It is hard not to feel sorry for Rachel Reeves. She is trying to be both responsible and pro-growth. But she is presiding over a stagnant economy with high indebtedness and a set of fiscal rules she herself set just a few months ago, but now seems likely to break. Her tax rises at the time of the Budget were (and remain) hugely unpopular. Yet they now look insufficient. She is constrained by pledges, notably not to raise income or value added taxes, made before the last general election. Financial markets now clamour for spending cuts in response to rising spreads over US and German bonds, while the need for increases in defence spending has become overwhelming. What is the chancellor to do? What is the prime minister to let her do?
The fiscal situation is laid out by Ruth Curtice, the new head of the Resolution Foundation, in a blog posted last Friday. Interestingly, she was previously the head of the Treasury’s Fiscal Department. Yet now she is running a think-tank that focuses on the problem of stagnant living standards. This would seem to put her on both sides of today’s debate on austerity versus generosity.
Curtice argues that the Office for Budget Responsibility has very likely told the chancellor, in advance of her Spring Statement on March 26, that she “would be missing her target to cover day-to-day spending with taxation in five years’ time (known as ‘balancing the current budget’)”.
She also makes two interesting points about the UK’s fiscal history since 2010. One is that it is nine years since the last discretionary fiscal policy change was in a tightening direction. The other is that the OBR has almost always forecast a current budget surplus five years hence. This, in turn, allowed that long history of loosening. But the margin, Curtice suggests, has been diminishing and might now have disappeared altogether.
One conclusion from this is that UK fiscal policy has been ill-executed over the past 15 years. There was tightening during the post-financial-crisis slump and loosening during the post-crisis recovery (with the expansion during the pandemic being a special case). That is the opposite of what should have happened. But, to be fair to Reeves’ predecessors, the “recovery” was also a miserable one, as the Resolution Foundation’s work on living standards has demonstrated.
One response would be for the chancellor to game her own rules, as others have done before her, by promising implausible curbs on future spending, yet ones that show her meeting her targets. If so, she would be proving that targets for deficits five years hence are ridiculous. At the same time, relaxing her rules a few months after setting them would also be ridiculous. If Reeves were driven to that, she should surely just drop them in favour of new ones.
The alternative approach, as I argued two weeks ago, would be for the prime minister and chancellor to say, rightly, that this is a new world. The country now has to contribute to the defence of its continent. Yet it must also do whatever it can to support economic growth and maintain social cohesion at home, in what are already tough and unhappy times. In this context, past promises cannot be binding. It will be necessary to borrow more in the short run for defence and also to raise broad-based taxes on income, sales and property and to cut inefficient spending more than previously indicated. The government must also pursue pro-growth deregulation and investment more enthusiastically than before and be open to far deeper integration into European initiatives in defence and new technologies than was previously imaginable.
Reforms are not difficult to envisage. It is unnecessary for the Bank of England to pay interest on the entirety of bank reserves, for example, as my colleague Chris Giles has argued. The UK should follow other central banks in tiering those reserves. This would not be a tax on banks, but one on intermediation via banks. We need to shift from a bank-based system of financial intermediation anyway. Again, we should not be spending huge sums keeping young people inactive. Again, the triple lock on pensions must also be abandoned. Moreover, many have enjoyed huge gains from property ownership. Some of this property wealth must now be taxed.
These, however, are details. The fundamental point is that the government should view the hard times coming upon us as an opportunity, as well as a crisis. The country needs leadership. A bold government would state that the constraints we have lived under on taxation, spending and regulation need to be reassessed. It must craft relevant new ones. This is not just important for the UK. It is also important for Europe. Times have changed. So must we.
martin.wolf@ft.com
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