Rachel Reeves’s impossible choice: break her tax promises or impose ‘austerity’

This time last year, Rachel Reeves said she had “no plans” to raise any taxes apart from the small increases, including VAT on school fees, that she had already announced. When her interviewer pointed out that “no plans” was a politician’s standard non-denial denial, she responded: “We won’t be doing that. It’s a denial. It’s not a non-denial, it’s just a denial.”

I wrote at the time: “Maybe it is just politics, and she will go back on it once in government. But that seems like a bad idea, and asking for trouble.” And so it came to pass.

Post-election honeymoon or no, the Labour government is in trouble. The chancellor and prime minister face an unavoidable choice. They tried to put it off by setting the date of the Budget as late as they could: 30 October. But they will still have to make their choice.

It is not just a choice about this year. The politics of that are just about manageable. Reeves says, with some justice, that the Conservatives left the public finances in a worse state than she in opposition could have known. She dealt with part of that in her speech on the “public spending inheritance” on 29 July – whatever you do, don’t call it a mini-Budget – in which she announced the cut in winter fuel payments.

The rest of the gap she can bridge with normal Treasury clevernesses in the Budget.

But in that Budget, she also has to set out detailed spending plans for the next three years as part of a credible trajectory for the next five years.

On this, she cannot pretend that the Tory legacy is worse than she thought. The Tory plan for five years ahead was for public spending to rise by 1 per cent a year more than inflation. As Sam Freedman, Michael Gove’s former adviser who was crying “Iceberg!” before the election, says, this is essentially no increase at all once population growth is taken into account.

Reeves, and Keir Starmer, knew before the election that they would have to pay public sector workers more than 1 per cent above inflation to settle the strikes. They knew that in years two to five of a Labour government there would be a yawning gap between what they must spend, as a simple requirement of viability for a party seeking re-election, and the money they will have coming in. Unless, that is, there is a miracle of economic growth akin to Ireland’s around the turn of the century – which is why their only way of not looking ridiculous in the election campaign was to go on about growth as their first “mission”.

Barring miracles, however, taxes will have to rise.

Strictly speaking, there are two other options, which can be ruled out. Big cuts in public spending could be made in departments that voters don’t care about. The foreign aid budget could go, having been reduced by Rishi Sunak, although a surprisingly large part of it is spent on housing asylum seekers here. The Labour Party is already in a pre-rebellious ferment over winter fuel payments and the two-child limit on benefits – of which more in a moment; I don’t think it would tolerate a cut in international development.

The nuclear deterrent could go: many Labourites would be happy with that. The deputy prime minister and foreign secretary even voted to abolish it eight years ago. But a patriotic, national-security-first prime minister is not going to do that. Besides, it would save a smaller amount of money than most of its critics imagine.

The second option for avoiding hard choices is to borrow more. Here, the debate is often confused. Yes, the fiscal rule that Reeves has copied from the Tories is daft – that borrowing should be falling by the fifth year of a forecast period that resets every year. It would make sense to borrow more for capital investment if we could be reasonably sure of a return on our money. But that does not apply to the salary costs that account for the bulk of spending on most public services. Any attempt to borrow more to pay for higher public-sector wages would drive the markets into a Truss-style meltdown.

So the decision that Reeves and Starmer cannot avoid is this: do they bite the bullet, break their promises and put up one of the main taxes to raise a serious amount of money that will make the kind of difference that the voters will notice; or do they try to muddle through with stealth taxes that raise just enough to stop local councils and universities going bust and the criminal justice system from collapsing?

Option two involves decisions that conjure the spectre of “austerity”, which are painful for the Labour Party. It was striking that Ed Miliband, the energy secretary, in his interview on Friday to say that he felt people’s pain over the rise in gas and electricity prices from 1 October, made it clear who had decided to cut the winter fuel payment: “It was a difficult decision that the chancellor, Rachel Reeves, made, but it was also a direct result of the legacy left to us by the last government.”

The winter fuel payment was introduced by Gordon Brown, when Miliband was his adviser. Miliband, Angela Rayner and Louise Haigh are all very well aware of where the party’s instincts lie.

Reeves and Starmer want to stick with option two, which is either “tough” or “muddling through” depending on your point of view, but they seem to be making it up as they go along. Their advisers say, with unconvincing bravado, that the winter fuel cut “won’t be the last” difficult decision they will have to make.

But it may be that they will be forced by the harsh dictates of arithmetic, namely the need to make the numbers add up, to go for option one. There is a strong case for reversing the last of the Tory government’s irresponsible cuts in national insurance contributions – the 2p in the pound cut in April this year.

After Miliband’s comment, the second most interesting thing that a minister said this week was when Darren Jones, Reeves’s deputy, reinterpreted the manifesto promise as a pledge not to raise “employee national insurance” in an interview with Times Radio. I don’t know if the British people would buy the argument that a rise in employer’s national insurance contributions is not a tax on “working people”. A close textual analysis of the manifesto reveals that the full sentence reads thus: “Labour will not increase taxes on working people, which is why we will not increase national insurance, the basic, higher, or additional rates of income tax, or VAT.”

But needs must, and if Reeves and Starmer decide to put up taxes significantly, that must be the likeliest option. They should have done it by now, while the argument about the “worst inheritance since the war” is still fresh in people’s minds, in the hope that it would soon be forgotten. Will that be the really difficult decision that they make in the Budget in October?