Perhaps the most important long-term change announced in the first Labour budget are the new rules the government has set itself to fund the expansion of public services and increase public investment. These fiscal rules, which set out how much the government can borrow and spend, are seen as critical to reassuring the markets and the public that the government is sensibly managing the economy.
Labour has long claimed that former prime minister Liz Truss casting aside the rules to introduce unfunded tax cuts in 2022 wrecked the British economy and left families worse off with higher mortgage and borrowing costs. Chancellor Rachel Reeves came into office determined to show that Labour would be fiscally responsible.
The government says this budget will make working families better
off. In its own analysis, it shows that only the top 10% of the income distribution are made worse
off (by 1%) by the plans. The poorest households gain the most (by 5%). However, this analysis counts benefits from the big increase in public spending on areas like health and education, which tend to be used more (relative to their income) by poorer households.
Actual cash income offers a different picture. Spending watchdog the Office for Budget Responsibility (OBR) argues that 75% of the change to employers’ national insurance will be passed on to workers in lower wages (although the minimum wage will be boosted by 6.7% to £12.21 an hour). And there is very little for the working poor or those outside the labour market on universal credit (although pensioners have been protected).
This budget was delivered against the background of two big challenges that need urgent action: the parlous state of the public sector after years of austerity, and the very slow growth of the UK economy, which has meant little increase in real incomes.
To deal with these two issues, Reeves made some big changes to the previous government’s fiscal rules. This will give her space to borrow more money to finance public investment – spending on things like roads, hospitals and emerging industries that should feed into economic growth.
Finding the money
She has done this firstly by changing the so-called “fiscal mandate”, which relates to how much the government can borrow in any individual year. Under the new rule, within three years the government must get as much back in taxes as it spends (excluding investment).
It is the need to meet this rule that means the government has to raise taxes by £40 billion (more than half from the increase in employers’ national insurance contributions) to fund the spending needed to run the NHS, education and other public services.
But the government has another rule to prevent the total amount of government debt becoming too large compared to the size of the economy as a whole (GDP). Here the chancellor has chosen to change how government debt is defined, adding some more government financial assets, such as money put aside for local government pensions and student loans, to set against the outstanding amount being borrowed.
This has given her the room to borrow an extra £50 billion a year for investment, although she plans to use only half of that. The hope is that more public investment will both boost the economy (for example, by providing more roads and green energy) and improve public sector productivity (by providing things like more schools, health centres and scanners).
Investment in equipment would lead to increased productivity within the NHS.
l i g h t p o e t/Shutterstock
The OBR has judged that Reeves will meet her self-imposed rules within three years, despite the huge £70 billion increase in government spending. But it warns that the margin for error is quite small for both measures. The OBR also suggests that the economic benefits of increased public investment could take a long time to materialise, well beyond the five-year forecast period.
There are other risks to Reeves’ strategy. The cost of borrowing could go up if those financial institutions that lend the government money demand a higher interest rate.
The OBR projects that the government will be spending £100 billion a year on debt interest payments for each of the next five years. While the large increase in government spending and borrowing will initially boost the economy, it also means inflation is likely to stay slightly higher as more money is pumped into the economy. This, of course, could slow the rate at which the Bank of England cuts interest rates.
Gains for the population as a whole over the five-year parliament appear to be modest, with the second smallest rise in household income of any recent parliament of just 0.5%. This is driven by OBR projections that the budget will not initially boost growth very much despite greater borrowing.
And if the economy does not grow as much as hoped, the government may need more money to meet its day-to-day costs – especially as much of the new money has been front-loaded to be spent in the next two years. This would necessarily increase taxes even further.
The fiscal rules mirror Labour’s political dilemma, the need for short-term pain in order to get long-term gains in improved public services, a more productive economy and higher incomes and living standards. What is not clear is how long the public will wait to see results.
If, by the end of the parliament, people don’t feel like they have more in their pockets despite all the additional spending then Labour’s credibility could be in jeopardy.
Steve Schifferes does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.