Keir Starmer and Rachel Reeves have a tough road ahead of them, not unlike that of Tony Blair and Gordon Brown in 1997. They step into the roles of prime minister and chancellor of the exchequer amidst difficult circumstances: numerous challenges within public services, a history of public and private underinvestment; an ageing demographic, rising interest rates, high reliance on international lenders. They also have the pressing issue of increasing defence spending, a rapidly deteriorating climate, lingering Brexit ramifications, and the pressing issue of a sluggish economy. All of this despite being voted in by a mere 34 percent of an already skeptical populace. Their failure to uplift public mood may brace them for a rougher road ahead.
These harsh facts are highlighted in reports by the Office for Budget Responsibility – “Fiscal Risks and Sustainability,” along with the House of Lords economic affairs committee’s “National debt: It’s time for Tough Decisions” (Note: my spouse is a part of this 14-member committee). Both reports are notably grim.
In the past two decades, the public sector’s net debt ratio to GDP has spiked majorly due to the global financial crisis, the Covid pandemic and resultant economic shocks, and the Ukraine conflict – moving from below 40 percent to nearly 100 percent. This level of debt within the UK is not unusual compared to other G7 nations, with several facing similar rises, even though the UK’s initial level was comparatively low. Viewing it through a historical lens, this isn’t even considered a high ratio of debt for the UK. Post WW2, UK’s debt was 250 percent of GDP. A speedy growth period coupled with high inflation decreased this ratio to slightly above 20 percent in the 1990s.
Regrettably, since an earlier time, we have taken considerable strides in the adverse direction: the successive crises in the recent past have cost almost as much as a global conflict would. While one may wish that further mega impacts are avoided, it would, sadly, not be sufficient to stabilise our debts. The OBR estimates, under the policy settings for 2024, that public spending is set to increase from 45 per cent of GDP to over 60 per cent in the following 50 years in their base scenario. Consequently, net public debt could potentially climb to a staggering 274 per cent of GDP — the highest ratio ever. Importantly, this rise would not result from a significant national crisis, but from decades of escalating fiscal deficits largely driven by skyrocketing expenses and interest costs.
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This scenario, however, isn’t a prediction as it is unlikely to happen. But what could alter this path? The OBR suggests actions such as restricting the global temperature increase to below 2 degrees could reduce the debt increase by 10 percentage points. Enhancing the population’s health could reduce the debt surge by 40 percentage points. However, a mere 0.1 percentage point increase in productivity growth could decrease the debt-to-GDP ratio by 25 percentage points. If this increase rose to a full percentage point, matching pre-economic crisis growth rates, debt could remain under 100 per cent of GDP for the next half-century. Hence, growth appears to be the key.
Consequently, the primary task for the chancellor is to clarify how her strategy for accelerated growth will operate.It will need myriad measures, such as increased investment spending, especially on crucial infrastructure; a liberalisation of planning; a drive to encourage innovation; a fresh source of risk capital, largely to aid inventive businesses at every stage of their lifecycle; and a more welcoming approach to foreign innovators. All this would need to happen in spite of the self-inflicted stumbling block of Brexit.
Regrettably, the impact of certain policies remains undetermined. Economic analysts remain unsure about the critical factors that could stimulate growth. Furthermore, some of these measures will inevitably require funding, which poses a problem in the face of our grim budgetary prospects.
A committee of the House of Lords suggests that for the UK to maintain trust, it needs reliable fiscal regulations. It further criticises the current strategy of promising to reduce debt ratios only in the last year of predictions, describing it as ridiculous. Rather, they propose a plan demonstrating a gradual decrease in debt over a five-year period, a task they aptly describe as “challenging”. This, according to them, embodies “fiscal caution”. Yet, the question remains about the impact of austerity measures on the nation in the context of the woeful condition of numerous public services.
The government must merge reforms with increased expenditure in response. For high-priority investments, they should risk temporary borrowing. They must also reconsider their approach to taxation. Charles Goodhart makes a compelling argument – that the obvious starting point should be property taxes, specifically land taxes, considering the extensive list of excluded taxation sectors. This would additionally stimulate growth.
It’s time for Reeves to transform necessity, often seen as the mother of invention, into the birth-giver of practical sense in tax matters. – Copyright The Financial Times Limited 2024