The first Budget of the new Labour government has proven the most feared and most trailed for many years. Rarely has a fiscal event permeated so far into the public consciousness.
The reason, of course, is that significantly higher spending is needed to avoid biting public sector cuts. Both major political parties chose to ignore this reality during the last general election campaign, and it was always a fiction that Starmer was as complicit in as Sunak, whatever is said now.
Yet the process of solving this problem has caused heightened levels of anxiety because the Labour government ruled out changing the main revenue-raising levers of income tax, VAT and employee National Insurance. These measures apply a small amount of pain to everyone and despite the political noise are scarcely ever noticed. For example, how many people could tell you how big a change to their pay cheque they felt when Jeremy Hunt cut national insurance by 2p last year?
Though once these mechanisms are excluded it becomes necessary to move other, much less profitable taxes by a much larger amount to make anything like a similar gain for the exchequer. These other taxes are generally paid by much smaller cohorts of the population and therefore members of these cohorts face a larger impact. With everything on the table to solve this problem, many smaller cohorts of people faced real fear over recent months.
However, these taxes are notoriously difficult to make money from. Capital gains tax, for example, is in the hands of people with capital; if it is deemed too high, they simply do not sell assets. Inheritance tax can also be mitigated with timely estate planning. Despite this, these routes are the most politically attractive to take in a governments’ bid to find more money because they are arguably more likely to be paid by ‘the rich’.
The fundamental difficulty that chancellor Rachel Reeves has had in extracting more money from these areas has left her with little choice but to target the only other big tax-raising means available to her, employers’ national insurance.
This means that, for private investors, fears of doubling capital gains tax rates have been quashed. For assets such as shares, the main rate moves from 20% to 24%. Instead, companies must pick up the tab for a wave of new spending through the trifecta of a higher minimum wage, higher employer national insurance and new greater employment rights.
Taxing employers with national insurance rather than employees may seem fairer. After all, companies can absorb the pain instead of passing it all on to employees. However, there is a sting in the tail. People do not quit their jobs because employee national insurance goes up. On the other hand, companies may choose to lay off some staff to counter a rise in employer national insurance. Chancellor Rachel Reeves is gambling that falling interest rates and declining wage inflation will prove a sufficient counterweight and avoid increasing unemployment.
Alongside these changes, we have an adjustment to the ‘fiscal rules’. This includes both a significant easing of rules to allow her to borrow much more to invest in big projects, and a tightening of what she will have to spend day-to-day. These changes, for the first time, create an actual obligation to reduce total debt by the end of the parliament.
We believe gilt markets will accept this package of measures despite the obvious increase in government borrowing that they involve. Markets are well-prepared for the change and sufficient guardrails have been put in place. However, we should not be under any illusions. This is a dangerous game (as Liz Truss found out only two years ago) and gilt yields did rise on the day of the budget to a five-month high. We are, as a country, asking international markets for a great deal of patience so soon after a major political failure. Those bond investors will require results in the form of real growth generated from this new public investment to push down our debt to GDP ratio if they are to continue to fund us at modest interest rates.
It is through this new government investment, however, that Britain has finally found its economic model; having spent the years since Brexit stuck betwixt the two potential models of high taxation with high public investment and a vastly different vision of a low-regulation, low-tax ‘Singapore on Thames’. It seems the new government has settled on the former approach. Perhaps this was always inevitable. The British people are unwilling to accept the loss of the social safety net that supports a functioning health and social care system, and so higher taxes are needed.
In this model, though, the only way to deliver these services – and provide for any credible volumes of infrastructure investment - becomes public money. Time will tell whether the government can execute on this plan