The first Labour Budget for 14 years, and the first Budget ever delivered by a woman, has certainly been a large one (and not just in terms of the length of the speech). The Chancellor set out significant rises in tax and borrowing, almost all of which will be used to prevent further public spending cuts. This was the Budget where the implications of the projected spending settlements, dubbed a ‘fiscal fiction’, were finally out in the open.
Ultimately the Chancellor has decided that delivering the cuts set out by the last government would be neither economically nor politically feasible. So what is the overall narrative of the Budget? In short, it is a Budget of two halves.
It was a good day for capital investment, with the government vowing to “invest, invest, invest” and new fiscal rules opening up room for additional public investment. But on current spending, there is less to celebrate. A huge £40 billion worth of tax rises have left public services merely treading water, with the exception of the NHS which received significant extra funding.
In today’s New Economy Brief we look at both sides of this Budget, unpack the key measures, and look at how the fiscal framework has contributed to this fragmented narrative.
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Towards a pro-investment fiscal framework?
The government wants today’s take home message to be that it is now serious about investment. Recognising the benefits of borrowing to invest, the Chancellor announced changes to the debt rule which has previously curtailed public investment. As a result of the headroom opened up by the change to the fiscal rules (more on this below), the Government is aiming to spend an average of £20 billion extra a year on capital investment over the next five years. The OBR notes that this will increase GDP growth by 0.6% by 2029, with even greater growth benefits felt beyond the five year forecast period (IPPR's Carsten Jung believes the real growth impacts could be twice as big). The OBR also calculates this extra public investment will ‘crowd in’ billions more in private investment.
Cancelling the cuts. This has allowed the government to keep public investment broadly flat at 2.4% of GDP over the parliament, and avoid inherited cuts which could have left public investment falling more at the end of Labour’s first term than across the entire 2010-24 Conservative administration. IPPR’s analysis shows that this “major revision in investment plans between the Labour manifesto and now” leaves “public investment in Britain approaching the average for the rest of the G7”.
What will it get spent on? The government is using some of its new headroom to “invest in the industries of the future”: key industrial strategy priorities like gigafactories, ports, green hydrogen, aerospace, automotives, transport and R&D, as well as housebuilding and broadband. DESNZ’s also received a 35% boost to its capital budget, while £6.7 billion of capital investment will be spent to rebuild schools and £3.1 billion to address backlogs in the NHS. But there are still huge investment gaps. EY warned of a £700 billion+ infrastructure investment shortfall to meet the UK’s long-term economic, social, strategic, environmental and defence priorities by 2040 and the Climate Change Committee (CCC) recently recommended a stronger emissions reduction target for the UK by 2035 which will further increase the need for green investment. While avoiding the planned cuts to public investment is likely to be welcomed by campaigners, keeping it flat at 2.4% of GDP is still some way below the ambition called for by many institutions (it’s half of what NIESR are calling for, for instance).
Changing the time horizon of the debt rule. Reeves criticised the previous government for making short-termist decisions, such as raiding capital budgets to meet day-to-day spending commitments and cancelling public investment projects. Changing the definition of debt to open up more space for public investment avoids some of this short-termism by unlocking more headroom now, but the Chancellor's new timeframe for meeting her fiscal rules leaves a lot of it intact. The Chancellor has given herself five years to get debt falling as a percentage of GDP, which will then have to be met every three years afterwards in a rolling target. This shorter three year timeframe could restrict future chancellors from making long-term decisions as they will have less time for the benefits of public investments to generate growth impacts, which tend to accrue over the longer term (She did announce that the OBR will judge these benefits beyond the forecast horizon, but as yet it is unclear how or if this will be integrated formally into the fiscal framework).
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Implications of Targeting Public Sector Net Financial Debt (PSNFD)
As predicted, the government is redefining the definition of ‘debt’ (public sector net debt excluding BoE) to a more expansive measure that also includes the value of financial assets held by the government (such as student loans, guarantees to businesses, equity holdings by public sector banks, and assets held by public sector pension schemes), as well as its liabilities. Targeting falling PSNFD rather than falling PSND more accurately reflects the benefits of borrowing to invest by capturing the value of the financial assets created through the investment as well as the debt taken on to fund it, whilst also discouraging the government from selling some kinds of public assets to reduce short-term debt.
PSNFD and PFI2.0? A PSNFD target could create incentives for the government to channel investment through financial mechanisms rather than directly building and owning infrastructure. This effectively makes public sector borrowing to invest in illiquid private sector financial assets (for example loans made by public banks like the National Wealth Fund) fiscally neutral. Conversely, investment in non-financial assets held by the public sector (such as MRI machines in hospitals) would only register as a debt under PSNFD; under more comprehensive measures of debt like Public Sector Net Worth, these physical investments would also be fiscally neutral. Barclays note this “raises the prospect of a change back to a “PFI-type” world of the early 2000s” (read our previous New Economy Brief on ‘derisking’ and the National Wealth Fund).
All eyes on the ‘guardrails’. This is why many experts have called for ‘guardrails’ to help guide additional public investment and maximise its value and quality. This includes greater oversight and assessment by independent bodies, such as the new Office for Value for Money to scrutinise spending, alongside a new infrastructure oversight body and an expanded role for the National Audit Office. Will these beefed up institutions prevent what Daniela Gabor has called ‘government-by-Blackrock’ and ensure public value is retained in a new wave of public-private-partnerships?
Questions remain over government incentives over PSNFD. Former Permanent Secretary to the Treasury and head of the Civil Service, Lord Gus O’Donnell, has argued that “all public investment decisions should be based on non-financial as well as financial returns as set out in Treasury guidance in the Green Book”. But the portfolio of investments delivered by the National Wealth Fund must have a return higher than gilts, so it is likely that necessary investments with social or climate returns may be sidelined over more profitable ones. Will the less profitable investments needed for climate mitigation/adaption still be pursued under this more financialised logic? (New Economy Brief will explore these questions in future briefings.)
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Golden rule: higher taxes to fix gaps in current spending.
Whilst the government has new powers to borrow for capital investment, they are steadfastly committed to not using borrowing to pay for current spending; this must be paid for by higher taxes. This ‘golden rule’ means that tax receipts must balance with current spending, initially in five years and then in a three year rolling target after that (with ‘balance’ being defined as a range of plus or minus 0.5% of GDP) .
Tax focus. To ‘prevent a return to austerity’ the government raised £42 billion in tax, over half of which came from increasing employer National Insurance Contributions (NICs). Here the government was significantly constrained by its manifesto commitments on income tax, employee NICs and VAT, meaning most of the big revenue raisers were off the table. Other manifesto commitments were enacted such as applying VAT on private school fees and scrapping the non-dom tax status, alongside new measures such as closing inheritance tax loopholes and raising the rates of capital gains tax. The result is a progressive set of measures, but tax campaigners will feel there is more to do to ensure wealth is more fairly taxed compared to work (Note that IPPR found these changes still leave the UK broadly in the middle of other OECD economists on tax as a % of GDP).
Did we avoid a return to austerity? This allowed the government to avoid the real terms spending cuts inherited from the last government (widely regarded as ‘politically unfeasible’ to deliver), and increase spending by 4.8% this year. Seven Departments will still be getting real terms spending cuts in this one year settlement; the Home Office, Foreign Office, DEFRA, DCMS, Business and Trade, Transport and the Cabinet Office. But the overall envelope for current spending will grow 3.1% next year and on average by 1.5% between 2026-27 and 2029. Whilst preventing even deeper austerity baked in from the last government, this will still result in very tight budgets for departments ahead of the longer-term spending review in March.
NHS is the big winner. The NHS is consistently top of voters’ concerns, and is one of the key issues (along with the cost of living crisis) that Labour will be judged on at the next election. It’s no wonder, then, that Reeves has announced a £22.6 billion increase in day-to-day health service spending and a £3.1 billion increase in the capital budget, including £1 billion for repairs and upgrades, and £1.5 billion for new beds in hospitals and testing capacity. The government has promised that the boost will help to bring down waiting lists to a maximum of 18 weeks.
Investment via current spending? However, there hasn’t been a significant change in either spending or rhetoric from the previous government when it comes to social security. The government is looking at continuing an Osbornite tradition of sanctions in Universal Credit by continuing the last government’s reforms to Work Capability Assessments and looking for cost savings by cracking down on benefit fraud. A Child Poverty Taskforce is sure to report by next Spring which campaigners will hope recommends more substantial action on welfare. A recent report from NEF argued that this spending on social security, such as reducing child poverty, should be recognised for its growth benefits, not just its effects on poverty reduction.
Verdict on the cost of living? The Chancellor highlighted some measures in the Budget that she argued would help ease the cost-of-living crisis, including a rise in the minimum wage, a boost of carers allowance, the extension of the household support fund, and a curtailment of deductions from Universal Credit. Overall the OBR suggested there will be an uptick in real earnings growth compared to their last forecast. However, poverty campaigners are worried that a 1.7% uplift to Universal Credit (likely to amount to a real-terms cut) will leave millions destitute and are disappointed by the Chancellor’s failure to end the two-child benefits limit. (For more on the cost of living context, see our New Economy Brief from earlier this week).
