Halloween may have been almost a month ago, but there was a ghost haunting Labour’s autumn budget: the spectre of the bond markets.
In her speech in the Commons, chancellor Rachel Reeves referred to Liz Truss’s disastrous mini-budget in 2022 as some kind of cautionary tale, and much of the post-budget analysis in the press focused on the market reactions, underscoring the fact that it has since become received wisdom that a government is only ever one fiscally irresponsible decision away from crisis.
This is an extension of the idea that governments are like households and must practice thrift or face ruin. Just as a mortgage provider would be loath to lend to you if your outgoings regularly outstripped your earnings, so it seems intuitive that the bond markets would baulk at governments that outspend their means.
The analogy is a fallacy, though. Reeves is not dealing with an overdue credit card bill; government debt, borrowing and spending doesn’t function like consumer debt, borrowing and spending.
Rather, the Treasury’s choices shape and are shaped by the choices of both bond investors and the Bank of England. The latter is often left out of the discussion of bond market power despite its influence, both because its decisions about buying and selling government bonds affect yields, and because overall interest rates can raise or lower the cost of borrowing.
These choices the Bank of England makes are political, not in the sense that they are made by politicians, but that they are not made according to ironclad economic rules. Even the relationship between interest rates and the inflation target is not set in stone.
It has been a choice, in this country, to rely heavily on monetary policy to fight inflation instead of a broader policy toolkit including price controls, intervening in supply chains, and tackling concentrated market power, all of which do more to tackle the root causes of price rises. This is one way in which the government might have more control than it lets on in the face of the bond market.
This is not to deny that bond traders have some power, just as pointing out that Reeves’ fiscal rules – designed to ensure that, within five years, all day-to-day spending is financed through revenues from taxes, not borrowing, and net that public financial debt as a share of GDP is falling – are self-imposed does not mean there are no real constraints on government borrowing.
But the government has done itself no favours by creating a fiscal framework that actually leads to more uncertainty, not less. It is highly sensitive to small changes in the economic forecast, leaving ministers scrambling to find additional tax rises or spending cuts – “efficiencies”, as Reeves calls them – to keep within these constraints.
The chancellor made much of having increased her “headroom” (the margin with which she is meeting the fiscal rules around borrowing) to £22bn, which is £12bn more than the headroom forecast in March. But the Office for Budget Responsibility cautioned in its autumn forecast that with so much uncertainty around the actual path of the economy in future years, this margin for error is small.
Being panicked and reactive rather than patient and strategic is a common thread through Labour’s economic policy since taking office last year, a symptom of its lack of serious diagnosis of the UK’s economic problems and vision for transformation.
The government has not gone far enough in acknowledging that, for most voters, the cost of living has spiralled in recent years while public services continue to crumble. Measures like abandoning the two-child benefit cap are welcome, if long overdue, as are plans to cut energy bills by roughly £150 for the average household, but they don’t come close to a comprehensive plan to ease cost pressures and alleviate poverty.
And despite some rhetoric about those with the broadest shoulders bearing the most responsibility, Labour has been very timid with taxing the wealthy. In its scramble to meet its fiscal targets, the government has reached for a patchwork of measures, some of which do aim to tax wealth more fairly. These include this year’s mansion tax on houses worth more than £2m and higher tax rates on dividends, savings and property, as well as the increase in the rate of capital gains tax at last year’s budget.
But much has been left off the table.
Taxes on capital gains and other forms of income from wealth could have been raised to the same rate as income tax, which would bring in £11bn a year. Applying national insurance to investment income would have raised £12bn a year. Instead, the mansion tax is expected to bring in £430m revenue, which pales in comparison and is even less ambitious than the version of that policy proposed by then Labour leader Ed Miliband in 2015.
Similarly, a tax on the windfall profits that banks made thanks to higher interest rates, which could have raised £11bn, appears to have been left off the table in efforts to convince banks to be positive about the government’s plans in the press.
Overall, Labour has yet to articulate clearly why we are in a position of ever-increasing wealth for some and economic hardship for others. An honest accounting of our economy must acknowledge that it has become extractive rather than productive, and rewards asset owners over workers, all while driving up the cost of living further.
Businesses are incentivised to pay out to shareholders rather than invest for the long term, with the average FTSE350 firm distributing 103% of its post-tax profits as dividends and buybacks in the past five years, taking on new debt to pay ever higher returns. And with vast swathes of the public realm privatised, from utilities to buses to childcare providers, governments have surrendered control over how these foundational infrastructures are built, priced and run.
Our water and energy bills, bus and rail fares and mail costs have all gone towards paying £200bn to shareholders of these industries since privatisation, a “privatisation premium” equivalent to £250 per household per year since 2010. This is money that should have gone into lowering bills and investing in vital infrastructure, like upgrades to the sewage pipes now routinely leaking into our rivers and seas.
Ultimately, Labour’s economic plans are muddled on cause and effect when it comes to growth. We are promised more public spending and better living standards when growth increases. But the economy is not an abstract thing. It is made up of all of us, and it suffers when people are sick and unable to access care, when they are reliant on food banks because social support is too low, when their bills swallow up an ever-growing share of their income. The economy won’t grow until we can rebuild public services and repair the public realm.
So much of our economic model is limited in its horizons, with private companies looking only to their next quarterly returns to shareholders. The government has a vital role to play in planning for the long term, investing strategically to reshape the economy for the good of all of us. Labour has tied itself in knots with its fiscal rules and manifesto pledges on tax, catching itself in a similarly short-termist cycle of decision-making. It must change course, for the sake of the country’s economy and its own political future.
