(Bloomberg) -- Rachel Reeves drew cheers from investors at a British Embassy reception in Washington this week when she pointed out the budget she’ll deliver on Oct. 30 will be the first by a female Chancellor of the Exchequer in the 800-year history of the role. It will also be a legacy-making moment that shapes British politics for the rest of the decade.
With Reeves due to announce as much as £40 billion ($52 billion) in tax hikes and spending savings, plus a revamp of Britain’s fiscal rules to allow for an extra £70 billion of government borrowing for investment, it will mark Labour’s bid to boldly reset the nation’s public finances and lay the foundations for an election win in five years’ time.
“I cannot think of a budget where the stakes have been so significant,” said Steven Fielding, emeritus professor of politics at Nottingham University and author of several books on the Labour Party. “The budget is going to define this Labour government.”
Gloomy assessments by Reeves and Prime Minister Keir Starmer in the run-up to the budget about the state of the public finances have dragged down business and consumer sentiment, while expectations that their plans will entail a significant up-tick in borrowing have weighed on gilts. But Reeves’ bet is that in time, voters and business will see the value of a budget containing upfront pain in the form of tax hikes and tight spending plans, with the promise of long term gains in investment and growth.
It’s a high-wire moment for Reeves, 45, a former Bank of England economist who has become the most powerful figure in Starmer’s new Labour administration, because of how much she’s trying to achieve.
The chancellor wants to simultaneously fix the nation’s straitened public finances through tax hikes and spending cuts, while delivering on Labour’s election promise to deliver “change” — requiring extra borrowing and investment. Meanwhile, she’s also striving to keep watchful financial markets on side.
The package she’s homing in on looks set to raise the tax burden to its greatest since World War II and lift debt even further from a 60-year high, while aiming for the greatest persistent investment commitment Britain has seen for decades and also ending austerity for public services.
Reeves’ goal to raise £40 billion has three core purposes: to plug a £22 billion budget void she says her Tory predecessor left her, to spend more on the National Health Service and ensure no other government departments face a real-terms decrease in funding, and to meet her main fiscal rule, that day-to-day spending should be covered by taxes, with room to spare in case of an emergency.
“Alongside tough decisions on spending and welfare, that means taxes will need to rise to ensure this rule is met,” Reeves said ahead of the budget.
But Reeves’ tax increases are in tension with her core goal of spurring economic growth. She’s preparing to increase capital gains tax, inheritance tax and national insurance bills for employers. The prospect of each of those measures has been met with warnings that they will hurt the economy, while business and consumer confidence have declined, voluntary liquidations have ticked upward and there’s evidence of some capital flight.
Other measures expected in Reeves’ budget include:
- A cut in tax relief for entrepreneurs who sell their businesses
- A consultation on raising taxes on the likes of Amazon through business rates, to boost high street stores
- A potential freeze on income tax thresholds beyond 2028
- Reforms to tax breaks for wealthy non-domiciled residents
- Closing the so-called carried interest loophole on private equity
There’s also significant political risk in Reeves’ plans because of Labour’s repeated pledge not to hike taxes beyond a limited few set out in its election manifesto. Reeves — who has said greater taxation is necessary because the Conservatives left the public finances in a worse shape than Labour expected — will have to convince voters that her tax-raising budget doesn’t amount to Labour breaking its promises.
“She’s going to get a lot of stick from the right-wing media,” Nottingham University’s Fielding said. “There will be a big onslaught, whatever she really does.”
Reeves’ hope is that she’ll be able to counterbalance those near-term hits with her long-term plan to boost investment. That will be achieved by changing the debt measure that informs the government’s other main fiscal rule requiring debt to be falling as a share of the economy in five years’ time.
Reeves is set to start targeting public sector net financial liabilities, which captures the value of assets created alongside any investment, rather than the existing metric of public sector net debt excluding the BOE. In so doing, she’ll give herself space to borrow as much as £70 billion extra over five years.
Yet changes to the fiscal rules also carry risks. Markets have wobbled at the news of the scale of the potential borrowing coming from Labour, with the spread between 10-year gilt yields and German bunds growing this week to its widest in a year. RBC BlueBay Asset Management Chief Investment Officer Mark Dowding said he’s concerned about the bond market’s willingness to absorb a steep rise in issuance.
“There is a sense that Rachel Reeves is walking a tightrope, with the memory of the Truss tantrum still fresh in investors’ minds,” he said, referring to former premier Liz Truss’ disastrous budget two years ago that roiled the markets and helped trigger an end to her brief tenure. “This should argue for some caution.”
If markets become unconvinced about Labour’s borrowing plans, Reeves could face a mounting debt interest bill, though her caution on laying the pitch before the budget makes a repeat of the Truss debacle unlikely.
Barclays Plc rates strategist Moyeen Islam said investors should take some reassurance from reports emphasizing the Treasury does not intend to issue as much as the increase in headroom might imply.
Reeves spent the past few days in Washington selling her investment plans at the International Monetary Fund’s annual meetings, after squaring off budget allocations with her cabinet colleagues in a process fraught with friction.
The opposition she faced from within the cabinet highlights the challenge Reeves faces in convincing the wider public she isn’t delivering another bout of austerity, said Vicky Pryce, chief economic advisor at the Centre for Economic and Business Research. “Politically, it’s a dangerous situation, there are lots of pitfalls,” Pryce said. “You can still have austerity if you increase taxes.”
While she’s unlikely to garner the sort of universal applause she received at the embassy in Washington this week, Reeves will hope her budget manages to avoid those pitfalls and stand the test of time by delivering Labour’s promise of economic growth.
--With assistance from Ailbhe Rea, Ellen Milligan and Alice Gledhill.
©2024 Bloomberg L.P.