By Alistair Smout, David Milliken and David Lawder
LONDON/RIO DE JANEIRO (Reuters) – New British finance minister Rachel Reeves will spell out on Monday the scale of the public finances mess she says she has inherited, potentially paving the way for tax rises that critics say she could have been more candid about before the election.
Following Labour’s July 4 election victory, Reeves ordered an assessment of public spending needs which were not fully captured by official budget forecasts published in March.
Reeves repeatedly said the election winner would inherit the worst set of economic circumstances since World War Two, but ruled out raising the rates of almost all main taxes to fix this.
Labour sources said on Friday that Reeves now expected to reveal a 20-billion-pound ($26 billion) hole in the public finances.
The Office for Budget Responsibility – Britain’s independent fiscal watchdog – said in March that the previous Conservative government’s five-year budget plans left just 8.9 billion pounds of leeway to meet a self-imposed rule designed to stop debt rising.
Reeves has said that – while she would rather lower taxes than raise them – she would not make any pledges that she could not stick to under debt rules which Labour pledged to follow.
Anticipating criticism of her assessment of the finances, Reeves told reporters at a G20 finance leaders’ meeting in Brazil late on Thursday that she had been frank about the need to repair public services and stop debt rising.
“We have inherited a mess,” she said. “I’ve always been honest that the scale of the challenge confronting this new government is immense because of the damage done to the economy and to public services by the Conservatives.”
Reeves declined to comment on whether the hole was 20 billion pounds or how exactly she intended to cover it before addressing parliament.
The Conservatives immediately attacked the 20-billion-pound figure as a prelude to unnecessary tax rises.
“Labour’s claims are nothing but a fabrication – the books have been wide open since the OBR was set up 14 years ago,” Conservative former finance minister Jeremy Hunt said.
POLITICAL EXERCISE
New Prime Minister Keir Starmer said on Wednesday “we have a more severe crisis than we thought as we go through the books” after 14 years of Conservative government, which ministers have said impacts everything from prisons to immigration and health.
But economists and analysts said that although a finance ministry review of spending needs might soften the political blow from tax rises, in economic terms there were no big surprises that Labour could not have foreseen.
Reeves herself told the Financial Times in June that Labour did not need to win an election to find out about the bad state of public finances.
The Labour Party’s manifesto heading into the election spelled out small tax rises to fund specific commitments but other fiscal details were scant, aside from a general commitment to boost resources through higher growth.
Neither main party set out how it would meet funding shortfalls forecast to hit the health service, and Labour accepted Conservative fiscal plans to cut spending on some public services which analysts had not considered tenable.
Ben Zaranko, senior research economist at the non-partisan Institute for Fiscal Studies think tank, said Reeves’ statement would be “a political exercise, not a genuine response to new information”.
“I think that the fiscal challenge awaiting this government was apparent to anyone who cared to look…. Maybe some of the specifics are a surprise, but the overall trend was clear,” he said. “Neither party was being fully open about the challenge.”
RED LINES
The fiscal picture is slightly worse in some areas than Labour might have expected.
Borrowing in the three months to the end of June was 3.2 billion pounds higher than the OBR forecast in March.
Debt is the highest since the early 1960s at 99.5% of GDP, 0.8 percentage points more than forecast, while the tax burden is already the highest since the late 1940s.
Reeves has also hinted she will accept a public-sector pay award recommendation that teachers and health workers receive a rise of a reported 5.5%, higher than expected.
She is set to outline that pay award on Monday too, along with the date of the next budget.
Pantheon Macroeconomics said such a pay award would use up almost all the fiscal headroom left over after Hunt’s March budget.
“What’s more, we estimate that the fiscal situation has worsened since (March),” it said.
The Labour Party has ruled out increases to the rates of income tax, National Insurance social security payments, value-added tax and corporation tax, tying its hands on the sources of future tax revenue.
Former Bank of England policymaker Michael Saunders, now a senior economic advisor at Oxford Economics, said the government could increase taxes by between 10-25 billion pounds, and would likely focus on inheritance tax or capital gains tax to avoid breaking election commitments.
But while Labour’s promise not to raise specific personal tax rates might be possible this year, the IFS’s Zaranko warned that it would come under increasing pressure if the government was unable to generate the growth it wants.
“Maybe eventually they’ll be forced to revisit those red lines,” he said. “The longer the parliament goes on, I think that it’ll be more and more difficult.”
($1 = 0.7772 pounds)
(Reporting by Alistair Smout and David Milliken in London and David Lawder in Rio de Janeiro; Editing by Toby Chopra)
