UK budget: Cuts and tax hikes loom as Labour seeks to invest

On October 30, the UK's center-left Labour Party will present its first budget in more than 14 years to the British people.

Since it inherited a sluggish and indebted economy after a decade and a half in opposition to the Conservative party, it has been signalling that this will be a tough budget. Shortly after coming to office, UK Chancellor of the Exchequer (finance minister) Rachel Reeves spoke of a "22 billion pound [€26 billion, $28.57 billion] black hole" in the public finances left by her predecessor. 

Yet in presenting its budget, the new government has to balance several pledges made during the campaign. It has vowed not to raise taxes on "working people" and it has also promised to ramp up public investment and borrowing to grapple with the country's serious public-services and infrastructure shortcomings.

Anton Muscatelli, principal of the University of Glasgow, says the government of Prime Minister Keir Starmer has a "much more difficult hand to play compared to previous administrations." Muscatelli pointed to the UK's much higher debt-to-GDP ratio than compared with when the Conservatives came to power in 2010, and the fact that years of poor growth and low public investment have created a crisis in public services across the UK.

"It's got a really tricky balance to strike between the promises that were made in the election to only borrow for investment and not to tax more, because there's a huge amount of demand for additional spending for day-to-day costs in in health, education and other key services," he told DW.

Winter of discontent?

For months now, a painful budget has been expected. An especially symbolic example of the "difficult decisions" the government said it faced was when it announced in July that it would cut winter-fuel payments for most of the pensioners who currently receive it.

While the decision to introduce a means test for the winter-fuel paymentwould cut the number of people receiving it from 11.4 million to 1.5 million, saving well over 1 billion pounds in the process, it left the government open to accusations of austerity policies.

Keir Starmer said recently that the country must face the "harsh light of reality," and up to 35 billion pounds is expected in tax increases when Reeves announces the details of the budget to the House of Commons (Lower House of Parliament) this Wednesday.

Edward Allenby, UK economist with Oxford Economics, expects the budget to have two main pillars — an announcement of a major increase in capital expenditure and the aforementioned tax hikes which the government says will be needed to cover day-to-day spending.  He believes Labour's promise not to raise taxes on what it calls "working people" means there will be major scrutiny on where the tax hikes actually come.

"Having ruled out tax rises across the main sources of tax revenue, this raises the possibility that the upcoming tax rises will be more concentrated then usual, which typically sparks a greater media reaction," he told DW.

Taxes for businesses and high-earners are expected to rise but Labour, apparently stung by criticism of the winter-fuel decision, has spoken out against the idea of austerity and cuts.

"Austerity is no solution," said Starmer this week, also rejecting criticism of the "working people" label by saying that the "working people of Britain know exactly who they are."

Changing the rules to invest

With that in mind, Labour says it aims to tackle some of the UK's main structural economic problems through this budget, with one of the biggest being its worsening public services and lack of public investment.

Anton Muscatelli noted that the UK is at the bottom end of the G7 group of nations when it comes to investment relative to its GDP, a problem exacerbated by weak growth. "The government sees reviving investment as being really important to bootstrap some of that growth for the UK, to get us into a situation where we're not having to constantly deal with a slower-growing economy that doesn't generate enough tax revenue for public services," he said.

Yet, how does the UK government ramp up fiscal spending when it has inherited such a difficult economic situation, by its own admission?

Reeves said last week she would change the fiscal rules so she can borrow more for public investment. Changing the rules could enable her to borrow an extra 50 billion pounds, according to some estimates. "I won't cut capital budgets to make up for shortfalls in the day-to-day running costs of departments," Reeves wrote in an article she authored for the business daily Financial Times last week.

Muscatelli thinks she was right to change the fiscal rules as those under which the previous government were outdated and had been designed for "particular circumstances."

"We've pointed out that one of the problems with the existing fiscal rules is that it forces you to be too cautious on public investment," he said, adding: "It may actually force you to make too many short term investments as opposed to ones that really will transform the economy towards net zero, and that will benefit you in the long run."

No pain, no gain?

For Starmer and his government, the hope is that any negative attention their tax hikes and spending cuts receive will be offset by optimism around increases in spending on public services such as the much-loved — but chronically underfunded — National Health Service (NHS).

There is also some optimism, according to Allenby, that the UK's economic position overall is not as bad as its poor public finances would suggest, giving the government some leeway to make major changes in the first budget of its term.

"While fiscal policy is expected to tighten over the course of this parliament, we remain relatively upbeat about the broader outlook for the UK economy, so I'm not sure the concept of 'pain' necessarily applies if one is thinking beyond just fiscal policy."

Edited by: Uwe Hessler