Is the UK government in a dismal fiscal straitjacket? Former officials see missed – and now lost – opportunities for sensible trade-offs, but also practical and ontological remedies still available. A bolder economic strategy combining wise but politically painful adjustments to taxation and welfare could give the government the grace it asks from markets.
The government has to contend with ostentatious subservience to the arbitrary deadlines set by the Office for Budget Responsibility. This market-facing restraint is designed to overcompensate for the impact on the pound and government debt market following the fall-out from the disastrous mini-budget of the Liz Truss’ government.
But the government has further boxed itself in with an ill-advised campaign promise of no tax rises ‘on working people’. Comments at the Labour party conference in September suggested that Chancellor of the Exchequer Rachel Reeves clearly believes the markets hurdle is less mutable than the no tax rises hurdle, a situation exacerbated by the naïve remarks of putative leadership contender and mayor of Greater Manchester, Andy Burnham.
Difficult decisions need to be taken
Ahead of November’s budget, civil servants and think tanks are beavering away on fiscal sophistry to break the promise de facto. Two senior former Treasury officials suggested to OMFIF that Reeves has already missed good opportunities. Either more should have been made of the hackneyed ‘the books are worse than we thought’ line immediately after the election, or the political opportunity should have been seized to follow the new obligation for raised Nato contributions with, say, a VAT hike. Reeves is belatedly signalling in this direction.
Both officials suggested to OMFIF that such politically painful moves would have yielded market tolerance for sleights of hand with the fiscal rules. Finding a way to raise income tax a little across the whole working population either through a small nominal rise or a reform to the tax allowance threshold would make a much more rapid impact than endless tinkering with a giant tax code, while potentially reducing bond market neuralgia if a balanced budget took a bit longer. But this is doubtless a political disaster for a government that behaves as if it has a slender majority.
What about cuts to public spending? Also hard for a party elected on promises to right post-Covid-19 dysfunction in the NHS. Reeves lost a battle to cut winter fuel payments, though markets sighed with relief when the debacle didn’t cost her job. Even though the age group is least likely to vote Labour, this episode might be scaring Reeves off scrapping the increasingly untenable and expensive ‘triple lock’, which is gifting pensioners a 4.7% rise next year. Pensioners account for 55% of the welfare budget (£175bn in 2025-26). As a collection of fiscal watchdogs told OMFIF in a recent meeting, government budgets have very little discretionary room once the sunk cost of such commitments is taken into account. They also pointed to the collapse of baby tax-payers in-waiting.
Rather than presenting the public with a discussion about trade-offs, an avoidance that three former officials put at the door of social media, a tawdry political theatre is served up instead with a repeated liturgy of abundance and sketchy productivity gains, while the NHS still struggles under a ‘cycle of crises’ despite the funding pledges. A party-conference announcement by Reeves about library funding for schools, which sank without trace in hours, is a case in point. A meaningful national debate about adopting a French-style socialised health insurance system is left to Reform leader Nigel Farage, for example.
Lack of strategy, not resources
Scarcity is the organising idea for Britain’s public finances. High debt, weak growth and stubborn inflation set the perimeter for fiscal movement. Debt servicing costs alone have nearly trebled since the pre-Covid era, with gilt yields displaying emerging market-like twitches to any political trouble.
In the late 1940s, with public debt far higher and national income far lower than today, the country built the NHS, nationalised industries and rebuilt bombed-out housing. Keynes’ ‘socialisation of investment’ seemed to work, with growth, state investment and tax increases managing to co-exist.
The Economic Affairs Committee’s ‘National Debt: It’s Time for Tough Decisions’ implies that the real constraint is not an absence of resources but one of strategy. Britain’s fiscal rules may well be causing the neglect of the long-term institutions that would channel capital into productive use that would solve the problem at source. Instead of rules that deter long-term spending, Britain could adopt institutions and incentives that actively channel capital into productive uses.
A UK National Investment Bank or sovereign fund could provide the scale to back infrastructure, green transition and digital projects. Pension fund rules could be reformed to encourage a Canadian- or Australian-style allocation into productive assets rather than gilts. Tax incentives could reward reinvestment into domestic growth rather than passive rent-seeking. Public–private issuance vehicles, such as green or digital infrastructure bonds with partial guarantees, could mobilise private savings at scale.
No quick fix
Non-fiscal levers to growth are understandably tempting to the Treasury. Several veterans suggested to OMFIF that this is a cyclical mistake in finance, even though the UK’s productivity has conspicuously been hampered by the loss of City receipts since 2008. One stated simply that the banks have ‘become mortgage machines’, their appetite for productivity-boosting small business lending notoriously poor. It would simply lay the ground for another expensive crisis. More promising regulatory efforts have been those to unclog planning for house-building, a programme pushed forward by the now-defenestrated Angela Rayner.
It may be that judicious re-regulation would actually improve the economy. British capitalism has ceased to be a system of productive risk-taking and has hardened into a landscape of rent-seekers, which the government is only marginally addressing. The mis-regulation of the privatised water industry, which borrowed to distribute dividends without maintaining infrastructure, is a case in point, though now under reform. Energy prices, which have a multipronged impact, are derived needlessly from wholesale gas prices.
A wider problem prevails: the giants of the digital economy are non-native, and able to transfer wealth out of the country with near impunity. Attempts to tax these American companies are met with threats from the US government. Escaping this status as a digital economic colony will require a generation of stealthy protectionism. Excitement about US foreign direct investment in artificial intelligence might be very misplaced. The government has used some political bravery to try to ameliorate trade friction from Brexit, but It remains to be seen whether it finds a way to align with both the US and the European Union, perhaps split between services on the one hand, goods on the other.
The process of quantitative easing and its reversal, where some see a fairly quick budget fix, exemplifies the kind of box the UK puts itself in. As Paul Tucker has observed, the government missed ‘an extraordinary opportunity to lock in almost miraculously cheap funding’ during Covid-19, producing ‘waste on a grand scale’ instead of long-term structural gains. Scarcity was never the true constraint; it was the absence of strategic foresight that turned opportunity into vulnerability.
Sofia Melis is Chief Commercial Officer at OMFIF and John Orchard is Chairman of OMFIF’s Digital Monetary Institute.
Over the past three years, OMFIF has collaborated with EY on a project that explores how to improve public finance management. This year’s project examines how governments can more effectively allocate public funds to support better fiscal, economic and societal outcomes. A series of roundtable discussions will result in a research report, publishing 2 December.
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