UK Budget Leaves Rachel Reeves Facing a £30 Billion Reckoning

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If she is to draw a line under the uncertainty of the past year, which has driven up the premium paid on government debt relative to the US, Germany and Japan, she will have to do better than that. Doubling the headroom would help deliver the “secure foundations” she has promised but mean finding another £10 billion at the budget, taking the total consolidation to £30 billion, or 1% of gross domestic-product.

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The challenge may even be greater. Scrapping a cap that limits benefits received by most families with children to just the two eldest costs in the region of £3.5 billion. Removing VAT from energy bills could add £2.5 billion. Should Reeves follow the habit of every chancellor since 2011 and freeze fuel duty, like she did last year, she’d need to find another £5.5 billion.

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Given the objections to spending cuts Labour MPs have evinced over the last year, taxes will need to do the heavy lifting. But rather than adjust a broad-based tax, as under the scrapped plan, Reeves must now try many smaller ones, each with their own inefficiencies and interest groups.

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Rupert Harrison, senior adviser at PIMCO who was economic adviser to the former Conservative Chancellor George Osborne, has first-hand experience of that approach. Osborne’s budget in 2012 — widely dubbed “the omnishambles budget” — unraveled after the targeted groups protested unfair treatment. 

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“Markets would be concerned if there is a long list of uncertain taxes where revenues are perhaps a bit harder to predict,” Harrison said. “The market would definitely prefer one big lever, like income tax, because it’s less distortionary.” 

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Former Institute for Fiscal Studies director Paul Johnson has likened the remaining options to a “moldy smorgasbord.”

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The government has promised to deliver housing, investment, deregulation and cheaper energy to spark a longer-term economic recovery, and put the UK on course for Labour’s ambition of 2.5% annual GDP growth, up from the current rate of just 1.3%.

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Capital Economics thinks the fiscal squeeze will lower output by 0.2%. That’s a problem. “This idea that the government needs to stabilize debt-to-GDP is very important for bond markets, and reducing growth significantly actually goes against all that,” said Ales Koutny, head of international rates at Vanguard. 

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Totemic announcements have been made, such as a third runway at Heathrow, Sizewell C nuclear power station and better rail connections in the north of England, but progress has been slow. Labour’s flagship plan to build 1.5 million homes is far behind schedule.

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If the budget harms Labour’s poll ratings any further, Reeves can look to Osborne for comfort. The disastrous 2012 budget, 22 months into his government, was his nadir. At the London Olympics that year, the crowd booed the former chancellor. Three years later the Tories won the election outright. 

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Get the budget right and Reeves may bounce back from her lowest ebb. She, too, was booed during a pre-recorded speech at a Lloyds British Business Excellence Awards event last Tuesday, shortly before her income-tax plans unraveled. Get it wrong, and it may be the beginning of the end for her and Starmer. 

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—With assistance from Julia Janicki and Michael Msika.

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