For a Labor voter who nodded off at the moment of the exit polls for last year’s general election, and woke up blinking in the chilly Wednesday sun 16 months later, Rachel Reeves’s budget will have cast a warm glow.
A type of mansion tax; abolition of the two-child limit on benefits; More money for the NHS, and cheaper utility bills for households through the jam today.
These were the “Labour option”, the Chancellor said, comparing his approach to investment protection with Tory and reform cuts, and underlining the importance of tackling unfairness, including the ridiculously skewed council tax.
However, the reality of this tax-and-spend Labor budget path is one that has been filled with missteps and U-turns, played out against a backdrop of weak bond markets, declining polls and leadership intrigue.
Winter fuel allowance was reduced and then reinstated; £5 billion of welfare cuts were introduced and then scrapped; And a ton of pitches were made in the lead-up to the longest budget anyone can remember.
Even on Wednesday morning, the choreography was ruined by the chaos of the Office for Budget Responsibility (OBR) publishing all the details hours earlier – and the deputy speaker criticized Reeves for a forced briefing to the press.
The impetus for Reeves’ latest tax rises, totaling £26bn – following his historic £40bn tax-hike first budget last year – came from a summer reconsideration by the OBR, which has consistently underestimated UK productivity since the great financial crash of 2008.
As expected, Richard Hughes and his crew of number crunchers blamed Brexit, Covid and stop-go government investment for the persistent weakness of productivity: the secret sauce of economic growth.
When the day came, this much-vaunted decline was actually much less significant than feared because it was partially offset by higher-than-expected wages and inflation, which boosts tax revenues. The public finances suffered a total loss of only £5.5 billion – not even eliminating the “headroom” against Reeves’ fiscal rules.
But to make room for more spending and create a buffer against his rules influencing bond markets, Reeves announced tax rises worth £26bn by 2029-30.
He and Keir Starmer flirted with the idea of breaking the letter of their manifesto pledge and raising income tax, which typically rises each year in line with inflation, before reverting to the secret approach of raising the cap on income tax.
In a lengthy statement Wednesday, Reeves was clear about that fact: “I’m asking everyone to contribute.” But he insisted he had reduced costs for most people through tax reforms aimed at ensuring the rich pay their share.
Why, he asked, should a landlord pay less tax than his tenant, and why should savings be taxed at a lower rate than wages? A number of measures in Wednesday’s statement addressed these inequalities – including council tax changes for high-value properties, but also a 2p increase in income tax on savings and property income.
When it comes to the economic picture, Reeves’ approach has become even more immediate than last year’s budget.
At the time, she focused on increasing public investment in everything from roads to technology, which she saw as vital to improving the UK’s lagging productivity; and gradual reforms, such as planning reforms.
But employers complained that at the same time it was reducing recruitment and increasing inflation, by increasing employer National Insurance contributions (NICs) by £25 billion a year.
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This time, Reeves had his sights set squarely on inflation, and he opted for more immediate intervention to tackle the cost of living for cash-strapped families.
Leading forecasters, including the International Monetary Fund, expect inflation in Britain to be higher this year and next than in any other G7 country.
The OBR calculated that by freezing train fares and prescription costs, and removing the green charge on utility bills, budget policies could reduce the headline inflation rate by 0.4 percentage points.
And that’s the heart of Reeves’ economic plan. She hopes to calm volatile bond markets by reducing the cost of living and restoring public finances, doubling the headroom against her fiscal rules to £21.7 billion, reducing the government’s interest bill. Lower than expected inflation should also open the way for more rate cuts by the Bank of England starting December 18, which will have an impact on the entire economy.
On the most optimistic reading, Reeves’ second budget could reassure consumers and businesses, rekindle the feelgood factor, boost real wages and spur economic growth. Perhaps, in this rosy world, he will not need to implement all the tax increases proposed for a few years, because growth protects him from it.
The first step to appease bond investors appears to have worked as of Wednesday evening, with yields on 10-year gilts falling 0.06 percentage points to 4.42%.
Yet his tax-raising statements are weighing heavily on an economy that grew only 0.2% in the third quarter. Public trust in government is at an all-time low; Employers are concerned about the cost of business recruitment following last year’s unexpected rise in NICs.
The zigzag route from last July’s “black hole” statement, in which the winter fuel allowance was slashed, through to phantom disability cuts, to Wednesday’s claim that everyone is contributing hardly helps the mood. And the OBR’s forecasts show that growth will remain slow, and the outlook for living standards remains bleak.
Bond vigilantes, who were a key audience for Wednesday’s statement, appeared reassured. But it will be some months before it becomes clear whether households and businesses, whose confidence is crucial to rekindling economic growth, will do the same.
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