Donald Trump will force a fiscal reckoning on Labour

Good morning. The biggest story in British politics is, ultimately, the story of Donald Trump and how he is reshaping America’s role in world affairs. (If you haven’t yet signed up to White House Watch, do!)

I’m not going to talk all that much about why Trump and his cabinet say the things they do, because that is not my wheelhouse. But I am going to talk today a bit about the pressures that they create for the government.

The smallness of man before the great events confronting him

Labour in 1964, 1997 and 2024 all had one thing in common: they came to power having made specific and far-reaching pledges about what they wouldn’t do in office. In 1964, the party wanted to avoid devaluing the pound, as the previous Labour government had done. (The 1964 manifesto also criticised the Conservatives for having overseen a fall in sterling’s value.)

In 1997, they pledged not to increase income tax. And in 2024 they promised not to increase income tax, value added tax or national insurance. The central reason for both commitments was the need to reassure voters about Labour’s tax plans.

In both cases, those promises imposed big limitations on what each Labour government could do in office. But in contrast to Starmer’s administration, in 1997 New Labour had the benefits of the best economic inheritance any government has ever received from its predecessor.

The Harold Wilson government in the 1960s could secure big savings by essentially completing the final stages of the UK’s retreat from being a world power, which meant it could spend less on defence.

Now Donald Trump is negotiating an end to the war in Ukraine so far without a direct role in the talks for the EU or the UK, while Pete Hegseth, his defence secretary, is saying that European nations need to take leadership of their own defence.

The UK will have to spend much more on defence than it does now and grip the long-running issues around UK defence procurement. Both of these things cost money. Added to that, Rachel Reeves is likely to be forced to announce either tax rises, spending cuts or a bit of both next month, because the OBR’s expected downgrade in its forecast will mean she has fallen into the red against her fiscal rules. This is not a great position for the government to be in, to put it mildly.

The UK’s current fiscal rules are suboptimal in my view, but even if you had a different set, the basic challenge remains. If you want to spend more on infrastructure and housing (two economic imperatives for the UK), to keep the country safe in an uncertain world (a strategic imperative) and to fix the UK’s tattered public services (an electoral imperative for any UK government right now), that is going to involve some reallocation of some private consumption.

Now, another thing that the Labour governments of 1964 and 1997 had in common is that they both ultimately broke those promises. Labour did devalue the pound in 1967 from $2.80 to $2.40, a 14 per cent drop. The FT’s front page laid out the economic pressures that forced the move:

And the Gordon Brown government would go on to raise income tax in 2009. Labour lost the elections that followed, though I don’t think that the 2009 budget was a big part of what went wrong for them in 2010.

I struggle to see a way that Labour’s geopolitical and growth objectives can be met while keeping their promises on tax: whether that reckoning comes later this year thanks to the OBR or down to Trump remains to be seen, but that reckoning is going to arrive sooner or later.

Now try this

I have mostly been listening to the delightful new piece by Emma Rawicz and Gwilym Simcock, “The Shape of a New Sun”.

Top stories today

• Return to growth . . . just | The UK economy unexpectedly grew by 0.1 per cent in the fourth quarter, in a modest boost for Labour.

• HMRC not ‘sufficiently curious’ | HMRC is significantly underestimating how much tax it loses to evasion each year and lacks a clear strategy to stop “bad actors” exploiting Britain’s public purse, the House of Commons public accounts committee warned.

• Engineering buzz | Prospective undergraduate students are turning to engineering courses in increasing numbers while shunning teaching and nursing degrees, according to the UK’s university admissions service.

• Keir-ing up for defence pressures | Keir Starmer has summoned defence chiefs for crucial talks over the future shape of Britain’s armed forces. People briefed on the strategic defence review, which is entering its final stages, say defence chiefs have been pushing hard to expand the military budget to deal with Russia and other geopolitical threats.

• Affordable homes push | More than 100 sites across England have put themselves forward to be considered as potential new towns and about a dozen sites are expected to be approved. Starmer claims that some would be under construction by the end of this parliament. “Our aim is for at least 40 per cent of homes to be affordable, including social housing,” he added.

• Reshuffle gossip | Attorney-general Richard Hermer and culture secretary Lisa Nandy could find themselves in the firing line in the first cabinet reshuffle being plotted by Starmer’s top team, the i’s Chloe Chaplain reports (paywalled). A senior No 10 source denied any plans for a reshuffle were already in motion. One government source said they would not expect any changes to happen before May. They argued it would be the ideal opportunity to “freshen things up” after the March Spending Review and early May local elections.