Rachel Reeves’ Budget: Anticipated Long-Term Financial and Economic Implications

Rachel Reeves will not have a specially commissioned Budget red box when she presents her Budget mid-morning on Wednesday, becoming the first woman to display one outside Number 11. The event is expected to be devoid of elaborate embellishments, humor, or unexpected announcements. It signals a return to traditional economic management, championed by “number crunchers, bean counters, and abacus economists,” a group previously criticized by Liz Truss. The reused Red Box will contain a Budget reflecting an expert-driven approach. This Budget is anticipated to stand in stark contrast to the infamous mini-Budget introduced two years ago by Truss and her chancellor, Kwasi Kwarteng. They notably declined an Office of Budget Responsibility (OBR) forecast, with Truss later asserting that the forecaster was part of a “deep state” conspiracy against her government. For the current Budget, the OBR has completed its comprehensive 10-week, iterative audit of both the public finances and all proposed tax and spending policies by Reeves, contributing to what has been perceived as a prolonged period of pre-Budget preparation. The three-month delay following the election has negatively impacted consumer and business confidence, consequently affecting the economy. Business leaders have indicated that while they can manage tax increases, extended uncertainty is detrimental to economic sentiment. Some observers believe an opportunity was missed, after three years of continuous crises, to capitalize on a significant summer turning point, marked by a new stable government and declining interest rates. Nevertheless, this turning point might materialize now. The Budget is part of a broader global economic shift. Years characterized by increased government spending and borrowing, alongside elevated interest rates to curb high inflation, are transitioning. The new economic paradigm involves looser monetary policy, signified by falling interest rates, and tighter fiscal policy, which includes higher taxes and limits on borrowing. The Budget box contains a wide array of tax increases, making it potentially simpler to list those that will not rise. The most prominent increase, as previously reported, will be in employers’ National Insurance Contributions (NICs). It is understood that Reeves was internally advised in July to simply reverse the “unfunded” 2% cut to employees’ National Insurance, which was implemented by the Conservatives. However, she was resolute in her commitment not to violate the election pledge against increasing this specific form of NICs. A significant debate is expected regarding whether an increase in employer NICs is functionally equivalent to raising employee NICs. Labour insiders reference a footnote in their election materials that clarified the manifesto commitment applied exclusively to employee NICs, and they state they faced criticism on this point in Conservative advertisements and speeches. This suggests the Labour manifesto’s wording was carefully formulated to permit an increase in employer NICs. Last week, during the International Monetary Fund (IMF) meeting in Washington DC, the chancellor was directly questioned about the lack of clearer communication to the electorate regarding potentially widespread tax increases, including National Insurance. She identified three factors driving this challenging Budget. She reiterated her calculation of an inherited “£22bn black hole,” which she stated was passed down from her predecessor but was unforeseen. She now projects this deficit will persist “in future years.” She also mentioned that the OBR would publish its review detailing how the overspend was “allowed to happen” concurrently with the Budget. The Treasury views this as an important secondary narrative to Wednesday’s main Budget announcement. Reeves further cited compensation payments for the infected blood and Horizon Post Office scandals, stating that “the previous government did not put money in place for” these. Thirdly, she conveyed that the UK’s current trajectory for public spending is unsustainable, given the condition of public services such as prisons and the health service, and the new government’s promise that there “would not be a return to austerity.” While initial information about the Budget suggests austerity, the chancellor defines austerity as real-terms reductions in government departmental budgets. It appears departments will receive supplementary funding to manage the increasing cost of services. The compromises within her Budget are shaped by new fiscal rules. A new “investment rule,” governing borrowing for investment, will replace the previous debt rule, allowing the reversal of a planned £20bn cut to spending on major capital projects. The new, broader measure of debt must decrease within five years. However, the new “stability rule” will serve as the primary constraint for Wednesday. All day-to-day spending by departments, on welfare, and on debt interest must be financed by tax revenue over a specific, yet unspecified, timeframe. This rule could prove to be quite stringent, potentially tougher than the Conservatives’ rule. Borrowing will be restricted solely to investment. These two rules combined will define not only this Budget but also the next five years, influencing every aspect of government expenditure. Labour has concluded that its substantial majority is based on a public desire to address underperforming public services, such as the NHS, and a decline in the quality of the public realm, from transport to town centers to housing. In this perspective, the true “black hole” resides within public services. The “fiscal fiction” of unrealistic spending plans is set to become fiscal fact. By mandating that spending gaps be addressed through significant tax increases, the strategy aims to convey a strong capacity for political endurance to the financial markets that lend to the exchequer. Essentially, a substantial parliamentary majority will be utilized to credibly guarantee surpluses on “current” spending. While some taxes will rise, the anticipated benefit is a contribution to keeping interest rates lower for households, businesses, and the government itself. As a prominent central banker remarked on the sidelines of the IMF meeting, market credibility depends not just on the volume of borrowing, but also on the coherence of the narrative and the strategy surrounding that borrowing. A new chancellor must establish financial credibility, as credibility is notoriously difficult to acquire and easily lost. This is the underlying purpose of these self-imposed rules. However, in recent years, chancellors have also faced challenges with political credibility. More than one held the position for too brief a period to even present an official Budget. It has not been a certainty that all Budget measures would be enacted by a dissenting and unruly governing party. Across the Channel, this is precisely the issue in France, where Reeves’s counterpart, Antoine Armand, must demonstrate his ability to pass difficult measures as a minority government. Rachel Reeves does not face these particular challenges. Indeed, at an event in Washington, addressing bankers, congressmen, and senators at the British ambassador’s residence, the chancellor paused for reflection. Exactly two years prior, Kwarteng had delivered the same address amidst widespread mini-Budget turmoil, including jokes about his shared role with Isaac Newton, who had resolved a historic sterling crisis. Following the aftermath of Kwarteng’s “fiscal event,” board members of British clearing banks were compelled to reassure their counterparties that Britain was “OK.” Finance ministers from developing nations were similarly making a half-joke about Britain, once a leader, now being the crisis economy. For a chancellor who, two decades ago, was seconded as an economist to the British embassy during one of Argentina’s debt crises, this situation was deeply anathema. Consequently, on Thursday morning, she and her team anticipate negative reactions from wealthier taxpayers and unfavorable media coverage in certain newspapers. However, the other side of this will be relief for users of many public services, and particularly, what the Treasury hopes will be stable financial markets as she initiates a long-term program of long-delayed investments in Britain’s economic future. This Budget is expected to undergo extensive analysis and scrutiny for months, possibly years to come.