Britain’s fiscal doom loop

Labour cannot fund the renewal of the public realm simply by relying on higher taxes on business and the wealthy.

Illustration by PPaint / Ikon Images

Labour entered office promising a “decade of national renewal”. Keir Starmer’s premiership, it was said, would be defined by landmark pledges such as building 1.5 million new homes by the end of the parliament and halving violence against women and girls.

Yet almost a year on, ambition is colliding with reality. Rachel Reeves’ Spending Review, which she will deliver on 11 June, threatens new cuts to unprotected departments including the Home Office, the Department for Energy Security and Net Zero and the Ministry of Housing, Communities and Local Government.

It is not only cabinet ministers such as Angela Rayner who are warning that the government’s pledges will prove impossible to meet without greater funding. Mark Rowley, the Metropolitan Police commissioner, has spoken of the “scar tissue of years of austerity”. Along with the heads of MI5 and the National Crime Agency, he warned that without the “necessary resources” from the Spending Review, the decision to release more prisoners early could be “of net detriment to public safety”.

Ms Reeves and the Treasury insist that any talk of a return to austerity is unjustified. The Chancellor did – commendably – use her first Budget to loosen the government’s fiscal rules for capital spending. An additional £113bn will be invested in infrastructure projects such as a new Manchester-Liverpool rail link. But she remains trapped in her own fiscal straitjacket. First, in an attempt to achieve market confidence, she vowed to eliminate the current budget deficit by the third year of the forecast period rather than the fifth. Second, to maintain voter confidence, she reaffirmed Labour’s pledge to freeze income tax, VAT, National Insurance (on employees) and corporation tax for the duration of the parliament.

Both sets of policies are now hindering rather than helping the government. As Isabelle Mateos y Lago, chief economist at BNP Paribas bank, has warned, the strictness of Ms Reeves’ rules “damages the UK’s credibility because they have to hurt themselves so much to meet them”.

The Chancellor’s supposed iron discipline has already been undermined by the government’s planned U-turn on winter fuel payment cuts and the anticipated abolition of the two-child benefit cap. Rather than announcing other undeliverable cuts, Ms Reeves should adopt a more realistic time scale over which to balance the books. She must also review her approach to taxation. At her first Budget she raised taxes by £41.5bn, including a rise in National Insurance on employers from 13.8 per cent to 15 per cent, and introduced a panoply of wealth taxes: the abolition of non-dom status, VAT on private school fees, higher capital gains tax and increased inheritance tax for agricultural properties.

But after a decade of austerity and stagnant economic growth, this was never likely to prove sufficient. Labour cannot fund the renewal of the public realm simply by relying on higher taxes on business and the wealthy. Instead, it must achieve a more resilient tax base of the kind seen in social democratic Europe. Though the overall tax take is at a postwar high, the average tax on labour income in the UK is among the lowest in the developed world (31st out of 38 OECD nations). A British employee on the average salary takes home more of their pay than an average-wage employee in the US, Canada, Japan or anywhere in western Europe.

Ms Reeves has ample grounds for arguing that the facts have changed. Donald Trump’s election as US president has necessitated higher UK defence spending and led to renewed global instability, as he imposes the biggest tariffs since the 1930s.

As the Strategic Defence Review made clear, the UK will need to go much further. The Defence Secretary, John Healey, declared in an interview with the Times that there was “no doubt” Britain would spend 3 per cent of GDP on defence “in the next parliament”. Yet in a symptom of the UK’s fiscal bind, he was later forced to downgrade this pledge to an “ambition” – an equivocation that will dismay allies and cheer adversaries.

Labour’s fiscal approach leaves it lacking the confidence of both the markets and the public (it now trails Nigel Farage’s Reform UK by eight points). Mr Starmer’s landslide victory a year ago reflected a profound desire for change among voters. If he and his Chancellor appear incapable of providing it, the electorate will look elsewhere.

[See also: Dickens’s Britain is still with us]