Labour’s Fiscal Black Hole

The Cupboard Is Empty

Quelle surprise! Chancellor Rachel Reeves is complaining that the Tories left the pantry bare and the cupboards empty. The mice (for which read the consultants) are nibbling at the crumbs. There is no more money. (Where have we heard that before?). The British state faces an unfunded shortfall between expected tax revenues and expenditure some £22 billion bigger than the one the Tories had anticipated. There is a fiscal black hole.

The cost of lodging asylum seekers in hotels – variously estimated at between six and nine million pounds per day – was not even included in the Home Office budget, according to Ms Reeves. Rather, it was being paid out of the government Contingency Fund, which is reserved for emergencies, such as wars. That is questionable. Furthermore, the £22 billion shortfall is roughly equivalent to the cost of reducing the rate of national insurance contributions (NICs) for employees from 12 percent to eight percent – Mr Hunt’s last act of generosity to us taxpayers, though not to those aged over 66 who do not pay NICs.

Never mind that much of that black hole arises from decisions made since 05 July by the Chancellor herself. She has agreed to a swathe of pay rises across the public sector – including a 22 percent hike for junior doctors over two years, 5.5 percent for teachers and nurses and six percent for members of the armed forces. This will cost around £9.4 billion. She claimed on BBC Radio 4 that these pay rises are in accordance with recommendations by the public sector pay award bodies which the Tories would have been obliged to accept.

But that is not how it works. The Tories, at least according to ex-Chancellor Jeremy Hunt, would have insisted on productivity efficiencies as a quid pro quo for generous pay rises. The slow growth of productivity in the public sector in recent years is a national scandal that neither main party has addressed.

“I don’t think anyone quite realised just how bad things are” Ms Reeves intoned last week. Labour had inherited “the worst set of circumstances since the Second World War”, she said. The truth is that she feels obliged to exaggerate the deterioration in national finances – which are independently monitored by the Office for Budget Responsibility (OBR) which affords a high degree of transparency – so that she can soften up the nation for tax rises which Labour had intended to impose all along. Meanwhile, UK gilt prices have hardly budged – the institutional buyers of British debt evidently believe that Reeves’s Woe, woe, and thrice woe is all hoo-ha.

The big reveal last Monday (29 July) in Ms Reeves statement to the House of Commons was the abolition of Winter Fuel Payments for the 11.4 million people who receive the state retirement pension. Hitherto, all pensioners received a bonus around Christmas of £200 – £300 for the over-80s – supposedly to help them with their gas bills in wintertime. This was a curiously untargeted benefit which has rightly attracted criticism in the past – why should Lord Sugar or Sir Richard Branson get a Christmas tip at the taxpayers’ expense?

It is a testament to the Tories’ timidity that they allowed this oddity to continue for so long. Henceforth, only the 1.5 million pensioners who receive Pension Credit – the top-up payment for those who are not entitled to the full state pension – will receive winter fuel payments. This will save about £1.5 billion a year. Not enough to close the deficit; but, as they say at Tesco, every little helps.

And why would a government committed to the net zero carbon agenda wish to encourage citizens to spend more money on fossil fuels? Surely, they should be encouraging seniors to insulate their heat-inefficient homes. Extinction Rebellion has a point about the fuel-inefficiency of British homes – though their clod-hopping and anti-social protests are entirely counterproductive.

The same Labour MPs who objected to the new government’s refusal to scrap the two-child benefits cap objected to the ending of the Winter Fuel Payment – Diane Abbott chief amongst them. If there are Tory MPs who are thinking about defecting to Reform, there are Labour MPs who are gravitating towards the currently one-man-band of Oh, Jeremy Corbyn MP!

Labour will press ahead in making Britain the only country in the world to tax education – something our government would not be permitted to do if we were still a member of the European Union. (New Zealand is an exception – but only because it applies a 15 percent sales tax to everything, including food).

VAT will be applied at the standard rate of 20 percent to private school fees from 01 January 2025. Some schools will endeavour not to pass on the full hike in school fees to parents by making efficiencies at the margin. But schools are subject to high fixed costs in the form of building maintenance and staff salaries, so it is difficult for them to cut their cost base. School fees will rise, and many aspirational middle class parents will not be able to afford to send their children to private schools from hereon in. As a result, there will an exodus of pupils out of the private to the state sector. The teaching of rich disciplines such as choral singing, music, classical languages and drama will decline further. Do not expect Team GB to win as many rowing medals in the 2036 Olympics as they have won in Paris in 2024.

The Bigger Picture

The economic backdrop, despite Ms Reeves’s protestations of Tory incompetence, is actually more favourable than for some time. The Bank of England was able to cut the base rate on Thursday (01 August) from 5.25 percent to 5.0 percent – its first cut in four years (the last cut being at the beginning of the Covid pandemic in March 2020). The Monetary Policy Committee (MPC) voted to cut rates by just five votes to four, with Governor Andrew Bailey using his casting vote – not an overwhelming consensus, then. Huw Pill, the Bank’s Chief Economist, voted to hold rates firm. But the markets expect further cuts in the autumn – and so does Andrew Bailey. Furthermore, the Bank issued its most optimistic growth forecast for some time. It reckons the UK economy will grow by 1.25 percent this year – up from its previous estimate.

The rate cut is not only good news for homeowners with mortgages but for the government too, since the soaring interest bill on Britain’s £2.7 trillion of national debt will moderate.

Labour’s “fully funded and fully costed” spending plans have proven illusory, just three weeks into the new regime, without tax hikes. The watchword of Labour’s strategy is “growth”. And yet everyone knows that there is a correlation between high growth and low taxes. Higher taxes mean, medium-term, lower growth. Low taxes feed into higher rates of return and therefore stimulate investment. But Labour wants the state to drive investment.

Proponents of capitalism (such as Ms Badenoch – a contender for the leadership of the Conservative Party) argue that it is not the role of the state to pick winners and drop losers. That is a role best carried out by the market. Concomitantly, more welfare creates more dependency and disincentivises ambition. And yet there is no sign that Labour will reform the benefits system. On the contrary, benefits for those who choose not to work will most likely be extended.

Moreover, Labour’s ideological approach to the net zero agenda will have consequences. The new government insists that it will decarbonise the national grid by 2030. It will not grant any new licences to extract oil and gas in the North Sea, meaning we shall have to import more crude oil from questionable actors. Labour will set up a new public sector entity – Great British Energy – with £8.8 billion of public money, but without any guarantee of a positive return on investment. (Yes – it already has a website). This curious entity will just shove money towards solar and wind turbine arrays that banks are more expertly able to evaluate already.

This week it became apparent that the 2030 net zero grid deadline is just not feasible. Especially since Britain’s four gas-cooled nuclear reactors are all due to be closed by 2028. The new and very expensive Hinkley Point C nuclear reactor may come online by the end of this decade – and possibly not. We shall most certainly need a cluster of back-up gas powered generators well into the 2030s – but please don’t tell Ed Miliband.

In the small print of Ms Reeves announcement, it became clear that the new government is to slash a swathe of spending commitments advanced by the Tory government. The lifetime cap on social care costs of £86,000 which was to have been introduced next year will be scrapped. The upgrade of our transport network is to be halted, saving an estimated £785 million. Supposedly, by scrapping the Rwanda deportation policy the government has saved a ton of money, but with no deterrent scheme to replace it the government will continue to incur huge costs associated with illegal immigration for the foreseeable future.

Mood Change

As Mr Sunak set off for Buckingham Palace to resign as PM on the morning of 05 July, he described his successor and the new prospective Chancellor as “Decent people and committed public servants”. At the King’s Speech on 17 July (about which I wrote two weeks ago), the new PM and his predecessor chatted and joked like old pals catching up. Even at the first Prime Minister’s Questions on 24 July, the tone was respectful and serene. But on Monday this week Ms Reeves laid into Messrs Sunak and Hunt, effectively calling them liars – and Mr Hunt reciprocated volubly. The grace and politeness of honeymoon politics is evidently over.

Americans often describe theirs as the Lucky Country – and nobody would dispute that theirs is the richest country in history. But, right now, I think British politics can claim to be saner than its American analogue with Donald Trump calling Kamala Harris a “bum” (and worse). The US presidential election looks set to be a dirty fight. In comparison, British political infighting looks tame.

That said, a number of high-profile and horrific crimes in the UK of late has accentuated a pre-existing sense of insecurity. The unspeakable events in Southport last Monday (29 July) have already unleashed a wave of civil unrest which is likely to persist throughout the summer. As the professor of Politics at the University of Kent, Matt Goodwin, wrote yesterday: When a nation cannot protect its own children, something has gone horribly wrong. I share his fears for the future.

Just as the fear of crime has fuelled the rise of the Rassemblement National in France, so the perception of widespread criminality combined with anxiety over immigration will only push more ex-Tory voters into the arms of Reform UK. The UK electorate, like the electorates in France and the USA is likely to polarise further – and this will be accentuated by Labour’s likely fiscal policy. All three western countries have also experienced a decline in trust in the police.

Ms Reeves announced on Monday that she will deliver the first budget of the Labour government on 30 October. That will be just days before the new Tory leader is crowned. (Not that whoever wins will still be leader by the time of the next general election in 2029). Most commentators expect tax hikes – indeed, Ms Reeves admitted as much on Tuesday. Then, on Thursday, she spoke of the need for “difficult decisions”.

She is committed – as the Tories were – to not increasing the headline rate of VAT (though its scope might be extended) and not raising income tax or NICs. We can, however, expect capital gains tax to be aligned with income tax, as I discussed recently – plus some additional nasties like the closure of inheritance tax allowances and the removal of higher rate tax relief on pension contributions.

Labour promised during the election campaign not to raise taxes on “working people”. “Working people” is evidently a demographic that does not include the provident, the thrifty, the entrepreneurial, nor those who value private or religious education. The social divide between Labour’s clients – recipients of welfare – and those who finance the welfare state will widen.

The rich, especially those with heritage and family connections overseas, are already leaving in droves. Some are moving to jurisdictions that one would not normally think of as tax havens, such as Italy. But the land of la dolce vita has become welcoming to the nomadic rich under Georgia Meloni.

All of my readers who are getting on a bit should embrace succession and inheritance tax planning ASAP. Rupert Murdoch – Hombre!

Afterword

It’s August, the sun is shining, and I’ve decided to take some time off – though my downtime is never leisurely. There are always projects on the go. I am exhilarated, having recently received my All-England Bus Pass. My Bus Pass Birthday lunch party at a restaurant in London’s Covent Garden was a gathering of fit and energetic sexagenarians who are still making waves.

I may be absent from these shores and from these pages for a while. In the meantime, I wish my steadfast readers a Summertime like Gershwin’s – where the livin’ is easy and the cotton is high.