Britain’s Labour Budget: bold ambition, uncertain prospects

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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

Britain’s chancellor Rachel Reeves inherited a deeply troubled economy: slow growth, strained public services and high debt. After months of confidence-sapping speculation, at Wednesday’s Budget she delivered a budget that was dramatic in scale: around £40bn in higher taxes — the largest increase for a generation — £70bn in higher spending, and £30bn more in borrowing, per year. This marks a turning point for Britain, towards a significantly stronger role for the state in its economic model, with the tax-to-GDP ratio set to rise to a postwar high by the end of the decade. Much of the tax burden is set to fall on business.

Reeves’ package has begun the hard work of stabilising public services, raising capital investment and improving the fiscal rules. But, when so much of the heavy lifting she envisages falls to the state, the question is whether the reality of her growth strategy matches the rhetoric.

The main beneficiaries of the chancellor’s dramatic fiscal loosening are public services, particularly the broken health service and underfunded schools. Long hospital waiting lists, chronic illness and teacher shortages impose strains on the economy. The major tax change was to raise £25bn from higher employers’ national insurance contributions. The move raises the costs for business but there must be no illusion: working people will still suffer as higher business costs translate into weaker wage growth and less hiring.

True, tax rises were inevitable. But the benefits remain uncertain. First, the Office for Budget Responsibility expects the chancellor’s spending measures to deliver a near-term boost, but reckons GDP will be largely unchanged in five years’ time. The government’s admirable plans to unlock the planning system and an ambitious capital investment agenda, if delivered, may yet convince the fiscal watchdog that Britain is on a better trajectory.

The chancellor listened to concerns, and contained some of the hit to the UK’s competitiveness by watering down rumoured plans to raise significant levies on private equity and wealthy investors. But businesses and investors — which power economic growth — will still feel squeezed. The NICs increase comes alongside capital gains tax increases, a minimum wage hike, and a costly workers’ rights bill. And although Reeves made some sensible tweaks to inheritance tax, she missed an opportunity to outline a broader plan for growth-enhancing tax reforms.

Second, if subdued growth — and strains on the private sector — continue, rising demands on Britain’s public services risk pushing taxes even higher. Reeves boosted day-to-day funding for public services by 1.5 per cent in real terms, which will still leave some services with tight budgets. Vague plans to make cuts by boosting public sector productivity and reduce welfare fraud and errors must actually deliver reasonable savings.

Third, driving growth, and improved tax revenues, will also depend on how well Reeves can execute on her plans to boost investment. She outlined important plans to spend £100bn over the next five years on transport, housing and research and development. Her new fiscal rules are an improvement on the old ones, and help maintain fiscal discipline while also freeing up additional space to borrow for much-needed public investment. Though gilt yields have hit a five-month high, for now it seems she has retained the confidence of financial markets.

The chancellor has opened the door to higher investment, which if sustained, could be game-changing for Britain’s growth trajectory. But it is now essential that new funds are channelled efficiently to productivity-enhancing projects. With her inaugural Budget, Reeves has begun to fix the foundations of Britain’s economy from a difficult starting point. But if this government is to live up to its branding as “pro-growth, pro-business, and pro-worker” it has a lot more to prove.