(Bloomberg) -- With the UK’s public services failing due to years of under-investment and the tax burden already at a post-World War II high, Chancellor Rachel Reeves has warned she faces “tough decisions” to balance the nation’s finances. Her first two months in office have been spent laying the groundwork to raise taxes and cut government spending in her first budget statement on Oct. 30. Yet Labour’s new economic chief is also hinting she’ll skirt around her self-imposed fiscal rules and find ways to increase borrowing too. Here are some of the ploys she could use to free up extra cash.
What’s the problem?
There’s not enough money to fund the improvements to health care, justice and other services promised by Labour in the election campaign. Since it took power at the start of July, the party claims it has identified an unforeseen budgetary black hole — £21.9 billion of spending commitments by her predecessors that they left “unfunded and undisclosed.”
Included in that is £10 billion that Reeves says she was forced to commit to settle disputes over pay in the public sector. (Former Chancellor Jeremy Hunt has said the idea of a funding cover-up is “absolute nonsense”). Reeves says she has found some savings but a £16.4 billion shortfall remains. Even more will be needed to get public services working properly again, according to the International Monetary Fund.
Labour has also promised to invest more in critical infrastructure, particularly to advance the energy transition. All this sits uneasily with a budget deficit that’s ballooned faster than expected, according to the latest figures, while the national debt as a share of gross domestic product is close to 100%, the highest level in more than 60 years.
What are the government’s fiscal rules, and how could Reeves change them?
Reeves has two key fiscal rules. The first is that all day-to-day spending is paid out of tax receipts. The second is that the national debt must be falling as a share of GDP in the fifth year of a period defined by the independent Office for Budget Responsibility. Though she’s promised not to break either rule, she can change the debt measure on which the second one is calculated. Doing so could allow the government to borrow tens of billions of extra pounds, sparing some of the pain of raising taxes or cutting ministerial budgets.
How would that work?
There are several ways the Office for National Statistics measures the national debt, each of which produces a different result. The traditional metric is called “Public Sector Net Debt.” But the last Conservative administration used a measure called “Public Sector Net Debt ex Bank of England” that excludes the central bank’s balance sheet.
Excluding the BOE’s liabilities is significant because the bank has been unwinding a £895 billion bond buying program that it implemented to stimulate the economy in the years following the 2008 global financial crisis.
This unwinding, known as quantitative tightening, has created huge balance sheet losses that in the UK are indemnified by transfers from the state Treasury to the bank.
Under the PSND ex BOE debt measure, the losses don’t show up until the Treasury compensates the BOE for them. Under the traditional debt metric, some of them have already been accounted for. As a result, using PSND ex BOE makes it harder to hit the government’s debt rules.
The loss since October 2022 amounts to £73 billion — and it’s still rising. Switching back to the traditional way of measuring national debt would enable the government to borrow an extra £20 billion or so and still play by the fiscal rules.
Is Reeves going to make the change?
It’s looking increasingly likely. Asked by the Guardian newspaper recently whether she would stick with the last government’s debt measure, Reeves said she would “set out the precise way to measure debt in the budget.” That contrasts with a response to the same question from Bloomberg last November, when she was unequivocal that the metric wouldn’t change.
Reeves also told the Guardian she considered the debt rule less important than the balanced budget rule and stressed that “it is reasonable for the government to borrow to invest.” Both comments imply the debt metric may change.
Are there other options?
Yes — again involving the Treasury’s dealings with the Bank of England:
TIERING: One strategy being urged on the Treasury by some former BOE officials is to save money by reducing the losses on the bank’s quantitative tightening program through so-called “tiering” — a practice of some other monetary authorities including the European Central Bank. The bulk of the BOE’s losses arise because the UK government debt bought by the bank earns around 2% interest, while the “reserves” created to buy them pay interest at the headline rate, now 5%.
Think of reserves as current account deposits, only the customers in this case are large retail banks such as Barclays and Lloyds. Their accounts sit with the BOE, which holds close to £700 billion of reserves. If the government changed the arrangement so that a “tier” of, say, £100 billion of those reserves paid zero interest, it would save the government about £5 billion a year.
Private banks would likely oppose the measure, since they would lose out on a source of income. And, since the current system is integral to how the bank sets interest rates, tinkering with it might have unforeseen consequences. However, two former deputy governors of the BOE have said the bank could tier a small portion of reserves without losing control of its ability to set rates.
TAX THE BANKS: A less complicated way of raising the same money would be to establish how much extra income on BOE reserves is being paid to the banks and to tax that “windfall.” Doing so would avoid interference in the BOE’s policymaking.
Documents released by lawmakers on the House of Commons Treasury Committee earlier this year revealed that NatWest, Lloyds Banking Group, Barclays and Santander UK between them earned £9.23 billion of interest on their BOE reserves last year – a £5.3 billion increase over the figure for 2022.
BOND SALE LOSSES: Some of the losses, also indemnified by the UK taxpayer, are caused by selling below the bank’s purchase price. Ending these “active sales,” and holding the bonds until they mature instead, would save around £10 billion a year.
--With assistance from Andrew Atkinson.
©2024 Bloomberg L.P.
