Growth from tax and creative accounting? Good luck with that.
The British Labour government's first budget is finally due, and it's all about growth. Is their plan credible?
In their 1997 manifesto, the Labour party promised to enforce the ‘golden rule’ - only borrowing to invest rather than to fund current expenditure. Labour’s chancellor, Gordon Brown, positioned himself as the epitome of prudence, soberly drinking a glass of Scottish mineral water as he delivered his budget at the despatch box in Parliament when a Tory predecessor, Ken Clark, favoured scotch.
In contrast to the current Labour outfit, the class of 1997 promised no new spending or outlandish pay hikes for public sector workers in the first two years of government1. Debt to GDP fell from 40% in 1997 to a low of just over 30% a few years later, although it then rose sharply to 60% due to the bank bailouts following the global financial crisis of 2007-9. Was that Labour’s fault? They were in charge, but it would be hard to pin light-touch financial regulation and excessive bank leverage (a global phenomenon) entirely on them.
In fact, Mr Brown’s sleight of hand was altogether more subtle but no less misguided, and it was right there in the manifesto for all to see. “New Labour will be wise spenders, not big spenders. We will work in partnership with the private sector to achieve our goals.”
Chancellor Brown was obsessed about keeping debt-to-GDP below 40%, yet to do good by spending taxpayers’ money, he instead simply went off-balance sheet using the Private Finance Initiative (PFI) - using the private sector to do the heavy lifting of investing while apparently keeping the public finances on an even keel. The NHS was the key beneficiary - lots of new hospitals and medical facilities.
There was however a price to pay. Private Eye magazine likened PFI to ‘taking out a mortgage on a credit card’. Capital costs at a new hospital in Dartford, Kent, rose from 6.7% to 32.7%, inevitably resulting in cuts to care for vulnerable groups as costs spiralled2. The long-term nature of many of the projects meant local and central government bore the costs well after Labour had been unceremoniously dumped from power in 2010.
The Labour government of 2024 has not had what you’d call an auspicious start. Promising an end to sleaze and infighting, it’s been subject to endless sleaze in the form of expense scandals and infighting in the Prime Minister’s office, with Sue Gray the first major casualty.
Within days of taking office, the new Labour Chancellor, Rachel Reeve, identified a £20b black hole in the public finances which the Office for Budget Responsibility (OBR) had apparently not been aware of. This has now grown to £40b ahead of next week’s budget, and these are the principal grounds on which a series of tax hikes, most likely on inheritance tax, employers’ national insurance contributions and capital gains tax, are going to be justified.
What is perhaps more worrying is the cacophony of voices justifying changing the accounting rules surrounding the public finances to justify more spending for growth. The former cabinet secretary Gus O’Donnell recently wrote in the Financial Times that valuing the national assets created by all this spending would justify higher levels of debt (taken out for example by a new ‘National Wealth Fund’)3. Mark Carney, the former head of the Bank of England, also advocates changing the fiscal rules to include the nation’s assets so that more can be borrowed4.
Both Mr O’Donnell and the FT’s own economics editor, Martin Wolf, have railed against the Tory’s rule of having a declining debt-to-GDP ratio within year five of any forecast period, with Mr Wolf going on to advocate broadening the tax base to include VAT on food and energy, as well as broadening property taxes5.
Quite how higher taxes are supposed to create growth is a bit of a mystery, especially if they include VAT hikes on food and energy in the midst of a cost of living crisis. It is the overall level of prices that matters as much as the rate of change (inflation), and adding VAT would not only be inflationary in the short term, it would likely hurt consumption, and this by any common sense measure would be bad for growth.
Writing at the end of August, I mentioned how the high taxation regime of the late 1960s and 1970s was responsible for an exodus of higher-rate tax payers from the UK, notably musicians like the Beatles and the Rolling Stones (see link above). The press is already pushing the story about millionaires fleeing the UK ahead of Chancellor Reeves likely tax raid, and while The Guardian for example is sanguine about this, it doesn’t bode well for future private sector growth if potential innovators and investors shun the country6.
Clearly the UK economy has stagnated since the global financial crisis, but this says as much about the character of the economic growth before 2008 (driven by excessive bank leverage and risk-taking due to financial deregulation) as about what has happened since.
The current mood music is clearly one of big government and big spending. In the private sector, it is usually small and medium-sized businesses that drive most economic growth, and it is perhaps here that government policy should focus, especially with respect to tax breaks and favourable lending rates. Encouraging banks to lend to small businesses at amenable rates would clearly be a pro-growth move, but this is not the meaning of the word ‘growth’ that is currently in favour. Borrowing isn’t bad in itself, it only becomes unsustainable when it focuses on current consumption not investment for the future.
Labour’s 1997 manifesto seemed to be aware of this, although it’s expression through PFI turned out to be naive, pandering as it did to banking greed. With the fumbling of Brexit having squandered what benefits of Britain distancing itself from EU regulation there might have been, it sadly seems that the UK is embarking upon another period of government-led macro and micro management, likely enabled by higher taxes and creative accounting. The last time a Labour government did this, it didn’t end up well. The current Labour government has got five years to prove that this time it’s different.
‘New Labour because Britain deserves better’, Labour party manifesto, 1997.
Paul Foot, P.F. Eye - An idiot’s guide to the Private Finance Initiative, Private Eye Magazine.
Gus O’Donnell, Ditch the Conservatives’ absurd debt rule and invest to grow, Financial Times, 28/09/2024.
Mehreen Khan, Mark Carney: change the fiscal rules to include the nation’s assets, The Times, 10/10/2024
Martin Wolf, Reeves struggles to escape from self-imposed restraints, Financial Times, 30/09/2024.
Nels Abbey, Britain’s millionaires are fleeing. Good night and good luck I say, The Guardian, 21/05/2024.