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Ahead of her first Budget, Rachel Reeves is facing a ‘trilemma’

To avoid a return to austerity, the chancellor must find £25bn a year without cutting deep into departmental spending. If only we could rejoin the single market or customs union, says John Rentoul

Thursday 10 October 2024 10:12 EDT
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Rachel Reeves has to hope that early tax rises will fix the government’s finances and allow growth to recover towards the end of this parliament
Rachel Reeves has to hope that early tax rises will fix the government’s finances and allow growth to recover towards the end of this parliament (EPA)

It is hard to see how Rachel Reeves can achieve the three incompatible objectives she has been set in the Budget. Her choices resemble one of those Venn diagrams popular at the time of the Brexit negotiations with the overlap in the middle labelled “La La Land”.

With Brexit, the objectives were: “Leave the single market”, “No border on the island of Ireland” and “No border in the Irish Sea”. With this Budget, the objectives are: “Raise taxes”, “Boost growth” and “Give Labour a clear sense of direction”.

The problem – apart from Labour’s manifesto promise not to raise taxes on “working people” – is that the first two clash with each other, thus making the third impossible.

You do not have to be Liz Truss to realise that tax rises are bad for growth. But you have to be Not Liz Truss to know that taxes do have to rise to pay for decent public services.

The Institute for Fiscal Studies (IFS) says Reeves needs an extra £25bn a year to avoid “austerity” – defined in rather, er, austere terms, as avoiding cuts in real terms in all departmental budgets.

Any tax rise will take demand out of the economy in the short term, but specific tax rises are bound to be presented by interest groups as being especially bad for growth. People such as Charlie Mullins, the former boss of Pimlico Plumbers who has patriotically relocated to Spain and Dubai, complain that changes to capital gains tax and inheritance tax will stifle entrepreneurs.

The bigger problem is that taxes aimed only at the super-rich will not raise significant sums, partly because the internationally mobile elite will follow Mullins and leave the country.

Given that Reeves needs to raise a lot of money, she needs something that will take meaningful sums from the broad mass of what, for these purposes, will definitely not be called “working people”. Ideally, the incidence of the tax should be obscure, so that it doesn’t look as if it is coming from “working people”, and it would also help if the burden falls more heavily on the better-paid.

Rishi Sunak, who knows something about how the Treasury works, thinks that she will follow the model of the past. On Wednesday, he asked at Prime Minister’s Questions about a rise in the employers’ national insurance levy, specifically by extending it to employers’ pension contributions. This is similar to what Gordon Brown did in 1997, when he changed the taxation of pension funds, in a way that few understood, to raise a significant sum of money.

Sunak’s other guess at the contents of the Budget was that Reeves would redefine debt to allow her to borrow more for investment. This seems likely – and it may even be a good idea, although I am sceptical about the ability of any government to identify productive investment. But it will not help with Reeves’s £25bn annual shortfall, which is the gap between day-to-day spending (as opposed to investment) and revenue.

Reeves has to hope that an early rise in tax will fix the government’s finances and allow growth to recover towards the end of this parliament, possibly assisted by public investment and the relaxation of planning law.

It is hard to see where else extra growth is going to come from, given that Labour has ruled out one of the simplest measures, which would be to make trade easier with the EU – by rejoining the single market or customs union.

However much it seems a good idea to strengthen workers’ protections in the Employment Rights Bill, there is no doubt that it will increase costs for employers. It may be possible to make the argument that the legislation will promote growth in the long run by making workers more secure and therefore more productive, but that is not going to happen before the next election.

As if Reeves’s “trilemma” was not difficult enough, the delay in staging the Budget has made it harder. It has raised expectations that all of the government’s early problems will be resolved with a dramatic flourish on 30 October.

As soon as a chancellor is into the territory where they need a “rabbit out of the hat” in order to make a success of a Budget, we know they are in trouble.

Reeves is a good politician and the Treasury boasts some of the best minds of officialdom, but it is not the Ministry of Magic.

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