prisons catastrophe and the general decline of the public realm were key factors in Labour’s election victory. In view of this, the fiscal plans pencilled in by the last government – which implied cuts of £10-20bn to unprotected departments – were never credible. Indeed, it was these plans that led many neutral observers to conclude that higher taxes would result no matter which party won the election.
Neither Labour nor the Conservatives, though, were open about the scale of this challenge during the election campaign. Reeves insisted that only the modest tax rises cited in the manifesto – on non-doms, oil and gas companies, private schools and private equity executives – would be required. Mindful that they were unlikely to have to deal with the consequences of winning, the Conservatives were entirely detached from reality. They insisted that taxes could actually be cut.
Reeves’ statements since the election are part of a neatly choreographed – and no doubt pre-planned – pivot towards tax rises. This is nothing new. George Osborne stated before the 2010 election that he could reduce the deficit without resorting to raising VAT. But within weeks of winning, having “examined the books”, he declared that things were much worse than feared and promptly increased VAT from 17.5% to 20 per cent.
Some things are a little worse than expected. The public sector pay bodies have recommended higher rises than many anticipated (5.5 per cent for NHS workers and teachers). It is perfectly possible that the Home Office budget has been more stretched than hoped by the cost of asylum accommodation (£2.5bn). Some capital projects are both late and over budget (as is often the case).
The big picture, though, is that Labour’s inheritance is about as bad as expected. And that is really rather bad.
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