Roger Whitfield, an independent local councillor in the West Country town of Portishead, is waiting anxiously to learn whether chancellor Rachel Reeves will make good on Labour’s investment pledges when she delivers her first Budget later this month.
Before the election, Whitfield was optimistic that his scenic waterfront town of 27,000 was on the cusp of clinching a long-promised rail link into the nearby city of Bristol. Work, he believed, would start in September.
Instead, the £152mn project to reopen a disused railway line and build a new station was suddenly put under review in July, after the newly elected Labour government warned it had to tackle a £22bn overspend that Reeves says she inherited from the Conservatives.
Whitfield, who chairs the town council, says the economic benefits of better commuter links into Bristol will bring benefits for generations to an area that has seen rapid population growth. On merit, he says, the project ought to get the green light.
But the long-mooted project has been repeatedly delayed and another U-turn would not be a surprise to local residents, he says while surveying the overgrown railway track on the fringes of Portishead. “We have been disappointed year on year with this project,” he adds.
Whitfield is not alone: business leaders, Labour MPs and the country at large are all waiting eagerly to see what Reeves does at the end of the month in what is building up to be a politically momentous Budget.
Although Reeves sought to strike a cheerful tone at her party conference in Liverpool last month, the chancellor is facing an economy mired in low growth, postwar record-high levels of taxation, national debt at 100 per cent of GDP, dilapidated public services and creaking infrastructure.
“The work of change is only just beginning and the stakes are high,” she warned delegates at a subdued Labour conference. “Trust is a fragile thing and we’ve seen the consequences when mainstream politics comes up short.”
Labour may have ousted the Conservatives in a landslide victory, but Reeves understands well the consequences if she fails, with Nigel Farage’s populist Reform UK party waiting in the wings and the world looking on to see if a centre-left government can deliver.
Reeves, a state-educated former Bank of England economist, inherited a tough enough task, but some economists warn she has made it worse for herself by creating three traps before the July 4 election, as she sought to convince the nation she could be trusted with the economy.
The first was telling voters she would sign up to the same debt rule adopted by her Tory predecessor, Jeremy Hunt. This was meant to reassure the electorate about Labour’s fiscal probity, but it severely restricts her ability to invest in Britain’s crumbling public realm.
She then severely constrained her room for fiscal manoeuvre by vowing not to put up taxes on “working people”, which she has defined as income tax, value added tax and national insurance. Combined with a promise not to increase the 25 per cent rate of corporation tax, at a stroke Reeves put 75 per cent of the Treasury’s tax levers off limits.
The final trap was signing up to Hunt’s eye-wateringly tight “spending envelope” for public services in the coming parliament, as Labour sought to defuse claims it was planning a “tax bombshell”. The decision implies real-terms cuts in areas such as prisons — which are so full that convicts are being released early — and local government, where services are already cut to the bone.
The problem, according to one senior official, is that Hunt’s spending plans were “literally incredible”.
Reeves’s decision to axe winter fuel payments for 10mn pensioners — part of an initial £1.5bn effort to cut the deficit — has sparked widespread questions about her political judgment. Labour MPs have been deluged with complaints, prime minister Sir Keir Starmer’s popularity has nosedived and the “cruel” policy was rejected by the Labour conference.
“She has hemmed herself in,” says Paul Johnson of the Institute for Fiscal Studies think-tank. “If you take at face value all her tax pledges and her decision to stick with the debt rule, it sharply restricts the options she has on public spending in this month’s Budget.”
Breaking out of her three traps will be a formidable challenge, but a picture of Reeves’s escape plan is starting to emerge.
The chancellor starts from the advantage of having a near-impregnable political position, at least for now. Starmer, a former lawyer, has generally given Reeves a free hand to craft her Budget. “It’s an extremely high trust relationship,” says one senior Number 10 insider. “They meet multiple times a day and clearly have a shared view of where they want to take the country.”
Another official says it is the closest relationship between the neighbours in Downing Street since George Osborne was Tory chancellor and his friend David Cameron was the prime minister between 2010 and 2016. “Starmer doesn’t feel he has to spend his time marking the chancellor’s homework,” the person adds.
Reeves’s most audacious act of escapology will, according to people briefed on the Budget preparations, see her loosen the grip of Hunt’s fiscal rules with plans to redefine debt. This will give her the space to borrow tens of billions for investment in green energy, transport schemes, hospitals and other capital investment over the next five years.
Leading economists have criticised the existing rules, while even senior Tories can see the case for rewriting them to allow more state investment. “If she borrowed more to maintain capital spending in real terms in this parliament, I don’t think many would disagree with that,” says one shadow cabinet member.
“My advice from Treasury officials was always very clear on this: more borrowing means interest rates stay higher for longer,” Hunt wrote on X last week. But with interest rates now on a downward path, the view in the Treasury has shifted. “Growth is the challenge and investment is the solution,” Reeves told her party conference.
Accused by business leaders and Labour MPs of talking down the economy in recent weeks over her warnings of a dire fiscal inheritance, Reeves needs something big to shift perceptions. Senior Labour figures have also been calling privately for an end to the “doom and gloom”, as they fret about fragile business and household sentiment.
The Department for Transport, for example, is being asked to make cuts to roads and railway projects, as it targets £785mm of savings for next year.
When asked about the status of the Portishead programme, the department referred to a statement from transport secretary Louise Haigh in July, which accused the previous government of giving communities across the country hope for new transport infrastructure “with no plans or funds to deliver them”. The internal review would “move quickly” to make recommendations about current and future schemes, she said.
“The Portishead rail line remains a hugely important project . . . one we are committed to delivering,” says North Somerset Council, adding that it expects to learn more about its future after the Budget.
Although Reeves has asked government departments to identify capital projects they can scrap or delay — part of an effort to plug immediate Budget holes — a big investment programme would help to raise spirits.
While insiders insist that the chancellor has no choice but to make tough decisions given the scale of the overspend, their hope is that a more positive narrative will emerge later in the parliament, aided and abetted by reform of the fiscal rules.
The key constraint inherited from Hunt is a rule requiring debt as a share of GDP to fall between the fourth and fifth year of the OBR’s forecast. For now, all additional money Reeves borrows for public investment will be included in that debt figure, leaving the chancellor with little space for flexibility.
Officials are considering a tweak to the definition of debt that could give Reeves an extra £16bn of wriggle room, as part of plans to mitigate the impact of hefty losses incurred by the Bank of England as it unwinds its quantitative easing programme.
But Reeves wants to go further. The debt measure the Treasury currently targets excludes the bulk of any assets created via government borrowing, incorporating only cash and other highly liquid instruments.
If the Treasury widened the definitions involved, it could include less liquid financial assets such as the student loan book in the debt measure and generate around £50bn of Budget headroom. Alternatively, the Treasury could strip out the liabilities of vehicles like the planned National Wealth Fund or GB Energy, creating room for manoeuvre.
The key dilemma is how to maintain market confidence while creating extra scope to borrow later in the parliament. If the chancellor loosens policy too far, she could potentially drive up gilt yields and even reignite inflation concerns, derailing Bank of England rate cuts.
Lord Gus O’Donnell, the former permanent secretary, wrote in an article for the Financial Times that the chancellor could shift to a broader regime incorporating wider measures of balance sheet strength, coupled with a tough Budget target when it comes to day-to-day spending.
In addition, economists said, the Treasury could beef up processes for reviewing and accounting for investments, as it reassures markets about its fiscal probity.
Ben Nabarro, UK economist at Citigroup, says Reeves should set up a “robust independent review process” on investment headed by the Office for Budget Responsibility. This would police the valuations and net returns on investments, reducing scope to blur the lines between current and capital spending.
A “cautious” initial plan would see investment spending dialled up only gradually, for example by around £5bn-£10bn per year over the course of the parliament, adds Nabarro, far less than would be enabled by the full use of a revised target using either public sector net financial liabilities or a measure focusing on public sector net worth.
“Additional investment will need to be paid for — at least in part from tight current expenditure — and deployed in a prudent and deliberate fashion,” he says.
The second pitfall for Reeves to navigate will be how to fix a fiscal hole in day-to-day spending, using a package of tax rises and public spending cuts — including to welfare — to plug the £22bn “black hole” that Reeves claims she inherited from Hunt.
Having played down any need for tax hikes during the election campaign, Reeves and Starmer quickly changed their tune in office as they began softening voters up for tax increases.
History suggests post-election hikes are very likely. The average post-election Budget delivered tax increases worth more than 0.25 per cent of GDP by the end of the forecast, according to IFS research, while pre-election Budgets tend to engineer cuts.
But Reeves’s task has been made unusually complicated by Labour’s manifesto excluding all of the main tax revenue raisers in Labour’s manifesto, forcing her to consider a series of smaller tax rises which might either end up being politically painful or cut across the government’s main “mission” to deliver growth.
An increase in capital gains tax has been mooted, although that might provoke a backlash among entrepreneurs, while a cut in pension tax relief would hit those who have public sector pensions, who are part of Labour’s bedrock support. Reeves is already scaling back plans to hit “non-doms”, fearing an exodus from Britain and no net gain for the Treasury.
None of Reeves’s options is easy, but the wealthy remain a target — especially after her raid on pensioners’ fuel payments caused such an outcry within her own party. A closing of inheritance tax loopholes is seen as a likely option, alongside cutting tax avoidance by private equity bosses, a promised imposition of VAT on private schools and the possible taxation of the withdrawal of pension “lump sums”.
Reeves may also explore whether to impose national insurance on employers’ contributions to pension schemes, analysts say. The Resolution Foundation think-tank has estimated that doing this, while providing relief on employee pension contributions would allow typical workers to save while raising around £9bn overall.
“The risks are we will get a lot of very complicated, uncertain and risky tax rises to get around her own red lines,” says Johnson of the IFS.
Starmer and Reeves have both spoken about cutting welfare “fraud and error”, but paring back support for individuals could be politically hellish. “They got their fingers burnt so badly with winter fuel payments, welfare reform will become untouchable for them,” Hunt said at the Tory conference in Birmingham this week.
Reeves’s final self-imposed trap relates to her pre-election claim that she would stick to Hunt’s extremely tight spending plans for public services until late in the decade.
Those involved in Budget preparations say that Reeves will seek to soften those spending cuts, which would have implied real terms cuts of up to 3.5 per cent a year or more in some departments, according to the IFS. Areas such as justice, local government, the home office and transport are already seriously stretched.
“The last envelope left by the Tories was totally unrealistic,” says one official working on Reeves’s spending review, which is running in parallel with the Budget. “I’m just looking at some very ugly spreadsheets.”
The £9.4bn cost of above-inflation public sector pay awards this year — agreed by Reeves — will have an enduring impact, but insiders expect other elements of the £22bn overspend unearthed by the chancellor to affect financial decisions in future years as well.
Senior Tories expect that Reeves will top up the projected departmental budgets they bequeathed the Labour government with extra spending — perhaps by £15bn a year. “That will allow them to say they’ve ended austerity,” says one. Given that Starmer has promised there will be “no return to austerity” under his government, Labour MPs are seeking reassurance.
But the prime minister has warned about the trade-off: “painful” decisions on tax, welfare and spending will be needed to patch up the underfunded public services that voters have entrusted to his party.
Upon her arrival at the Treasury, Reeves told staff that she wants her department to be a “growth department”, not just a finance ministry. “Growth was the bit that was neglected,” Reeves tells allies. “The previous government did not have the headspace.”
Three months later, Reeves is operating in a claustrophobic economic environment and finding that the commitments made before polling day on July 4 are even harder to keep than anticipated.
Her much-anticipated Budget on October 30 will be a crucial test of whether Reeves can escape both the burdens of the past and the hazards she has placed in her own path.
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